The Great Chasm

Organized retail in India which got off a very promising start some years back is now fighting for survival.

Today we see a "great chasm" between what constitutes a fully operational and organized retail sector and what we have in India currently - a fractured, disorganized and bruised industry running like a headless chicken. The pundits have come up with diverse reasons for this debacle of an entire sector, some of the reasons are core and many are symptomatic.

Some such popular myths are

- Inability to compete with mom and pop stores, who have very strong ties with local community and customers (where family ties with micro short term credit are the bonding agents) and are well entrenched

- Lack of supply chain infrastructure

- In case of stores which ran into financial trouble, high debt and low gross margins

- Govt regulation to freely let foreign players enter the market that constrained easy capital - a key to starting and running large chains

I would like to dispel some of these widely held beliefs before presenting what I believe may be the key reasons why organized retail has largely fared badly

Inability to compete with mom and pop stores
Customers switch for value, the switching is sustainable when the value is real and not just perceived. Consumers may flock a store if it represents novelty but will not stick to it. I believe lack of competitiveness of organized retail store has been their inability to create distinct and differentiated value for customers. This is more relevant in case of grocery retail than in other categories.

For retail consumers value is price, quality, ease, experience, customer service, no hassle purchase and return. Low price, high quality is something that is always a "work in progress" and chains need to make it a central factor in their operations. Ease is something that chains overlook - ease of buying, selecting, returning, replacing etc increases customer satisfaction. Mom and Pop stores will not be able to compete if chains can deliver on overall value.

Lack of supply chain infrastructure
This belief is reinforced when we tend to compare India to retail sectors in other developed countries where superior infrastructure strengthens the supply chain components and makes operations more efficient. But retail is a local phenomenon and stores compete locally not globally. Presence of infrastructure or lack thereof impacts all players equally. So its impact on competitiveness is minimal. Most of the chains have failed in India not because the infrastructure was not present to make them operate like an American or a European store, but because they tried to operate like one in absence of it!

US stores operating model is based on local factors like sprawling and cheap developed real estate and hence large parking space, distributed population, cheap and big cars, cheap gas, extensive road network where people do not mind driving 20 miles for a bargain.

Indian stores cannot operate on the same model and must take into consideration local conditions and realities. They cannot operate like a loss leader for initial years and then turn in profit (when the supply chain is in place), for the operating model and core assumptions are flawed. Stores in India have to face some tough realities
- lack of space and expensive real estate
- lack of road infrastructure and expensive fuel - so if you open a store in wilderness no one will come driving because there is a deal on marshmallows!
This is a classic paradox since there has to be a fine balance in cost of real estate vs. the location. Many chains failed because they focused on only one factor at a time. While it is essential to open store with critical mass of target demography, it does not make sense to open up a store on most expensive real estate just because it draws lot of crowd (or footfall). Chains should not just focus on "who comes" to the location but also on "why they come". I am sure most of the families when they visit a multiplex for watching a movie or a family dinner will hardly want to club an evening of entertainment with grocery shopping. On the other hand they would like to buy groceries from locations near their residence. Hence a grocery retail chain ought to be located in thick residential areas where real estate is not so expensive while fashion and high end departmental stores can be located in malls etc, where high cost of real estate is justified by high margins.

High cost of debt/capital
Though India has higher cost of capital than other countries but there are many indigenous businesses catering to the local market that have done well, by creating the value and by running on a model that helps them make money without eroding the intrinsic value (what ever that may be). Most of the retailers failed as their unit margins, gross margins and store level operating margins were out of whack, coupled with heavy investment in things like real estate and store interiors, which left less money for investments in areas like technology, supply chain etc that can help them outsmart the local mom and pop stores.

The holy grail for Indian retailers was, "number". Large number of stores will create brand and pull, which subsequently will increase leverage over supplier and hence better prices etc etc.

Having more number of stores do not necessarily create value for the consumer, intuitively it seems like the more stores you have better you will be, but it is not actually true.

The fact is that more stores you have with a bad operating model, the higher the risk of going belly up - which eventually many Indian retailers did. The money that retailers raised by debt or by equity was largely to expand the number of stores and thereby invested in their own doom. The money was not spent in investing in IT and systems to understand consumer buying behavior and cater to them more intelligently, it was not spent in introducing innovative products and delivery mechanisms - but just lifted ideas, concepts and models from west, which was like a double whammy!

Does anyone recall that Walmart failed big time in Mexico? It is a B School case study!

They did not fail because they lacked capital (or raised capital at high cost), or that they did not have as many stores, or for that matter that supply chain was not in place (Mexico is like another state south of Texas/California). They failed because they did not catch consumer fancy!

Which brings us to the last falsely perceived factor

Govt regulation on FDI

Let me start with a disclaimer - I inherently and thoroughly despise anything to do with the government!

Yet I believe in case of failure of Indian retail chains, it would be unfair to single out the government. Though they have contributed to the overall misery in the country in terms of abdicating responsibility to govern and protect, yet in case of Indian retail story they may not be the "1000 pound Gorilla" in the room. They may have tried to level the playing field in some way and protect the small and medium traders in a myopic way that it always see the reality, via prism of votes and popularity, but essentially that is not what contributed to the decline of the retail hype.

I believe the presumption that organized and large players hurts smaller and mid sized players in the industry and cannibalize their share of business is flawed.

Yes, they do create competitive pressure and weaker players exit faster than they would otherwise but smaller need not be weaker! McDonald does not kill business of small family owned restaurants, serving burgers as long as the burgers they serve are better (even if pricier) than McDonald. If an entity is able to attract customers and give them tangible value it will be profitable, however small it is. Any entity that forget the customer will close its shop eventually however big it is.

You cannot protect yourself by wishing away competition. Consumer may stick to you for lack of alternatives but this state is neither desirable nor permanent.

Having said that in case of Indian retail the small guys (mom and pop stores) took the big guys to the cleaners. I do not see in all this how entry of foreign players or direct investment from them would have helped our already limping friend to get ahead in the race.

When Subhiksha fell, some people in media woke up from the slumber but I am sure its customers or an everyday consumer who look out for best deals would have sensed the fall long back (definitely much before Premji could smell it) and had abandoned the much hyped retailer months before the hell broke loose.

You cannot restructure a company by negotiating with suppliers and injecting new funds - you cannot resurrect a corpse that way. Injecting funds and keeping suppliers at bay may buy you some time but it will not make customers buy from you.

As one of my friend said that businesses that run on strategy might fail but the ones run on principle never fail, I believe the failure of the sector and lack of success for many of its players stems from the fact that customer is not central to their core principles and hence planning. When you go shopping for your kid or spouse, don't you have their picture, preference and lack of it before you buy the stuff? How many buyers at retailers have the same approach when procuring from suppliers?

The chasm that exist today in the sector is not because of govt regulation or millions of mom and pop stores that operate at lower cost. The chasm is the metaphoric distance that the key strategist in these organizations have created between the way they run the business and what the customer really values.