BAZAAR BEHAVIOR

Indian retailers like Pantaloon have unprecedented growth plans. Can they sustain the pace?

By M Mahanama

In a bid to belittle the military might of the British, Napoleon Bonaparte once famously dismissed the English as "a nation of shopkeepers". Although the French emperor never ventured into Asia, his words would have carried far more resonance had they been directed at India. With more than 12m outlets - most of them tiny traditional kirana shops - serving a population of 1.1 bn, India has the highest retail density in the world, at around one shop for every 90 people.

Ironically, it is against this backdrop that India is currently witnessing one of the most aggressive retail expansions anywhere in the world. With a booming economy lifting incomes and spending power, coupled with a young, growing population, a consumer revolution is underway. Sensing an opportunity, companies are tripping over each other to bring modern, organized retailing to the subcontinent. Not only is the number of new entrants staggering, but so too is the scale of their plans, showing an ambition that would have rivaled even Napoleon's imperialist dreams.

Leading the charge is India's biggest retailer, Pantaloon Retail, a 18.5 bn rupee (US$451m) pioneer in the sector. From only 1.1m square feet of retail space in operation back in July 2004, Pantaloon is aiming to grow to 30m square feet by 2011. Such breakneck growth - an average of 60% a year - would present any company with challenges.

But for Krishna Kant Rathi, Pantaloon's finance chief, the task will be especially hard. Not only is almost every major Indian business house busy formulating its own retail strategy, but foreign firms are also circling the market. Decent retail space is in short supply and rents are soaring. Qualified workers are scarce, infrastructure is inadequate, and political threats are significant. There are also the complexities of serving a vast and diverse market where most people remain extremely poor. And yet, say observers, Rathi and his colleagues have devised a set of unique strategies that could see the firm thrive in India's unfolding retail sector.

Consumer revolutionaries

The factors underpinning India's consumer revolution are well-known. Following sweeping reforms in the early 1990s that unshackled India's economy, growth has picked up sharply, reaching a heady 9.4% in the last financial year. Just as important is India's demographic profile. Not only is the population growing rapidly, but the median age is just 24 and two thirds of the country is younger than 35. What's more, this wave of young adults has new aspirations and a different attitude toward spending. The 1990s brought an explosion of cable and satellite TV and other media, travel abroad became cheaper and easier, and people were exposed to a much wider array of goods, fashions, and tastes.

Consequently, conspicuous consumption is no longer frowned upon, notes Anirudha Dutta, a retail analyst at investment bank CLSA. Indeed, with the expectation that wages will continue to rise rapidly, young people are starting to borrow heavily to support their spending.

"A new generation that was born during the 1980s is now entering the workforce and never knew the shortages of the past," explains Dutta. "They've never known a time when India had only two makes of car, when it took eight years on a waiting list to buy a motorbike, or 10 years to have a phone installed."

A report released in May this year by consulting firm McKinsey shows the scale of India's consumption story. Assuming a real compound GDP growth rate of 7.3% over the next two decades, the authors calculate that income levels will triple between 2005 and 2025, leading to a fourfold increase in consumer spending, and catapulting India from being the 12th biggest consumer market to the world's fifth largest. In the process, India's middle class - which McKinsey defines as households with incomes of 200,000 rupees or more (US$4,900) in 2005 terms - will expand by more than 10 times from 13m households or 50m people to 128m households or 583m people. As a percentage of the population, the middle class will swell from 5% in 2005 to 41% by 2025.

This rising wealth and spending clearly supports the bold aspirations of the country's emerging retail players, says Ireena Vittal, a partner in McKinsey's Delhi office. And yet, India has always had a middle class of consumers willing to spend - albeit smaller than today's. Instead, Vittal stresses that the real drivers of India's nascent retail sector are twofold: a falling cost of capital and the growing availability of real estate.

"Retailing is really just an efficient trading business with very thin margins, so the cost of capital is critical," she notes. Historically, the cost of capital has been high in India, but has fallen dramatically in the past decade, pushed down by improving capital markets and better government finances, among other reasons. Indeed, in the mid-1990s, capital costs stood at around 15% to 20% compared with less than 10% today. That's made retail much more attractive. "The difference is huge," stresses Vittal. "It's a paradigm shift."

