SECTORAMA RETAIL SECTOR (RET) ANALYSIS REPORT NEHA GUPTA neha.gupta@astra.xlri.ac.in RISHABH CHINDALIA rishabh.chindalia@astra.xlri.ac.in SHUBHAM SINGHAL shubham.singhal@astra.xlri.ac.in

XLRI JAMSHEDPUR

EXECUTIVE SUMMARY

Organised retail in India is growing at a fast pace, mainly owing to the enthusiasm shown by the domestic retailers by way of their expansion plans and joint ventures with the foreign investors. The sector witnessed an approximate CAGR of 19.5% during the period 2004-07. The Indian economy, meanwhile, grew at an average of over 9% in the past few years and even moderate growth expectation of above 7% in coming years will continue to fuel the growth of the retail industry. At present organised retail accounts for about 4% of the total retail market and is expected to grow at a CAGR of 40% thereby increasing in size to $75 billion by 2015. This upbeat projection can be attributed to the fact that the country comprises a huge market of 1.2 billion consumers coupled with increasing rate of urbanisation, young population, acceptance for consumerism and rising consumer credit usage. The immense business potential offered by the retail industry has attracted large Indian business groups like Tata, Reliance, Bharti and Birla, as well as international retailers like Wal-Mart, Carrefour and Metro. However, the spill over of the global economic crisis into the Indian market has adversely affected the affordability of customers and also impacted the fund raising ability of developers. For the retailers to survive in this macro-economic condition, the revenues will have to increase substantially. We believe that this situation coupled with the quantum of supply in the pipeline will lead to a stable organised retail market. In fact, if this current phase of economic slowdown breeds financial prudence and greater risk-awareness the retail sector, will come out a greater beneficiary in the long run. Our main objective of the report is to give the overall investment attractiveness of the Indian Retail sector. The recommendation to invest in the sector or not is best left to the interpretation of the reader of the report. In our report, we have discussed how the Indian Retail Sector, particularly Organised Retail Sector has performed over the years and the reasons for its success and failures. Also discussed are the present key players in the market. Government’s latest rules and regulations have moved this sector towards liberalisation have also been touched upon in the report. The report then entails the key success parameters that an investor would look for before investing in this sector. The future growth projections of the Indian Retail sector are discussed next, along with the potential of the future markets. We hope that with this report, the reader will get into the insights of the true Indian retail sector, which is obviously not limited to the malls present in the cities of India. And that it helps a new entrant in taking his decision of investing in the Indian Retail sector.

THE INDIAN RETAIL

With over 28 states, 18 major languages, 8 major religions, 4000 different castes and communities celebrating 72 festivals, India is the most diverse country. India is at the brink of a Creative Economy driven by speed and imagination. Retail is one of India’s largest industries, contributing to about 10 per cent of the GDP and providing employment to 8 per cent of the nation’s workforce. Its growth and potential is being recognised even internationally with India topping the Global Consumer Confidence Index June- 2009 conducted twice a year by the Nielsen Company. Retailing in India is growing rapidly with the consumers spending more than ever and the entry of domestic and global players in the Indian retail market. India’s retail market has grown enormously with the present size being US$ 350 billion. The golden period for the growth of the Indian retail has been the years from 2000 to 2006, when the sector revenues increased by 93.5% translating to an average annual growth of 13.3%. The Indian retail sector consists of traditional/unorganised and organised retail. Retail sector in India is primarily categorised by the type of products retailed, as opposed to the different retail formats in operation. Following are the different verticals present in the Indian retail (both organised and unorganised) and their corresponding market size:

VERTICAL MARKET SIZE (US$ billions) MARKET SHARE (%)

Food and beverages 217 62.0

Fashion 33.2 9.6

Leisure and entertainment 28 7.9

Fashion accessories 22.5 5.5

Consumer durables 14 4.0

Health, beauty and pharma 13.3 3.8

Consumer durables 12 3.4

Telecom 6.3 1.8

Books and music 3.9 1.1

The unorganised retail forms the major chunk, 95%, of the total retail revenues. Over 12 million small and medium retail outlets exist in India, the highest in any country. The unorganised retail is prevalent in almost all neighbourhoods as the ‘kirana’ stores. However, the current share of organized retail is estimated to be only 4-5% i.e. US$18-20 billion market. Hence, there’s a whole lot of potential that has been untapped.

