Devangshu Dutta
October 15, 2008
(Written in September 2008)
Over the last few years India has had one of the highest GDP growth rates, across the world, and consistently. In the last two years GDP growth is estimated to have been 9.6 per cent (2006-07) and 9 per cent (2007-08).
A combination of private and public investments in recent years, as well as steady liberalisation of regulations, has created a situation that is unique in India’s history as an independent country, where business growth has lead to individual prosperity which is, in turn, leading to explosive growth of further business opportunities. Although India’s per capita income still places it in the list of “developing countries”, a significant population has emerged that is truly middle-class.
Rising incomes have created visible shifts in consumption patterns. Certainly, more Indians regularly consume cereal flakes, processed cheese and fruit-based drinks for breakfast than did ten years ago. A generation has grown to adulthood wrapped in ready-to-wear clothing (with visits to the tailor mainly for wedding trousseaux). And, yes, Indian consumers are increasingly welcoming modern retail environments over the traditional
These economic developments have attracted the attention of both domestic and international consumer-goods companies and retailers, and several of these companies have seen annual growth rates 20-50 per cent in the current decade. Many of the new entrants into the retail sector are large business groups that have set up modern retail chains whose share, although still small, is growing year-upon-year.
This growth of modern retailing is also having an impact on the processes and the infrastructure deployed for the retail sector. These businesses are run as true chains which require processes and systems similar to any chain-store business anywhere else in the world including merchandising, sourcing, human resource management, logistics and store operations. These modern retail stores demand Grade-A buildings for shopping centres, with associated infrastructure and services within them.
Therefore this, in turn, has created a growing opportunity for companies that are manufacturers or vendors of consumer products, suppliers of other goods that are used within a retail business or companies providing services to the retail sector.
In the rush to grow, while challenges have been acknowledged, none of them have appeared seriously debilitating in the long term, until possibly now.
During the years 2003 through 2007, news headlines mainly focussed on joint-ventures or strategic alliances, new store openings, new format launches, and mega-investment plans. If human resources were mentioned, it was about the apparent domestic shortage, about the expatriate talent being pulled in, and about incredible salaries. If shopping centres and retail space was studied, it was the phenomenal growth in square footage and the increasing scale of the new malls that was the focus.
Suddenly, however, the tide in the press seems to have turned. There’s mention of “slow” growth plans of major retail joint ventures. There’s whisperings and denials about lay-offs, accompanied by some high-visibility exits.
It would be tempting to read the signs as evidence that the previous growth was based on hype, which has run out of steam. It would be tempting, and it would also be too simplistic.
The fact is that macroeconomic factors are also acting as dampeners in 2008, and the year may be marked in the recent history of India’s modern retail sector for the dawn of realism. Just as the growth of the retail sector was reaching into the not so profitable geographies and beginning to ride on not very efficient structures, economic growth has begun to slow down dramatically. From a 9 per cent-plus growth rate in previous years, a variety of agencies expect GDP to grow between 7.5 and 7.9 per cent in 2008-09. Further, the Prime Minister’s Economic Advisory Council forecasts a GDP growth rate of 6.8 per cent in 2009-10.
What’s more, 2006 and 2007 have brought about phenomenal increases in two critical cost heads: real estate and human resource.
So on the one hand, retailers are facing dramatically higher operating costs, and on the other hand demand seems to be weaker than they have expected. For businesses that have been launched in the last 5-7 years, such a situation is completely new.
Estimating the Demand – Still an Art?
Since the early years in the decade, most retail chains have grown quickly by identifying new sites and replicating existing successful business models and formats. Typically, the growth was limited in its geographic spread, and the underlying consumption pattern differences between the existing markets and the new locations were not stark enough to be immediately visible. Much of the growth, in fact, came from new stores in the larger cities, including the metros, mini-metros and the next tier markets.
