Atanu Dey On India's Development

Organized Retail

December 1, 2011 by Atanu Dey | 31 Comments

When one is talking about anything that has to do with economics, I think it is best to use a bit of common sense and to stick to the basics. Recently, the government has moved to allow up to 51 percent foreign direct investment in “multi-brand” retail in India (and single brand retail is allowed 100 percent FDI.) Some people (and some parties such as the BJP) oppose FDI in retail. The question whether FDI in retail is good or not is being hotly debated. The debate is pointless because it takes only a few minutes to get to the heart of the matter. Here’s my take on the matter.

The fun facts.

1. Retail is an essential service in any economy.

2. Organized retail is a good thing in any sufficiently large economy.

3. Organized retail requires investment, in terms of capital and human resources.

4. Foreign investment augments domestic investments and is good for the economy.

5. India needs an efficient retail sector.

6. India’s domestic resources are insufficient for creating an efficient retail sector.

Therefore inflow of foreign investments in retail is good.

But what about the millions of small kirana store keepers? Some of those stores will no longer be viable. Some, not all. Some of the people currently in the unorganized retail sector will find employment in the organized retail sector. Fewer people will be needed for the same volume of retail — which is another way of saying that there will be labor efficiency gains. Increased efficiency also means higher wages in the retail sector. That is good news. But wait, there’s more.

A growing economy implies that the retail sector will also grow. Given sufficient growth, it could even be that the number employed in retail grows even with increased efficiency in retail.

It is a mistake to consider the economy as a static game. Economies are dynamic structures and it is possible to have changes that benefit some without hurting others. In other words, Pareto improvements are possible.

An example of this is the telecom sector. At one time, it was feared by some that increasing the efficiency of the sector will lead to unemployment among the current labor force. As it turned out, those fears were unfounded, since the growth in the economy, and therefore of the sector, saw an increase in employment together with higher wages. Not just that, it also led to cost decreases which are reflected in the low prices of telecom services we all enjoy.

The cost of retail is a wedge between the consumer and producer prices. Reducing the size of the wedge is good for everyone with the possible exception of those who gain from the inefficiencies of the current system. The losers will have to find alternative ways of making a living. But that is another story.

  • Darwin

    But why foreign investment. cant we do it ourself ? an organised retail sector?

  • RC

    Nice explanation. On top of all the great things the good professor has explained above, one thing I would like to point to all the people “worried” about employment in the small unorganized retail sector that these employers are not all angels. Some are nice and might even be angels and egalitarian in their views but some are extremely exploitative.
    When this workforce enters in organized sector, labor laws can be applied and monitored properly. Organized employment will empower these employees in that they will have verifiable income which will enable them access to credit (not loan sharks). Remember more than 91% of working adults in India work in unorganized sector. Any move that moves a portion of them into organized sector can only be good.

  • http://oshantomon.blogspot.com Sambaran Mitra

    1. Do you have any data (anecdotal or otherwise) whether the domestic retail-chains (food-bazaar, reliance fresh, spencers, hypercity) were successful in bringing efficiency into the system?
    2. What is your take on chances of oligopoly being created in retail? May be domestic-retail-chains were not huge enough. However if foreign retail chains can invest huge amounts, is there a chance that significant portion of retail trade in cities get limited to 3-4 chains?
    3. My fear is that in case of oligopoly, the retail chains can create cartels. In that case whatever efficiency is brought into the system will not be used to reduce prices but increase profits. Profit is not a bad word but increasing prices of food essentials can be devastating.
    4. I have been discussing about FDI in some blogs. I got some good reasons why big retails will not be able to replace local kirana. The reasons are: home-delivery, credit, big retails located in outskirts. Do you have any more points regarding why big-retail may not eliminate local kirana?
    5. Have you read an article by shekar swamy against FDI? If you haven’t let me know at baransam at the rate of hotmail dot com and I shall send you the pdf. My opinions are mostly formed on the basis of this article.

  • Dhairya D.