ORGANISED RETAIL IN INDIA The Indian Brand Equity Foundation (a public-private partnership between the Ministry of Commerce & Industry, Government of India and the Confederation of Indian Industry) has divided the entire organised retail in India into 8 verticals. The following are those 8 verticals with their corresponding key players:

FOOD AND BEVERAGES o Café Coffee Day o Barista

o ITC o Aditya Birla Group o FabMall o Mc Donald’s

CLOTHING AND TEXTILE o Globus o FabIndia o Biba o Levi’s o Pepe Jeans o Raymonds o Lee Cooper

CONSUMER DURABLES o Croma o Videocon o Whirlpool o LG o Philips o Next o Samsung Electronics o Godrej

JEWELLERY AND WATCHES o Tissot o Gili o Tanishq o Kiah o Carbon o JBL

HOME DÉCOR o Raymond o Lifestyle o Durian o Bombay Dyeing o Nilkamal o Carmicheal house

BEAUTY CARE o L’oreal o Amway o Revlon o Maybelline o Lakme o Himalaya

FOOTWEAR o Bata o Reebok

o Liberty o Adidas o Woodland o Paragon

BOOKS, MUSIC AND GIFTS o Depot o Music World o Crossword o Hallmark o Planet M

Some of the players have their presence in more than one vertical. Following is the list of such companies:

Pantaloon Retail (India) Ltd

Reliance Retail

Shopper’s Stop Ltd.

Tata Trent Ltd.

Landmark Group

Subhiksha Trading Services

ADVANTAGE INDIA The Indian retail revolution can be attributed to the following reasons:

RAPID ECONOMIC GROWTH India is one of the fastest growing economies of the world. Its GDP had continuously been increasing, and will continue to do so once the effects of recession wither away. This has made the Indian consumers more confident of their earnings and led them to spend more. GDP growth rate of India

THE YOUNG INDIA India possesses the advantage of having a largely young population. 35 per cent of India’s population is under 14 years of age and more than 60 per cent of the population is estimated to constitute the working age group (15-60) till 2050. The large proportion of the working-age population forms a lucrative consumer base placing India as one of the most promising retail destinations of the world.

HIGHER DISPOSABLE INCOME India’s per capita income doubles in 7 years to Rs38, 084. The growth in the per capita income takes into account the increase in the country’s population, which is likely to rise to 115.4 crore by March 2009 from 113.8 crore a year ago. The increase of per capita income has been more pronounced in the metros and the emerging cities with a progressive growth in the standard of living.

MATURING METROS NCR comprises of National Capital Territory (NCT), Faridabad and Gurgaon of Haryana and Noida and Ghaziabad of Uttar Pradesh. NCR contributed to US$ 16,342 million of retail revenues in 2005-06, and is projected to open doors to markets worth US$ 19,522 million by 2010-11. Mumbai is a city with a large percentage of the rich and super-rich households, with businessmen, politicians and Bollywood personalities having their base in the city. This city is projected to offer a retail potential of US$ 14,927 million by 2010-11. Metros of

Bangalore, Hyderabad, Chennai and Kolkata are growing at an exceptional rate, with the retail buzz in these cities becoming more pronounced by the day.

THE MALL PHENOMENON From the setting up of India’s first mall in 1999, there has been a steady proliferation of malls especially in the urban cities. Total number of malls was 200 for 2005-06 and is projected to increase to 600 by 2010-11. With increasing number of malls, there is increasing retailing space availability for players, with malls further providing incentives like lower rentals for anchor tenants and greater consumer exposure.

INCREASING INVESTMENT ACTIVITY Many international retail giants are showing interest in the Indian retail market. Following are the recent joint ventures that have taken place in the sector: o Bharti – Walmart o Reliance retail – Vornado o Pantaloon Retail (India)- Lee Cooper o HCL- Nokia

ABUNDANT AVAILABILITY OF SKILLED LABOR India has a vast resource base of talent and skilled labour. With English being the language for business in India, the language skills of the Indian workforce score higher than that of emerging economies. Retail Management is a sought after education stream amongst students, with over 15 premier institutes offering specialised courses in Retail Management.

ADOPTION OF TECHNOLOGY Application of computer aided technology is necessary for modern retail formats spanning across large area and stocking a variety of products. Many sophisticated systems have been developed to cater to the specifications of this sector. Systems used in the retail industry includes retail enterprise solutions, customer relationship solutions, supply chain management solutions, inventory systems, electronic data converter machines, bar coding and decoding, etc. The recent buzz in retail and logistics technology is about the Radio Frequency Identification (RFID). It involves storing and remotely retrieving data using RFID tags (small chips that can be attached to or incorporated into a product, animal or person) for the purpose of identification using radio waves. World’s biggest retailer, Wal-Mart has implemented this technology across its stores.