This high replicability has allowed the businesses to rapidly scale up into becoming truly national chains, and the presence of modern retail formats has become visible among the larger cities and towns.
As the companies have begun to feel “saturated” in the larger cities, they have gradually moved towards the smaller towns, with their existing product-price-format offer tweaked slightly.
However, the ethnic, linguistic and cultural diversity of India’s 28 states and 7 Union Territories makes it less like any other single nation-state and more like a collection of countries such as the European Union. The result is sharp differences in income, tastes, habits, and culture, all of which present a challenge for consumer products and retail companies in terms of product and pricing mix.
Most European brands do not approach different markets within the EU with identical strategies. So why should we believe that the business formula that works in one part of India will work in exactly the same way in other parts?
A bigger issue is the realistic estimation of the target population. There are cases where the demand has been grossly overestimated, and the business infrastructure and investment plans are over-weighted by these expectations.
Estimates of 200-300 million middle class (50-60 million households) sound very attractive, but by what measure of income and spending standards?
Going by the pricing of many of the brands in the market today, it would be logical to use developed market income standards. If we use global income standards the middle class numbers are much smaller. The number of households earning truly middle class annual household incomes (not adjusted for Purchasing Power Parity), is less than 5 million.
Of course, the upside is that the growth rate in this income class is estimated to have been over 20% a year during the current decade and this group is forecast to comprise of over 3.7 million households or about 20 million individuals by the end of the decade. There are few other markets in the world where the target population displays a growth of over 20% a year! Moreover, the annual growth rate of the incomes earned among this population is also the highest in the country. Further, a large proportion of this population is concentrated among the metropolises, as mentioned earlier.
So it is a nice market to be in, if the business plan is sized appropriately. You can expect some homogeneity based on the socio-economic classification, and the geographical reach is also limited, allowing for organic growth.
A specific challenge for companies wishing to enter with a “western” business model or product mix is that, even through its most controlled years, India has been a market economy (unlike China’s decades of a completely centrally controlled economy). Therefore, in most consumer products there are several domestic brands and Indian avatars of foreign brands available, even if the choice is narrower than on the shelves of western supermarkets. Competing offers are available, whether from Indian companies or Indian subsidiaries of global consumer products companies. In that sense, India is not a virgin market. There is already some (or significant) amount of marketing noise and clutter, created by the existing competition.
It is vital, therefore, for any company to identify the true overlap between its offering and the most appropriate consumer segment(s) in India to assess the real short-term and mid-term potential for its retail business.
The Urban Retail Opportunity and Challenge
While we are on the subject of the cities, it is very pertinent to look at the spread of the urban population.
As India’s population moves increasingly into cities, it is the larger cities (Class 1, with a population of over 100,000) that are growing the most. From 308 Class 1 towns, the number of Class 1 towns and cities in India had grown to 643 in the 2001 census, and are estimated to hold about three-quarters of the urban population.
These cities are also economic magnets. No matter how attractive the new boomtowns may sound, the larger cities still pull in huge numbers of immigrants from the smaller cities, towns and villages, keeping the ecosystem vibrant.
Within these, in terms of economic potential for retail businesses, it is the Tier 1 cities (metros and mini-metros) that are the still unmatched. In 2001, the top-8 cities were estimated to have 40 per cent of the urban disposable income, and despite rising costs and rising competition these remain the most attractive market for a company looking to establish a new retail business. In socio-economic terms there is more homogeneity available to a brand wishing to tap into a critical mass of customers, discretionary incomes are higher (in absolute not just percentage terms), and the infrastructure available to service the consumer is better.
Of course, the side effects of the population overloading are now visible, ever more, on the cities’ infrastructure and governance. And some of the overloading is contributed by the development of shopping centre space.
The growth of modern retail has brought with it a rapid expansion in shopping centre space. This is both an opportunity and a challenge.
While the extraordinary growth of shopping centres has provided more space for brands and modern retailers to grow their business, much of the growth has been concentrated in the metropolises.