    A bi-lateral trade is based on certain counter-concession and concession, that both the parties grant to each other. US and Europe have become more protectionist, especially about their farm and dairy products. We are opening up our retail sector without extracting any benefits, I am not sure, if that is prudent?

    Another hypothesis from my side is, Walmart in US buys cheap goods from China, pays for them in US dollars, passes on benefits to US customers, who save a lot from shopping there, those savings are used to buy even more useless stuff from China ( Black friday shopping for flat screen TV’s ) but this works as long as US prints dollars at will and keeps raking up huge deficits. If this model is bought in India and Big Retail starts sourcing aggressively from China, it will worsen out Balance of Payments since we pay China in dollars and India cant print USD. Besides, it can impact out manufacturing sector.

    Please advice.

  • SV

    “India’s domestic resources are insufficient for creating an efficient retail sector.”

    I don’t know if the domestic resources have even been tried. Do you mind elaborating on that?

  • http://themmindset.wordpress.com/ The Mindset

    The local retail/kirana shops are least like to be affected.
    most people in India buy grocery items on daily basis. They are least likely to go to Walmart or any other large retail.
    The kirana shops may get profit. The reason being the absence of muddle man. They can buy from Walmart at lower prices and increase their profits.
    In my view the distributor will be affected more than the kirana shops because their role will be marginalized.

  • http://sabhlokcity.com/ Sanjeev Sabhlok

    I’m collecting all possible questions that India might have on this issue here: http://sabhlokcity.com/2011/12/please-ask-your-questions-on-fdi-here/. Once the list of questions is finalised, a response will be prepared.

  • http://oshantomon.blogspot.com Sambaran Mitra

    Question asked by Darwin is very relevant. India has got loads of money now in private hands. Why is that money not able to create an efficient retail sector?
    I must clarify that I see no difference if similar investment is made by foreign firm or Indian firm. I do not believe Indian firms will behave differently than foreign firms when incentives are the same.

  • Manish

    @Sambaran Mitra,

    There are few reasons why inspite of having loads of private money, we in India have not been able to create efficient retail sector:

    First, Indians lack know-how on how to execute such large retail operations efficiently, that can create a win-win scenario for them as well as customer. And the reason for this lack of know-how is primarily a “I-know-it-all” attitude. Try telling a retailer how you can make your operations efficient, and the pat answer would be he already knew it. If you probe further on why he is not implementing it, his answer would be because that would not work in India. It is altogether a different story that couple of years later he would be doing exactly the same.

    Second, as most retailers are small, they keep their margin to sustain their operations very high. In US typically grocery margins are between 5-15% and for other items it touches 20%. In India the margins are kept very high especially for non-grocery items. Sometimes the margins are so high that it is mind boggling. Try comparing price of some products between Amazon and any Indian retailer, you’ll see what I am talking about. I was personally given quote of Rs150K for an item that sells for $300 on Amazon.

    Third, currently most retailers are making money even in this inefficient supply chain. So, there is no incentive for them to bring efficiency. It is the consumers who are getting fleeced as he has to pay top money to get shoddy products (made in china and sold as made in ).

    Finally, most organized retail operations in India are in-organic in nature. It took western retailers years and years before they could make this supply chain this efficient. You simply cannot pump money and expect efficiency. Time, money, and knowledge is what makes the whole operation efficient.

  • Mallikarjuna

    Thank you, this explanation helps.

  • KC

    It is not the small retailers I’m worried about it is the fear of not getting fresh fruits in the market or worse choosing them for the want of a cheaper canned product.

  • KC

    forgot the not up there …. ‘not choosing them…’ :p

  • Suren Patel

    FDI has its own pros and cons. However, the simple matter of faci is opening the FDI in retail in all probability widen the trade gap as Multi nationals would outsource products out of India, e.g China

    Questions should be raised how India is going to bridge this current account/trade gap deficits without creating alternative exports when it own NRI remittances are under severe squeeze. Surely this is a recipe for future disaster, hence FDI cannot be permitted till when India is confident of creating her own indigenous trade surpluses, not through superfluous remittances, NGO monies from abroad and inward investments only in shares and stocks. The current position of IR should in itself is a warning that without a proper trade surplus regime, the country would only go in direction, i.e downwards.Even with today,s current reserves, India is covering its Import for about ten months only.
    Lastly, would these FDI Retail Investors create any value added resources towards foreign exchange reserves which is doubtful and anyway,they would rather strain the system through profit repatriation.