THE GOVERNMENT POLICIES The Government is progressively liberalising the retail sector thereby attracting significant foreign investments. FDI up to 51 per cent is allowed for retail trade in ‘Single Brand’ products with the objective of attracting investment, technology and global best practices and catering to the demand for such branded goods in India. This implies that foreign companies can now sell goods sold globally under a single brand, such as in the case of Reebok, Nokia and Adidas. However, retailing of multiple brands, even if the goods are produced by the same manufacturer, is presently not allowed. The most common channels for entry of foreign retailers are the franchising, distribution, manufacturing, joint ventures and cash and carry wholesale trading.

Franchising This is one of the most common routes taken by foreign investors. The franchisor grants the independent operator the right to distribute its products, techniques and trademarks for a percentage of gross monthly sales and a royalty fee. Pizza Hut, Domino’s Pizza and Nike follow this model.

Distribution The international company opens up its distribution offices in India and supply products to the local retailers. Hugo Boss and Mango fall under this category.

Manufacturing International companies can set up manufacturing units in India. United Colours of Benetton is an example of such company.

Joint ventures The Indian company and the foreign investor enter into a joint venture. This has become common in India recently: HCL- Nokia, Reliance Retail – Vornado.

Cash and Carry Wholesalers buy primarily from manufacturers and sell to retailers and other wholesalers. Also, customers of the Cash and Carry wholesaler arrange the transport of the goods themselves and pay for the goods in cash and not credit. Bharti- Wal Mart joint venture in this model is the most famous example.

KEY SUCCESS PARAMETERS

As Indian Organized Retail enters the next phase of evolution, we need to identify the winning formats, winning themes and winning retailers in the next round of evolution. Given the construct of the Indian retail landscape, large formats (hypermarkets) are likely to be the winning format in value retail segment, whereas lifestyle and luxury retail are expected to see faster growth from here.

Encountering competition effectively

The Indian Organized Retail accounted for a mere 2% of the USD300bn Indian retail industry in 2006. Lured by the humongous opportunity and backed by favourable demographics there is always a new entrant trying to penetrate into the market. While latent demand has always been there, supply too has kept pace in the recent years with easy access to growth funding for existing retailers like Pantaloon Retail, Shoppers Stop, Vishal Retail, Provogue, Trent, etc and entry of deep-pocketed corporates like Reliance Retail, AV Birla, Bharti Wal-Mart, Videocon, Essar group, etc. We have seen in the recent past how Clutter in the space has been ahead of penetration, as every retailer looks to straddle formats in a market offering limited breadth, which had essentially led to doom.

Selecting the appropriate retail format

What matters is not investing in the retail sector alone. But the funds need to be used efficiently. The company first needs to identify the opportunities and then correlate them with their strengths so has to set up the right model. On one side are the opportunities while

on the other are complexities of getting the format right, i.e. choosing from supermarkets, hypermarkets, departmental store, niche lifestyle retailing, infant-wear, catalogue retailing, airport retailing, etc.

Managing Inflation and rising costs

In a lean-margin business like retail with operating margins of 6-7%, managing fixed overheads and improving gross margins are the most critical aspects. While limited scale of operations and lower proportion of private labels restricts the ability to improve gross margin profile, competitive pressure on retail resources (people and property) and accelerated pace of store roll-out tends to push fixed costs through the roof. Business economics may deteriorate further as same stores may fall prey to cannibalization. It is very important to keep the fixed overheads per sq. ft and the average fixed overheads to sales ratio under control. Unlike globally, retail real estate in India has been a sellers’ market with retail demand far ahead of real estate supply and players looking to lock in properties to be ahead of competition. In such a scenario, it is highly probable for the lease rentals to shoot up. To abe able to devise a strategy to encounter it becomes very critical to success.

Controlling Employee cost

With limited retail talent available, more so at the management level, and aggressive talent acquisition by the big players there is always a threat of the employee costs rising multi-fold. In this scenario it is critical that the organizations adopt rightsizing and focus to efficient manning and adopt centralizing of its back-end support functions like finance & accounts and IT to improve efficiency.

Capital efficiency to be the buzz word

With internal cash generation being the likely source of growth funding, retailers need to work on improving capital efficiency and releasing capital from non-productive streams like rental deposits on overcommitted retail properties, inventory, non-retail exposure, etc. Inventory efficiency: Of the total capital employed in the retail business, 30-40% goes towards inventory. This makes inventory management the most critical tool to improve capital efficiency. Space efficiency: A key focus area for achieving capital efficiency is through rightsizing the retail space and optimizing sales/ sq. ft. Besides optimizing sales and bringing down overheads, this would help reduce capital employment towards inventory and lease deposits by FY11.