Almost half the shopping centre space by the end of 2007 is estimated to have come up in the conurbations of Mumbai and Delhi. This “over-shopping” could potentially lead to the failure of a significant number of these malls. The failure may not result in outright closure – the better sites may change ownership, while others might get repurposed as office blocks or other commercial projects – but it will be painful, nevertheless.
Paradoxically, despite the proliferation of malls, for retailers and brands high real estate rental costs are the possibly the biggest headache. In many instances, brands have signed-on high-rent shops with the aim of balancing their portfolio over time, and fully expect these shops not to make money in the foreseeable future.
Further, the intensive development of malls, without adequate zoning and planning of support infrastructure such as roads and public transportation is now stressing not just the city, but the malls themselves. Even if there is adequate parking space within the mall (as compared to a few years ago), what good is it if a two kilometre stretch of road before the mall is choked with traffic moving at 2-3 kilometres an hour? The convenience of shopping under one roof is totally outweighed by the inconvenience of spending thrice the amount of time on the road, and is a critical deterrent to a serious shopper who is being targeted by the tenants of the shopping mall.
Tier 2 and 3 Cities – A Work in Progress
A recent study by NCAER and Future Capital Research compared 20 cities, and classified them into the Megacities (metros and mini-metros), Boomtowns and Niche Cities. The naming of these groups is quite telling.
Megacities on this list include Mumbai, Delhi, Kolkata, Chennai, Bangalore, Hyderabad, Ahmedabad and Pune, and have approximately 50% of their income as surplus after household expenses (other than Kolkata and Pune which show surpluses in the 30s). They have large populations, and combined with the surpluses, this up to a massive economic opportunity.
However, the smaller cities have been developing into economic hubs in their own right. If population is a key factor, then Surat would be classified as a metro. It has a high average household income, as well as a high surplus. Similarly, Nagpur, with its logistically important location is also developing into an important market. Along with Lucknow and Jaipur, households in these cities have seen double-digit booms in terms of income growth since 2005, a trend also seen in the Megacities.
This trend of income growth, infrastructure development, trickling of business hubs into the 2nd and 3rd tier cities, will continue to broaden the base of modern retail and distribution further outside of the major cities. On the other hand, while households in cities such as Chandigarh and Ludhiana have high surplus incomes comparable to the Megacities, the much smaller base of population would force marketers to treat them as niche markets until a critical mass develops over the next few years.
Thus, while much has been made about the boom in the smaller cities and towns, the formulaic approach of rolling out the same business model will certainly not work.
The signs of overestimation of demand in Tier-3 and Tier-4 cities is visible in instances of downsizing of store-space by prominent retailers, as well as relocation or closure of some of the new stores which have not performed to expectation.
The Tug of War to Modernise Retail
In my opinion retail is fundamentally an organic business.
Countries that have displayed inorganic growth of modern retail through large-scale corporatisation tend to be economies that have developed rapidly in the last 20-25 years. Among these are the East Asian economies and the former communist Eastern European countries. Three critical factors that have enabled the disproportionate and rapid growth of corporate retail in these countries are: financial muscle, a bank of real estate and strong political linkages. In other countries the high share of modern retail has grown over many more decades.
In other countries such as those in western Europe and North America, retail consolidation has happened over many more decades, boosted occasionally by phases of economic boom (such as the 1920s, the 1950s and 1960s, and then the 1980s).
Many observers have imagined that India’s retail growth would follow the East Asian and Eastern European countries’ pattern, and have projected that India will reach a state of significant consolidation through corporate retail businesses by 2015.
If that were to happen it would be a rather sad “monoculturisation” of the business. Fortunately, I believe, that it is not likely to happen easily.