  • http://oshantomon.blogspot.com Sambaran Mitra

    @Manish, Thanks a bunch for your explanation. Especially in the current scenario where either party is assuming the worst motive on part of other.
    Can you answer the questions I posed in my previous comment, especially the one about apprehension of oligopoly?

    Regarding margin by small retailers, I would like to share one anecdotal experience. In one city I have seen small retailers charge less than printed MRP. I have seen items quoting at 10-15 Rs below MRP. Whereas in two other cities, a mere hint of charging less than MRP is met with a stern look or supercilious smile.

  • tp

    “either party is assuming the worst motive on part of other” — that is quite well justified. Why this sudden interest in “making the retail sector more efficient” even as lawlessness is the norm, trillions are stashed in Swiss banks, primary education is terminally ill, cities are bloating and rotting away without a plan, public transport is in ruins, no city has walkable communities, public spaces are gobbled up by developers to leave less than 1000 square meters of park for over 10,000 city dwellers, and trillions are parked from abroad in bloated real estate? I don’t see a retail problem nearly as big as the above problems that needs fixed. We are big boys now and the Congress still calls mommy and begs for FDI in education, FDI in retail, even FDI in taking the Akaash tablet forward. If only Congress ministers repatriated their Swiss bank money we would have many times the liquidity of Walmart.

  • http://www.parrikar.com Rajan P. Parrikar

    Atanu,

    Dr. Arun Gupta has raised substantive issues on the FDI issue. You may want to give it a read (and perhaps formulate a rejoinder) -

    http://arunsmusings.blogspot.com/2011/12/india-foreign-direct-investment-in.html

  • Manish

    @Sambaran Mitra,

    First, let me clarify that I am neither an economist nor have I ever taken any formal course in economics ever. Still, let me try to answer your apprehension of possible oligopoly in the retail sector based on my observation.

    I agree that there is a real possibility of having an oligopoly limited to 3-4 chains. More so, when the regulators like competition commission of India do not do their job properly. However, the possibility of such eventuality can be minimized by framing the FDI policy something like this. How about FDI is allowed only for publicly listed companies. Where the 51% is owned by the foreign entity, but the rest 49% is traded in the stock market openly. And, no entity is allowed to own more than 1% (or any other reasonable percentage). By doing this, although the management of the company would remain with foreign entity, but still the bulk of the ownership would remain with public at large.

  • http://oshantomon.blogspot.com Sambaran Mitra

    @tp,

    I won’t get into the debate whether motives are justified or not. My point is that, irrespective of the motives, the debate should stay focussed on FDI-issue and not meander into motives behind them.

  • tp

    @sambaran — That’s exactly what Congress wants: the debate must remain contained in retail-FDI or not, so that the I’m-better-at-debating-than-you-are gang are safely kept off more dangerous alleys. You keep pooping diverse debate parties with “but after 60 years we still don’t have universal primary education from teachers that can fog mirrors” and the smart guys will diagnose you with attention deficit disorder and stop inviting you.

  • RC

    The government has backtracked on the FDI decision and put it on hold. Folks nothing to worry. This is just a blip, India’s march towards 19th century is on track.

    That Deepak Parekh, Kishor Biyani, all economists etc. dont know anything.

  • Sid

    India’s Economic Decline Is One Of The Most Under-Reported Stories This Year:

    http://www.businessinsider.com/indian-economic-decline-december-2012#ixzz1fjEjmX9d

    We need the retail sector. And we need it now.

  • Vinit

    At last,once in a life time, I TOTALLY DISAGREE with Atanu…
    Infact I am SURE that he is TOTALLY WRONG here…:)…here’s why and I will try to be quick..( Note: I am not a Bania or Retailer)..