As for real estate, successful retailing depends on securing the right retail space in the right locations at the right price. It is only in the past couple of years, says Vittal, that modern malls and shopping centers have started to emerge on a sufficient scale to support the industry.
For Pantaloon's Rathi, it all adds up to a promising picture. "Retail in India is in a sweet spot, and this is just the beginning," he says, pointing out that modern, organized retail - as opposed to traditional bazaars and neighborhood kiosks - accounts for just 5% of the market. "In China the figure is closer to 20% and in Southeast Asia it's nearer to 40%, so the potential is huge."

Retail rising

Given this backdrop, it is hardly surprising that Indian companies have stampeded into retail. While cities like Chennai had a few hypermarkets as early as the 1970s, it wasn't until the 1990s that Indian retail ventures really began to take off, with a handful of relatively small businesses launching chains such as Shopper's Stop, Nilgiri, and Subhiksha. More recently still, giant Indian conglomerates like Reliance and Bharti joined the fray in 2006.

Pantaloon itself was launched in 1987 by maverick entrepreneur Kishore Biyani and is now the flagship of his Future Group. The firm began life as a textiles business, manufacturing trousers, and it wasn't until a decade later, in 1997, that Biyani launched his first Pantaloon's retail outlet in Calcutta selling clothing. In 2001, Pantaloon's retail expansion gathered pace with the launch of Big Bazaar, a hypermarket format that aims to blend the chaotic feel of a traditional Indian market with the convenience and choice of a modern store. A year later, the company launched its supermarket chain, Food Bazaar, followed in 2004 by a retail format known as Central - giant "seamless malls" where many retailers operate under the same roof, yet feel like a single department store with centralized billing.

Numerous other formats - almost 30 in total - have followed in quick succession, specializing in goods such as furniture, books and music, consumer electronics, shoes, and beauty products. Each of the formats is designed both to stand alone and to operate in conjunction with other formats, such as the Depot chain of book and music stores which are often located inside a Big Bazaar hypermarket or as part of a Central mall. By August 2007 - a decade after opening his first outlet - Biyani had launched 400 shops taking up 5.5m square feet of space across 40 cities.

The record so far has been impressive. Revenues, for example, grew by 76% in the year to June 30, 2006. Results for the latest financial year, due out in late September, will show similar growth, says Rathi.

"Pantaloon has been a trailblazer, particularly through the introduction of so many new retail formats," notes one analyst at an Indian stock brokerage. "Its execution has been excellent. A lot of companies have announced big plans, but Pantaloon is out there making it happen."

Healthy competition?

Arguably, though, the next stage of Pantaloon's development will be tougher. For one, competition in organized retail is ramping up at a frightening pace. In mid-2006, petrochemical giant Reliance - India's largest private-sector company - announced plans to invest US$6 bn in a chain of 5,000 supermarkets called Reliance Fresh. By 2010, the firm plans to have retail revenues of US$20 bn and become India's largest player in the sector. The expansion is already well under way: during the first quarter of this financial year, Reliance opened 105 new stores, more than one a day.

In February, Bharti Enterprises, a telecoms-to-insurance group, followed suit. By 2015, it plans to have invested US$2.5 bn to build up a chain of hypermarkets and supermarkets employing 60,000 people. Not to be outdone, Aditya Birla, a textiles-to-metals-to-cement conglomerate, opened its first supermarket in June in Pune under the brand "More" and is planning an aggressive expansion, with a chain of hypermarkets also in the works.

At Tata Group, another Indian business house with interests ranging from steel and cars to IT services, the firm's Trent subsidiary has been in retail for several years now, operating supermarkets under the "Westside" brand, hypermarkets under the "Star India Bazaar" label and book stores called "Landmark". All these ventures are ratcheting up their rate of expansion, even as Tata opens new formats. In October 2006, it launched Croma, a chain of electronics shops. It operates six such outlets today but plans to open 100 more within three years.

Foreign firms are joining in too. Although prevented from opening multi-brand retail stores such as supermarkets, single-brand shops are allowed. High-end luxury brands like Bang & Olufsen, Chanel, Versace, Louis Vuitton, and Valentino have all opened outlets. Foreign firms are also expanding in the wholesale business, supplying local Indian retailers. US retail giant Wal-Mart, for example, has signed up with Bharti in a venture to build a sleek supply chain sourcing goods for Bharti's supermarkets.