Firstly, the modernisation of retail trade has typically moved in step with broader economic and infrastructural development. If we use per capita retail sales as a surrogate measure for the overall economic development of a country in conventional terms, the share of modern retail is closely correlated with that (see the accompanying table). Viewed through that lens, the Indian retail sector is still very far down on the list, and is likely to remain fairly fragmented for some time to come.
Secondly, India has a strong entrepreneurial and organic retail ecosystem (not just retailers, but also suppliers and support organisations). Given the diversity of the market, and the sustained fragmentation of consumer needs, I believe the growth of India’s retail sector will not be driven by large companies alone, although they are helping to accelerate the process of sophistication – indigenous, non-corporate retailers and their suppliers have a strong role to play in the ongoing development.
I believe the Indian retail sector will evolve along a path that may be a hybrid, and in fact, may be closer to the European and American model, with a significant amount of entrepreneurial competition dominating the landscape.
Therefore, it is important for the executives in corporate retail organisations to think innovatively, as an entrepreneur would – think truly like a “dukaandaar” (shopkeeper).
Would a dukaandaar open a store in a place where he has no hopes ever of making money? Would he consistently follow this strategy for years? Would he believe that he is building brand equity and goodwill by doing so, that will sustain him in the future? The honest answer to all those questions would be an unqualified “no”.
Any long-term strategy can only be built on the premise that the business will be sustained into that term. If the short-term cashflows are not available to keep the business alive, no amount of long-term thinking will help, as some retailers have recently acknowledged while shutting stores or entire businesses.
It is also important for the corporate dukaandaars to continue to evolve relationships with the fragmented supply base, and support the growth of indigenous national-scale suppliers.
Models for Inclusion
Inclusive growth has become a buzzword in recent years. However, I believe India is one of the few major economies where it is more than just a buzzword.
In 2006, at the National Retail Summit organised by the Confederation of Indian Industry I expressed the concern that we were getting too preoccupied with the western model of urban economic development and consumption and we were ignoring the gap that was creating in India (the text based on that presentation is available on Third Eyesight’s website). To my surprise, I had no fewer than 60 conversations during the day about the subject, many of them with senior managers in large consumer goods and retail companies.
Clearly, the thought of sharing the growth and prosperity more widely does strike a chord with many more Indian urbanites than one would realise. What’s more, quite a few companies are actually taking a direct approach into bridging the gap.
There is no one single model that is applicable to creating these bridges.
Some – large companies such as ITC and Mahindra or smaller ventures such as Drishtee – have created retail businesses that also act as local exchanges of services and goods in the villages. Many of them include villagers as co-entrepreneurs through franchise structures, thus helping to generate and retain wealth within the locality.
Others – such as Fabindia among the visible, or Khamir and Dastkaar – are channels for rural artisans to participate in the economic growth as suppliers to the burgeoning urban demand.
Food retailers have started co-opting farmers into supplying to them directly, where possible. The attempt is to bypass middlemen who act as aggregators, thus making more margins available to both retailer and farmer. Many farmers are indeed happy to put in some extra investment in minor equipment and some effort, to help grade, sort and clean the produce, so as to get a still better price.
Yet, certainly, more could be done. For instance, how about if the largest modern retailers in the country created a permanent display for regional crafts in all their stores, and took these along as they grow their chains in the coming years?
And how about retailers growing businesses through demand generated by economic growth in the much smaller towns? By encouraging regional suppliers and local buying (as opposed to the central purchase mindset), not only would retail chains be better merchandised for local needs, but also be plugged more into the local economy.
Let us not ignore the possibility of local retailers who are right now “flying under the radar” to become important factors in the growth of these smaller towns.
Demand generation in Tier III towns and semi-urban areas will accelerate as the logistical connectivity improves and shipping costs decline through multi-modal transport. There is significant investment happening in both road and rail connectivity, and the newly well-connected dots on India’s map are visibly more prosperous than earlier.
As these developments continue, we should fully expect strong retail chains to begin building up, first locally and then regionally.