    Government/Atanu ‘excuses’ for FDI in Retail:

    1. Investment in backend retail infrastructure
    2. Increased Employment/Salaries
    3. Farmer Upliftment
    4. Lower Inflation
    5. Consumer Satisfaction

    If I missed anything above, please feel free to add them…

    Out of all the “excuses”(sarcastic) given above to bring FDI in retail only #1(create retail infrastructre) holds solid, rest all(2 to 5) are also achievable by Indian retailers such as Reliance, Big Bazaar, Birla etc with good National Policies(these national policies will anyways be required for Walmarts also to give benefits to farmers etc)…

    My Objection is to give 51% STAKE to FDI for creating Backend Retail Infrastrctre for following reasons:

    1. Government hasnt given any STATISTICS on the AMOUNT OF INVESTMENT that is needed to create backend Retail Infrastructure.. Are there any numbers please????

    Once we have numbers an attempt to EXPLORE raising that money from the market/IPO/tax/black money etc etc can be made…Has The Government published/EXPLORED any of these options??

    2. The responsibility of creating backend retail infra is supposed to be done by Mandi Parishad/ Agri Ministry…where is the Tax Payers Money? The government needs to publish what it intends to do with the Agri Ministry Finances going forward …

    3. Indian Retail market is pegged at USD450-600bn (3 times the entire GDP of Pakistan) ..Why give 51% of this market segment just for the sake of Finance ?….. Reliance gave 30% stake (worth $20bn) to BP in KG D6 oil fields to get deep water technology that India doesnt have… Do we need to give 51% stake (worth 300bn) for Supply Chain Management Infrastructure, is this some Rocket Sicence that India does not have??

    4. Retail sector is the largest wealth creator in the world after Energy…Walmart is 2nd largest company in the world… I want to see an Indian Retailer as large as Walmart ….Thats a Proud Indians Dream and I am sure many of you share the same dream…

    Thanks
    Vinit Srivastava

  • RC

    @Vinit,
    How do you explain that Kishor Biyani (creator of Big Bazaar stores) is so vocal in his support for FDI in retail? One would assume that the new companies would be competing against him. Yet he is enthusiastic supporter ….

    India needs foreign investment to come back, which has been fleeing in recent times causing the Indian rupee to plummet which fuels inflation further.

  • Vinit

    @RC

    1. At the Same time Reliance CEO has said “They are not looking for FDI investment since Bringing in a foreign partner at this point in time would be like giving away too much for too little.”

    http://articles.economictimes.indiatimes.com/2011-11-28/news/30450474_1_foreign-partner-retail-revolution-foreign-retailers

    Big Bazaar’s Kishore Biyani may have dept issues for they grew too fast, but I am sure many others may not be in such a dire condition…

    2. I am sure there will be more clarity if the Government publishes some STATISTICS on the overall amount of INVESTMENT that is needed to create entire Retail Backend Infrastructure…but none so far I have seen, nor is any EXPERT giving any data on this….

    It is utter waste of time for everyone to talk in support or against FDI unless this FIGURE is published.. even then I believe more than 26% FDI will be detrimental for Indian Businesses

    3. I am Sure that atleast 20 to 25% of this backend infrastructure cost can be met from the budget of Agriculture Ministry ….Can the government please publish Agri Minisrtry budget..? I guess the electricity/fertilizer subsidy for farmers alone is close to INR 100,000 crore…Overall subsidies in India is around 14% of Indian GDP :) …

    4. The business houses will not OPENLY oppose FDI in retail for a simple reason, they dont want to be blocked by developed countries that allow them in…but I am sure Indian retail giants wont look very happy if 51% stake is allowed to foreign partners. For a start India should go for 26% FDI, if it doesnt work increase the cap…

    5. We have given only 10 years to Indian businesses in Organized retail Sectors to take a lead…10 years is far too less in such a huge market, we shoudl give atleast another 5-7 years to Indian businesses to consolidate and at the same to bring in Reform Policies to eliminate Middle men and allow direct deal with the farmer…Agricultural Land reforms can be brought in for Reliance/Big bazaar to do agri farming etc etc..