As the aggressive expansion continues, it's not clear who the winners will be. On one side, notes Percy Panthaki, an analyst at HSBC, are the smaller entrepreneurs who first pushed into the retail sector. "They have the know-how and the experience in retailing, but are constrained by how much capital they have to expand," he says. On the other side stand the larger, more recent entrants "who have very deep pockets, but not necessarily the know-how yet," although they do have a proven track record of success in other sectors.

At Pantaloon, a small company in relation to the likes of Reliance and Bharti despite being India's biggest retailer, the CFO is relaxed about the stiffening competition. "Organized retail has such a small share of the market today that there's plenty of room for everyone to grow. It will be that way for at least eight to 10 years," predicts Rathi.

HSBC's Panthaki acknowledges that, with a fast-growing market and low penetration for organized retail, the Indian market offers "plenty of opportunity for existing and new players." However, he cautions, this assumes that retail grows in an even way across the whole country, which is highly unlikely. While India has 1.1 bn people, the vast majority still work in agriculture and are spread across the countryside. The most attractive locations for new retail ventures are India's eight tier-1 cities, such as Mumbai and Delhi, followed by another 50 cities that each have 1m inhabitants or more. The fact that these urban areas offer attractive population densities as well as a large proportion of India's rising wealth means that retailers will all tend to concentrate on the same geographic areas, making competition tough in many places.

And that's not to discount the presence of traditional father-and-son kirana stores. Because there are so many of these outlets, most city residents never have to walk more than 100 yards to get their daily groceries. And yet, with city-center land hard to come by, new retail ventures are often located farther out of town. Persuading Indian households to travel to a distant mall once a week to do their shopping rather than to the corner of their street once a day will require a big change in mindset. "With India's congested roads, lots of consumers won't want to drive 10km to do their shopping," says Panthaki. Indeed, many Indians still regard a trip to the mall as an experience and an opportunity to browse, and instead do their shopping closer to home.

Kirana shops also present a political challenge for retail companies. Many small-scale operators are unhappy with what they see as big corporate India undermining their livelihoods. Politicians, aware that kirana owners present a significant mass of votes, have jumped to their defense, campaigning for organized retail to be curtailed. While most observers believe that both sides can do well alongside each other, some firms are taking steps to smooth the way. Bharti, for example, is developing a franchise model to partner with existing local shop owners.

Property pains

For many observers, the biggest challenge to aspiring retailers is real estate. While the emergence of new shopping malls helped get the retail industry off the ground, the accelerating expansion plans of most players mean that mall developers aren't keeping up, causing rents to soar. A report released this year by Jones Lang LaSalle Meghraj, a real estate consultancy, states: "With retailer demand outstripping supply, double-digit rental growth has been a feature of most major metros since 2004 ... small retailers with tight margins are being squeezed and increasingly discouraged from occupying space due to prohibitively high asking rents."

Developers are responding with grandiose expansion plans for new shopping centers, with the amount of retail space in India's seven biggest cities due to triple from 19m square feet in 2006 to 60m square feet in 2008. (See chart, page 35) The recent emergence of big, professional developers, such as DLF, Unitech, Emaar-MGF, and Prestige Group, is accelerating the construction of new malls. Nonetheless, warns Jones Lang LaSalle Meghraj, "In the competitive rush to build shopping malls, we assess that over 90% of the current and planned shopping mall stock will fall below international standards." In particular, the company highlights poor infrastructure surrounding the malls, low levels of maintenance and cleaning, health and safety risks, and inappropriate tenant mixes.

For companies like Reliance and Bharti, huge financial clout means they can weather a period of high rents, or even buy their own retail sites. Smaller players will have more trouble.

At Pantaloon, Rathi and his colleagues have devised a way to overcome the issue. The firm has set up its own real estate asset management company called Kshitij Investment Advisory, which has launched two retail-focused funds. Between them, the two funds have raised US$350m from a variety of sources, much of it from wealthy individuals. Working with real estate developers, these funds are being used to build 51 new malls and other retail centers with a floor space of 16m square feet.