Availability of capital

Lack of external capital might be a major growth constraint, especially for new players. While retailers would be averse to debt funding, equity funding, if at all, will come first for the established players. Also given the stance of Government, it is not expected that the sector will get completely opened up to FDI given the sensitivity of the sector to the ruling UPA party’s ‘Aam Aadmi’ slogan. And most of the large Indian corporates like Reliance, Bharti, Tatas and Birlas are already in the business. This implies that it would be very difficult for the new players to conquer the Indian organized retail horizon. Hence fund availability becomes an important pre-requisite for success.

FUTURE GROWTH PROJECTIONS EFFECT OF MACRO INDICATORS: Had somebody asked for the growth projections of the Indian retail sector 3 years back, the figures would have been entirely different compared to the growth projections done now. 3 years back, the picture was very rosy with the year on year growth rate continuously been increasing. But then the macroeconomic scenario changed. There was a global financial crisis precipitated by the collapse of leading financial institutions; leading to recessionary fears across geographies; which in turn resulted in significant slowdown in consumer spending. Keeping in mind the above situation, following growth projections have been quoted:

The Indian economy, meanwhile, grew at an average of over 9% in the past few years and even moderate growth expectation of above 7% in coming years will continue to fuel the growth of the retail industry.

India’s working population is expected to be 68% in FY2020 from 63% in FY2008. This means that people in India will have higher disposable income. And will hence have a tendency to spend more.

Also by 2016, it is expected that more than half of households will be middle class. This means that the people will be more willing to spend and have a higher standard of living.

Organised retailing accounts for about 4% of the total retail market and is expected to increase in size to $75 billion by 2015.

The organised retail sector owes its growth to the huge consumer market supplemented by increasing rate of urbanisation, young population, acceptance for consumerism and rising consumer credit usage.

Malls have emerged as family entertainment centres with food courts and multiplexes benefiting the most. NCR, Mumbai and Bengaluru will be the major contributors to the new retail supply that will enter the market by end-2010.

Around 332 malls to the tune of approx.102 mn.sq.ft are in the pipeline in the major Tier I and Tier II cities.

EFFECT OF MICRO INDICATORS:

The sector has been growing at a very rapid pace, with a top-line growth of around 17 times in the last 9 years. Despite of the worsening of the macro-economic environment and the global economy, the growth momentum in the topline has been sustained with an average increase of 49% in the past three years.

In the nascent phase just as in every other industry, the returns here also were negative. But across the years there had been a steady rise in ROI from negative phase to around 8%. The momentum was on the upside but just then due to a combination of factors it started falling again and entered the negative zone. This was largely due to the melt-down of the global economy, too much of leveraging, cluttering, inefficient management of resources, unacceptable format of stores, costs going high with rising inflation.

The period from 2002-06 saw a ten-fold increase in profits. But the past three years has a shocking experience.

Margins have gone up three fold reflected by PBDITA/total income from 2.2 to 6.89 but have fallen in the past 3 years.

Investments gone up 16 times in 9 years so shows the kind of investments which has been happening. Many people have identified this opportunity and still given the macroeconomic indicators it has further scope.

The falling figures in the last 3 years can be attributed to aggressive expansion plans; high rentals and Capex costs; and that the companies are mainly financed by Debt leading to leveraged balance sheets.

SOURCES

Indian retail industry report: E & Y for the Indian Brand Equity Foundations

Retail report Q3 2008: Knight Frank

India Retail Market Review 2006: Knight Frank

Annual Results Analyst Presentation 2008-09: Pantaloon Retail (India) Ltd.

Indian Organised Retail: IDFC SSKI India Research Sep 2009

India Retail: India Infoline Ltd. 2009

Technopak Retail Credentials: KSA Technopak 2009

Indian Retail Industry 2008: Aarkstore Enterprises

Challenges, opportunities & strategies for Indian Retail industry: Rakhi Garg

Organised Food Retailing can increase rural income: Crisil Research 2008

Consumer Markets India: KPMG 2008

Economic Survey 2008: Government of India

Annual Report 2008-09: Shopper’s Stop Ltd.

Annual Report 2008-09: Tata Trent (India) Ltd.

Overview of Retail sector 2008: AdEx India Analysis

Booming Retail sector in India: RNCOS 2008

India Retail report 2009: Blog by Rajeev Damani

India’s organised Retail Sector strengthens into 2008: Milagrow Retail blog

Indian Retail industry: Cygnus India 2008

The Retail Industry- From Myths to Malls 2007: Amit Singla

Organising for Organized Retail in India: E & Y 2009

AT Kearney GRDI report, 2008