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Big retailers find profit swallowed by size and sales

Raghavendra Kamath, Business Standard
Mumbai, October 16, 2013

Spencer’s Retail, part of the Sanjiv Goenka group, was looking to break even in financial year 2010-11. As the deadline passed, the retailer postponed the target by another 18 months to the second quarter of 2012, only to revise it again.

Now, Spencer’s hopes to turn profitable at the earnings before interest, depreciation, taxes and amortisation (Ebitda) level by December 2013.

Spencer’s is not the only company which has fallen behind its break-even target. Saddled with high overhead costs and low margins in a slowing economy, food and grocery retailers such as Sunil Mittal’s Bharti Retail, Kumar Mangalam Birla’s Aditya Birla Retail, and Tata group-owned Star Bazaar are struggling to turn in a profit.

Most of these retailers started operations between 2006 and 2007 or went on an aggressive expansion spree during that time. The only exception was Mukesh Ambani’s Reliance Retail which decided to go slower on opening stores. And that seems to have paid off. Reliance Retail, which started in 2006, posted a profit before depreciation, interest and tax of Rs 78 crore in 2012-13. In comparison, both Spencer’s and Aditya Birla Retail logged losses.

While these retailers saw their sales grow, they made themselves more vulnerable to economic downturns by expanding aggressively. At the start in 2007, retailers such as Bharti and Aditya Birla paid hefty rents to book whatever space was available to build scale and kick in efficiencies but when the slowdown struck in 2008-09, their stores could not sustain such rents. Many retailers leased large properties just because they were available, hoping they would return dividends. The rush to acquire retail space was such that the Bharti group used to pay Rs 6 to Rs 8 per square feet more than the other contenders and sign 30-year leases against the industry practice of 18-24 years.

Turning cautious

"Today, we have become realistic about store size. We will not book 6,000 square feet just because they are available at Rs 25 or Rs 30 a square feet," the then chief executive of Aditya Birla Retail, Thomas Varghese, had told Business Standard in an interview in 2010. Aditya Birla group insiders say the company also paid exorbitant fees to retail consultants to conduct market studies and chalk out strategies.

But as modest sales and expensive rentals made these stores unviable, retailers began to aggressively close stores or curb expansion. Aditya Birla has closed down over 150 supermarkets in the last four years, while Spencer’s wound up operations altogether in cities such as Pune to focus on profitability. Even Reliance Retail closed around 50 stores and downsized its employee strength.

The retailers have also been weighed down by the lack of a unified tax regime. Kumar Gopalan, chief executive of Retailers Association of India, which represents the voice of retailers, says local taxes are posing a big challenge for the companies. In the absence of goods and services tax (GST), retailers have to pay taxes in every state where the goods are moved. For instance, in Mumbai, retailers need to pay octroi, a local levy for goods transported into the city. That raises the cost as in the absence of GST, retailers prefer to set up multiple distribution centres instead of one unified centre. "Most retailers open their distribution centres with taxation as a factor and not according to ease of transportation," says Gopalan.

As things stand, there is no common formula to success in Indian retail. Arvind Singhal, chairman of management consultancy Technopak Consultants, says: "The biggest problem is that there is no single format which works for the entire country."

Mohit Kampani, chief executive of Spencer’s which is focused on hypermarkets, says: "Developing our compact hypermarket model took time; we got it going in earnest only in 2011-12."

Aditya Birla retail, which was initially focused on supermarkets, too has taken to the hypermarket model recently. Bharti experimented with different formats as well. Kampani says it took some time for companies to understand that grocery retail business works best in partnership with developers where retailers pay a share of their revenue instead of fixed rental amounts.

Singhal says there is a fundamental mismatch between costs and earnings as rents in India are almost double of what retailers pay abroad. He says ideally, hypermarket chains should pay 2.5 to 3 per cent of revenue as rent to make them viable; supermarket chains should pay 5 to 6 per cent of revenues and clothing retailers 8 to 9 per cent.

While most retail chains overshot these limits, they also faltered at another level. Sanjay Badhe, an independent consultant and former chief marketing officer at Aditya Birla Retail, says big retail chains did not understand what customers wanted and underestimated the clout of kirana stores.

"FMCG companies serve 14 million kiranas and they will not move to a new channel unless modern trade demonstrates efficiencies and through put," says Badhe. "Why would they allow retailers to take away pricing power?"

Badhe believes the break-evens have also been delayed because of frequent management changes that resulted in unnecessary strategic U-turns and discontinuity. Spencer’s saw two new heads within six years, Aditya Birla Retail saw similar changes at the top. First, CEO Sumant Sinha quit and the group replaced second CEO Thomas Varghese with Pranab Barua who came from Aditya Birla Nuvo last year.

"If you frequently change the leadership, there will be no continuity in business strategy and direction," he says.

Funding woes

Delays in foreign direct investment have proved costly too. Many believe that availability of low-cost foreign funds would have helped the retailers improve their operating profits by lowering the cost of finance. "Some of them built the business to attract foreign direct investment within a few years. That did not happen and this is dragging them down," says Devangshu Dutta, CEO of retail consultancy Third Eyesight.

While the government has allowed 51 per cent foreign direct investment in multi-brand retail, policy restrictions such as 30 per cent mandatory local sourcing have dampened the hopes of foreign retailers who are taking a slow, cautious approach to entering India.

"Most Indian retailers are not able to raise funds from foreign institutional investors and private equity funds. Domestic markets do not have that kind of depth, so funds come at a higher cost," says Technopak’s Singhal.

Retailers, however, are trying out new formats to turn the tide. Spencer’s is focusing on compact hypermarkets (25,000 to 30,000 square feet) in five chosen geographic clusters and growing its non-food component to improve profit margins. It is also building a centralised distribution system and evaluating franchisee model to reduce logistics costs. The retailer is also increasing the share of unique commodities in the food and beverage segment from about 5 per cent to 30 per cent.

Aditya Birla too is developing new strategies. It is conducting store-specific surveys and planning to offer customised products depending on the taste of the people in the locality. For instance, at its Mahadevpura store in Bangalore, which attracts a cosmopolitan crowd, it offers more non-vegetarian and bakery products, while at the Bull Temple store in the city where shoppers are mostly traditional Kannadigas, it stocks more puja flowers, rice and local fruits and vegetables.

Eventually, it is sales that will matter. As Singhal of Technopak puts it, "If the economy grows a bit faster and optimism returns, retailers will reach profitability in 15 months."

(Sourced from Business Standard.)

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