"Pantaloon was very smart getting into real estate funds," says Dutta at CLSA. "They are now a stakeholder in many of the new malls coming up, they have a direct input on whether the malls get finished on time and on target and they get preferential contracts at the malls." The company has also been far-sighted in signing agreements with other mall developers, and Rathi says developers have promised 24m square feet of retail space to Pantaloon as soon as it is built.

Moving fast

Even without real estate headaches, growing between 60% and 70% a year will present Pantaloon and the rest of India's retailers with a major execution challenge. In particular, observes Vittal at McKinsey, companies will struggle to find enough qualified staff. Salaries are already rising rapidly across the board in India as all firms compete for talent. And while retailers may succeed in training enough store managers, merchandisers, and other retail staff, they will inevitably struggle to hire other kinds of employees, such as IT managers to build retail support infrastructures.

That said, Vittal believes that Indian firms are adapting well to rapid growth. "Time has become a strategic imperative in India," she notes. "Companies are increasingly confident hiring 100,000 people over two or three years and making growth happen." This has happened already in telecoms, IT services, and business process outsourcing and is under way in real estate, cars, and the steel industry. Retail, she argues, will be next.

"It's a more entrepreneurial approach," says Vittal. "Traditionally, companies like to have everything optimized up-front before they proceed, but in India that is too ponderous. There's a great need to move fast. Companies are realizing that they can always go back and perfect later what isn't right the first time round."

Some of the greatest operational challenges lurk in the back-end supply chains that feed the retail business, especially in the food and grocery category. Agricultural supply chains in India are notoriously inefficient; partly due to poor infrastructure, with most experts estimating that between 20% and 40% of all farm produce rots before it reaches the consumer. Equally, farm land is highly fragmented and hardly suited to supplying large-scale modern retailing. Problems are further compounded by the structure of rural markets, where farmers in most Indian states are forced to sell their produce through government-approved channels that offer little price transparency or flexibility and present middlemen with opportunities for fat profits.

A few of the larger operators, like Reliance, are busy building out new proprietary supply chains to replace the traditional ones, dealing with farmers directly where they can, and pursuing a "farm-to-fork" philosophy. The opportunities to raise efficiencies, not to mention the lot of India's rural population, are huge.

"If agricultural supply chains can be reformed it could have an impact as big as the 1991 economic reforms," says Dutta at CLSA. "But it's a big 'if' and there's a long way to go."

With far less capital than Reliance, Pantaloon is choosing to rely on existing rural supply chains. "We're working closely with traditional suppliers to help them improve," says Rathi, "we believe building a parallel supply chain over the existing one would not deliver a return on the investment."

The real opportunity?

India's agricultural population presents another challenge for retailers. Although farmers make up 60% of the population, their output only accounts for 20% of the economy. They represent a great swath of the country that is generally not wealthy. Even in the big urban areas, much of the population remains poor and has yet to see much benefit from India's economic growth.

And yet, if India's retail revolution is to continue its rapid expansion, then companies will have to serve the middle and bottom of the economic pyramid as well as the top. Pantaloon opened its first pilot store in August aimed at the bottom of the pyramid. Called KB's Fairprice, it is a stripped down version of a supermarket, offering a reduced range of food and general merchandise, with amenities like in-store air-conditioning left out.

Any company able to develop a successful, profitable retail model for India's poorer citizens will do well, for the market is vast. However, attempts to move down market will inevitably hurt margins. Rathi is well aware of such pressures. Even before launching its low-end format, Pantaloon was already suffering falling margins. In serving its existing customers, Pantaloon divides its offerings into "lifestyle", where margins are 15% and growth is 52%, and "value", where margins are lower at 7.7%, but growth is higher at 114% last year. Moving into a category below "value" that serves the poorest consumers, will bring even lower margins alongside potentially higher growth rates.

Serving such a huge market has much allure. But, just as Napoleon overstretched with his disastrous push into the endless reaches of the Russian steppes, so retailers may find themselves overreaching in the vast markets of India. Whether the bottom of the pyramid turns out to be the making or breaking of some firms, the attraction of this giant nation of shopkeepers is likely to keep getting stronger.