    6. Indian Manufacturing is very weak, bringing in walmarts will further weaken it for they will import textile etc from Bangladesh/Vietnam/China in no time… Indian MNREGA scheme renders labour cost too expensive for factory owners (I have first hand experince on how difficult it was for me to lure in labour and sustain profitability due to high wages gauranteed by MNREGA/ration subsidy..I and my friends ultimately sourced our supplies from Bangladesh instead of setting up manufaturing unit in India..)..

    MNREGA/Ration Subsidy has adversely affected Manufacturing ..Labor does not turn up to work, since they are gauranteed employment, they get 30kg rice per adult/family…their stomachs are full..they dont need to work hard now…Instead of NREGA teh government should create a pool of labor to supply to industries and set a minimum competetive rate in consultation with the industry..but COngress wants Votes more than Growth..

    Thanks
    vinit

  • RC

    @Vinit
    That article you linked to does not mention that Reliance is against the FDI in retail policy, the statement you selected only highlighted his company position not requiring additional capital. Reliance may not need capital infusion but others do. Reliance retail does not seem to be against FDI in retail at least from that interview transcript.

    FDI in retail is not going to happen so this is all academic and a moot point anyways. May be after another 10 years and after another balance of payment crisis.

  • Vinit

    @RC…

    1. What do you expect Reliance to say to the world via press ?
    “We dont want you to eat our pie but I would like to gorge on yours ?” ….There is something called PR..

    2. Lets put forward our analysis based on the facts on FDI policy and its pros and cons.. not on what Reliance/Big Bazaar want….they may want Walmart to have 51% stake in Indian Defence …will you give it to them?

    3. The small fish wants FDI..cause they know very well of having no chance in a long term fight against Reliance, Tatas and Birlas…Bharti/Big Bazaar are not a cash rich organization

    4. Question to ask ourselves is “Why India is so eager to share 51% of its retail wealth (currently $300bn and growing exponentially)?” … Is it only because we dont have money?? But then how much money do we need?..ooops we dont know that in the first place….yet we want FDI in retail….most illogical and Surreal…

    5. I am not against FDI in retail.. I am against 51%..thats a rip off… we are definitely not that desperate otherwise teh government would have mooted many policy reforms to eliminate middle men, promote farm land reforms to encourage large scale farming, eliminated food subsidy for vote banks etc etc…

    Thanks
    Vinit

  • Loknath

    The bare truth is no Indian organized retail has managed to show a decent profit till date. Insiders will tell you that. All of them have gone wrong on strategy of targetting the great Indian middle class, who will walk a mile or 2 for a bargain of 1 rupee 25 paise on just one item that may be expensive in the store. Indians need to be majorly pampered and only Walmart can do that, to begin with by their money might.

    Unfortunately, with the kind of real estate rents that India has, that is on an average 4 times the American retail overhead costs, there is little money to make in organized India. Ultimately we are talking of some 25 to 30 odd cities in India where people will go to Walmart and shop. If Walmart were to open a superstore in Bandra, can it provide for parking of 500 cars ?. In America the Walmart supercenters have parking available for twice the footballs on a busy day, thus allowing Americans to fill their boots with stuff they dont actually need. This is called the retail experience. In a place like Bandra or Andheri or even New Mumbai, such parking space even 10 floors under the ground will cost them 50 bucks by the hour to rent, let alone buying it. Add to this the engineered shortages and hoarding of basic foods and groceries in India by the Banias and Marwaris.

    Evetually Walmart will need to bribe the lords to allow them to import stuff from China and elsewhere at 5% duties or get into agriculture and manufacturing full time in India. Unfortuantely even that is expensive in India. An acre of fertile well-irrigated land anywhere in India costs upwards of 30 lakhs these days. This is 5 to 10 times more than the cost of farm land in America.

    It would be commercially wise of Walmarts and Targets to wait for some more time before thinking of setting shop in India.. 51% or 100% FDI. Meanwhile they should lobby for reduced import duties on food and agricultural items from Pakistan, America, China and SE Asia.

