FDI in Retail: The International Retailer perspective

In the past few days, we have seen and heard a lot of opinions on the opening up of FDI in Indian Retail. While the move to open up Retail to FDI has been in the works for more than a decade, the government has finally made a move in this direction after much deliberation and debate. Whether the timing of the move is right and whether vested interest politics will derail policy is something time will tell.

Let us attempt to take a big picture view of what could happen, keeping in mind how international organized retailers really work.

Why allow FDI?

To begin with, Retailers like Walmart or Tesco are interested in India primarily to tap the wallets of our ever growing population with increasing incomes. There is nothing wrong with that. The likes of Pepsi and P&G are already doing that. However, with organized retail we have an opportunity to reform our outdated and inefficient food distribution system which lets 20-40% of our produce go to waste due to poor post-harvest techniques and technologies. There is too much inventory in our supply chain in some places and too less in others. There is a demand supply gap because of a poorly developed supply system. This is where the debate should really focus. The idea of single-brand vs multi-brand is simply a misplaced way of saying food vs other kinds of retail. Consumer products like shampoos and soaps although multi-brand, already have an established distribution network which works reasonably well under Indian market conditions. The opportunity to improve efficiencies exist here as well, but are not as large as in fresh produce and food. Apparel, footwear, accessories, etc already have several modern and traditional players vying for the consumer's attention with good depth of merchandise and varying price ranges for various customer strata.

The reason why Western retailers will improve the food distribution system in the country is simply because it makes business sense. Food discounters work on the principle of lowering cost so that they can pass on the benefit to the consumer, which in turn will help them gain market-share and scale. This is not possible if they continue to source produce with unreliable quality from state mandis and local markets. In a manner similar to how McDonalds in India was forced to invest in its key suppliers, it will be in the retailer's benefit to invest and grow Indian suppliers that adhere to their corporate standards of quality and pricing. This will encourage local Indian food suppliers to improve their standards and invest in better processes and technologies. The beneficiaries will include farmers who will get better and reliable pricing from their processing partners / retailer clients as well as the end customer whose monthly food bills will reduce by upto 30% (As a proportion of their incomes, Indians today pay amongst the highest prices in the world for basic food products).

The 50% investment in back-end clause

The government has proposed a clause that 50% investment from foreign retailers has to go in the back-end. While this is a good safeguard in theory, clarification will be needed on what constitutes back-end. Also, is 50% a reasonable figure? Will a foreign retailer realistically be able to sustain itself with this kind of investment in non-store related activities? All these questions need to be investigated and answered.

Will kiranas/small retailers be displaced?

The reality is that eventually there will be some displacement. In the short to medium term, overall growth in consumption will ensure growth for both organized and traditional retailers. When consumption growth slows down though, we will see some business flowing from traditional retailers into modern trade due to better variety and pricing at large retailers. While the complex and fragmented land holdings and unplanned nature of our cities and towns will delay the transition from traditional to modern trade, some small retailers will be forced to shut down and hawkers may be forced to move to a different part of town. In the West, many cities have begun to discourage big retail because of the impact they have on smaller retailers, but the context is very different. The back-end infrastructure in terms of the supply chain is available to all retailers, big and small. The advantage that big retailers have is scale, which enables them to squeeze suppliers and provide lower prices on commoditized products to consumers. The small retailers are competing based on differentiated merchandise and service offerings. In India, we have an antiquated and inefficient supply chain which can only be fixed with support from big retailers (because they stand to benefit the most from it and they have the funds). The government's move to restrict foreign retailers to cities with over $1 million population and first right to procure food produce for the government are in the right spirit, as the benefits of modern back-end infrastructure can be availed by smaller retailers in small towns and villages, as well as by the government for welfare schemes.

Will organized retail generate 10 million jobs?

The number of jobs being touted are way higher than financially feasible for retailers. Organized retailers will thrive on efficiency which would mean extracting as much productivity as possible from employees. While organized retail will provide a good employment option for the 10th standard graduate, with a chance for a career ahead of him, it will not replace all the jobs lost in traditional retail. However, accounting for the fact that many of the next generation youth would rather not choose to run a kirana store or man a vegetable cart, there will be a natural attrition of kiranas.

The 30% sourcing from Indian SMEs clause

The 30% sourcing from Indian SMEs clause is interesting. Again, it is in the right spirit, but enforcement can be an issue. A Walmart or Tesco would love to source from small vendors who provide differentiated product of good quality at a reasonable cost. They can provide a market to these SME producers that didn't exist before. However, what happens when an SME crosses the $100 million threshold being used to define an SME and becomes big because it is successfully able to sell through Walmart and Tesco. Will they become victims of their own success?

Will big retailers engage in predatory pricing?

This is something the communists and lately the BJP love to quote as a reason to disallow FDI in retail. While big retailers will have deep pockets to potentially take losses for some time, a predatory pricing formula will not work as it will lead to a race to the bottom because of competition amongst the big retailers themselves. In the long term, the government will need to enforce competition laws that prevent collusion, etc in a manner similar to how it was recently imposed in the aviation sector.