With the government having allowed 51% foreign direct investment (FDI) in multi-brand retail, the economy has opened up to global players in retail. One name in particular has hit the headlines — Walmart. The American retailing giant is the third largest public corporation in the world
According to the Fortune Global 500 list for 2012, and it has become the poster boy for anti-FDI protests and increasing opposition rhetoric.
Economists are divided on the effect that Walmart and other retail chains will have on the domestic economy. The prime minister claims this step will increase prices paid to farmers, reduce prices for customers, reduce agricultural wastage and create thousands of jobs. Montek Singh Ahluwalia, Deputy Chairman of the Planning Commission, said the measure is not a threat to small retailers and it will create efficiency in supply chain infrastructure. Wastage will fall, leading to lower prices of primary commodities. In India, 30% of fruits and vegetables, and 5-7% of grains are wasted between harvest and consumption.
But professor of economics at Jawaharlal Nehru University, Jayati Ghosh, disagrees. She argues that one Walmart will replace 1400 small retailers at the cost of 5000 jobs. “It is hard to believe that a capital intensive supply chain will lead to higher productivity. It should have been improved by public investment, not FDI. His (Ahluwalia’s) argument doesn’t withstand scrutiny.” Although Ghosh concedes there will be benefits in the initial years, “when companies establish dominance, they will drive out competitors. The government is barking up the wrong tree if they think this will revive growth.”
Keeping out the big box retailers
In a queue snaked around a Manhattan block, people waited patiently to hear the New York City council’s verdict on Walmart. The council was holding a hearing to decide if the big box retailer should be allowed into the city.
That was in February, 2011. A year-and-a-half later, Ann Romney, wife of Republican presidential nominee Mitt Romney, gushed at a late night show: We love Costco.
Costco is a rival of Walmart’s wholesale chain Sam’s Club competing for the same consumers who drive away SUVs full of groceries. Founded in 1962, Walmart operates 10,000 retail units under 69 banners in 27 countries. It employs 2.2 million people with sales of $444 billion in 2012.
Goods at Walmart move in bulk. The seller can cut costs sourcing in bulk and buyers cut their bills buying cheaper supplies. But smaller retailers — mom-and-pop stores, kiranas — cannot match them and get squeezed out. The chain’s expansion in Iowa in 2005 shut down 555 grocery stores, 298 hardware stores, 293 building suppliers, 161 variety stores, 158 women’s stores and 116 pharmacies. A Chicago study showed businesses closest to Walmart were most vulnerable: 40% of those in “immediate proximity” would close in two years. But, by a process called “creative destruction” new businesses spring up to replace them, showed a 2008 West Virginia study.
Even Washington DC is trying to keep out Walmart. Residents from around the proposed site are opposing it saying they have enough supermarkets. India, however, is another story. It needs big box retailers to build a distribution network to support a vibrant manufacturing sector.
“This is really about creating a pull from the farm to the retail sector,” said FICCI president R V Kanoria. He sees many smaller related businesses queuing up to enter India with niche technologies — cooling, logistics, etc.
Tuck business school’s Vijay Govindarajan said that global competition in distribution is important for India to grow as a manufacturing power house. But, he said, Walmart might want to change its business model for India. Indian customers do not have the resources needed to buy in bulk. Also, Indians don’t go shopping in SUVs. Most use public transport. How much can they carry home? Certainly not months of supplies.
Retail stocks have been partying on news of the Government permitting foreign direct investments in multi-brand retail. But what will the opening up of foreign investment bring to companies in the listed space?
While it may be early days yet, companies do stand to benefit in the long term in terms of back-end infrastructure and capital inflow. However, their challenge will be to work around the restrictions on location and build up economies of scale.
Type of retail
Foreign entities can invest up to 51 per cent in multi-product retail — retailing various products bearing different brand names under one roof.
Multi brand retail could refer to specific product segments such as electronics or furniture, or it could be the quintessential supermarket that bundles farm produce, groceries and household items under one roof.
It is this segment that will attract the most attention as it has the largest market potential in India. Indian retailers who do operate in this segment are Pantaloon Retail’s Big Bazaar, Trent (Star Bazaar), Shoppers Stop (HyperCITY), and CESC (Spencer’s Retail).
One significant constraint for existing retailers hoping to sew up FDI deals would be the location restrictions. Foreign retail is only allowed to open stores in the most populous cities — as far as possible, retailers should stick to those cities with a population of over 10 million. States also have the last word in permitting entry.
Existing stores of retail players are spread across the country and are unlikely to comply with these location criteria.
To comply, they would either have to shutter some existing stores or open a new chain altogether with the new partner. Even if they do, the question is if the foreign player will be keen to invest, given that multi-brand retail requires immense scale to be economical.
According to Rachna Nath, Leader, Retail & Consumer, PwC India, such economies could hinge on the saturation and maturity of the city. It could be possible for retailers to attain scale by setting up many stores in a particular regional cluster — say, Maharashtra, Rajasthan and Andhra Pradesh. These are the States that have flashed the green signal for entry of foreign retail.
For the existing retailers, the restriction on store locations for foreign players is a big plus. With these limits in place, new entrants are unlikely to pose stiff competition to listed retailers operating supermarkets and hypermarkets. These players have also already expanded to smaller cities.
Better supply chains
The rules say that half the foreign investment should be used to build supply-chain infrastructure, completed within three years. This could be a big benefit, given that Indian retail chains have so far lacked the capital and incentive to invest in supply chains. An efficient back-end set-up could lower costs for the entire set of retailers in a particular business. Given that hypermarket business operates on low margins, any cost savings will help plump up margins.
But there are roadblocks to this — restrictions in movement of farm produce between States, taxes such as octroi, and the sheer size and fragmentation of the agricultural market. Geographical limitations also throw into question effectiveness of the supply chain. Restructuring to create entities to work in the current framework would need a lot of thought, but managing an efficient supply chain, considering that only nine States have given approval, will pose a big challenge, according to Rachna Nath.