  • Vinit

    @Loknath… Do you know the profit margins of Walmart? ..Its mostly from 2- 4 %… Indian Fixed deposit look like heaven sent in comparison…

    Multi Brand Retail is genearally low profit around the world…

  • Loknath

    Vinit,

    Obviosuly Walmart is not looking for windfall profits from day 1 in India. I would rate them more ethical than Indian bania run retail chains who write off huge inventories as wastage to claim some bottom line. This is because they work on a mark up model based on cost on purchase. The fatter the better but without any solid commitment in back end investments like in climate controlled storage and contract farming. In fact I have found local kirana shops now selling cosmetics and toileteries at prices less than the likes of Spencers and Big Bazaat. These guys love the mark up margins. Tomatoes are still available at 5 rupees a kg in the flush season but not in the retail market. The retail cost is high because no one has the controlled storage facilities to buy them in bulk and store it. If effect they are nothing more than air conditioned well lit kirana shops. Recall a 10 year old news of farmers in Karnataka dumping truck loads of tomatoes on streets in Bangalore because the selling price was less than 25 paisa a kg then in wholesale market. This was sometime in 1999.

    Like everyone else Walmart too needs to recover their cost of working capital and inventory. So they will borrow from Indian banks at preferential rates of e.g. 8% but they will first make clever investments to keep their average cost of procurement to the lowest possible. If such is made possible my Walmart, then rough back of the envelope ROI calculations will mean that they need to have just 10% mark up on COGS to make 15% profit before taxes. Not a bad deal if we are talking of sales in 1000′s of crores. Moreover they wont and cant afford to operate here on a superstore format because there is no land available with the facilitates at par in America. They will size their formats appropriately to maximize thier returns.

  • Loknath

    If I might ask a laymans question. I am no way connected to the formal world of finance so find these terms confusing.

    What does a 51% FDI in effect means to Walmart and India ?

    -Does this mean Walmart can finance upto 51% their business in India using capital from their bank accounts in America

    -Does this mean Walmart can borrow upto 51% from American Banks for their working capital needs in India, rest 49% borrowed from Indian banks.

    -Does this mean Walmart can also import inventory worth upto 51% from anywhere in the world at zero % duty.

    I assume 51% FDI doesnt mean a 51% ownership in the legal entity of Walmart.

    How does the Govt. keep a track of whether Walmart breached 51% FDI norms on a day to day basis.

    I am clueless. Atanu can you explain.

  • Vinit

    @Loknath…

    I am not an economic expert either, but when I was planning to setup a manufacturing unit in India(which fizzled out) I built the following undersranding on FDI ownership:

    51% FDI means:

    51% stake in the business entity that you are going to create in India. 51% share in expenses, revenue and profits.

    That means if your business entity captures a market revenue of $100bn..you are entitled for $51bn share of it in revenue/profit and the FDI partner has to shell out 51% of whatever investment that you is needed to create the infrastruture Indian partner shells out 49% of investment and share the same % revenue/profit)….

    I agree that Kirana stores and Middlemen (Mandi guys) are a rip off both to the customer and poor farmer who continually commit suicide…It may be Better if they both(middle man/kirana) VANISH… Infact if you see my post, I am not at all talking about Job loss to Kirana stores and Middle men…Infact I want their era to end since it is retro and harmful for all…why? I will give you a personal account of a friend of mine whose father is a middleman in the Wholesale Mandi in Karnataka(mind you not the lawless UP/Bihar)…

    My friends father FINANCES some 50 odd poor farmers with seeds, fertilizer, equipment etc in exchange of the 80% of the Farm Produce…this is all done on legal papers which the farmer has minimal insights on.. the farmer is given minimal buying rates since the money is interest free… The farmer is left with only 20% of the produce that is only enough to sustain his family till the next produce…If they decide to sell directly to the mandi, they face phyisical intimidation and legal prosecuation.. In the end the farmer is forever in the grip of this middle man…Mind you this is not the lawless UP/Bihar, this happens in Karnataka …

    But I feel, With proper policies, financial support/subsidy and planning the Indian government can promote Reliance, Big Bazaar, Tata, Birla to reform/organize the Retail sector…