When we speculate about who India’s Wal-Mart might be, we shouldn’t forget that the world’s largest company emerged from sleepy, semi-rural locations in the US, and similar developments might happen in India as well.
Facing the Challenges
The Indian retail sector also has some distinct environmental challenges that are bigger than the specific economic blip it is facing right now.
For instance, to my mind retail is an integral part of urban infrastructure, but in most cities retail is a sideshow for urban planners. Either the space provided is too little, or laid out in such a manner that no sensible retailer can expect to have a sustainable and profitable store in that location. Or, if a large space is provided for the private development of shopping centres, the public transportation connections are next to nil, while the car-carrying capacity of the connecting roads is usually poor.
Some of the other challenges are related to the Indian government regulations controlling the sector. As an example, in the area of fresh produce, some states still have regulations that restrict the wholesale trading of the commodities to the mandis, or controlled market yards. This means that the consolidation and processing of farm produce is more difficult and expensive.
Real estate costs are an ongoing challenge for retailers, especially those that wish to develop mall-based businesses. Some mall owners have begun evolving from being “builders” to mall managers with a long-term view on creating a business of shopping centre management, and have begun linking their rentals to the revenues actually generated by their retail tenants. However, in several cases, the real estate costs are still in the double digits.
Reacting to the high real estate costs, brands have begun looking at the possibility of generating higher gross margins to compensate. In most cases, this has meant that selling prices are pushed up, rather than sourcing costs being reduced. While the consumer has been largely transparent to these increases in the last couple of years, I don’t believe this to be a sustainable margin strategy. The cracks are already showing, in the steadily increasing volumes sold under discounts, and the emergence of discount retailers who sell off-season and surplus branded merchandise. The message, clearly, is: the real, sustainable, price is at least 25-40% lower than the MRP. The market looks ripe for the emergence of every-day-low-price business models.
If I were to list out my top priorities for retailers in India, these would be:
1. Realistic demand estimation
Many chains are grappling with too much square footage in a certain geography in the form of very large stores or too many stores. While allowing for the fact that the market is significantly different from what it was 10-20 years ago, let us not expect entire populations to have increased their consumption multi-fold. Sales expectations need to be realistic.
2. Store productivity
For an entrepreneurial business, each store needs to produce results. Sure, there will always be some superstar stores and other locations that are a drag on the bottom-line. The performance needs to be analysed on an ongoing basis, and fairly dispassionately. Store productivity is a function of merchandise availability, store operations, advertising to build customer traffic and a host of other factors. However, unless the store is a marquee location (which very few are), there is no excuse for sustained losses. Fortunately, Indian management teams are today less scared of damage to their reputations, and more business-like when it comes to taking hard decisions on resizing, relocating or simply shutting doors.
3. Pace your growth
Think of a teenager who gets into a growth spurt, and suddenly adds length to his legs. The gait becomes ungainly and he doesn’t really know what to do with the extra inches. Many Indian retailers have gone through a similar disproportionate growth spurt. While stores have grown, the sophistication of the business has not. Let’s remember, the race for retail market leadership is a marathon, not a sprint. The appropriate rate of growth should be determined by organisational capabilities, rather than what others are doing in the market.
4. People
There is no shortage of people in India, as one of the leaders of the industry pointed out a few months ago. Let’s stop creating an artificial scarcity. There are people around who have been in modern retail trade in India for decades and are committed to it – they have the experience. There are others who have only recently entered but need direction and training. The investment in these two sets of people will possibly provide longer lasting returns than artificially inflated compensations for round-robin resumes.
A major “macro” risk to my mind is that retail is seen through narrow lens both by itself as well by as the government and its various arms.
In most cases, the governments various departments continue to treat retail as an incidental trading activity, or as a milking cow through indirect and direct taxes. The outlook towards retailing needs to change beyond the few government luminaries who can be identified as the retail sector’s friends. Whether it is provided “industry status” or not, the fact is that retailing is an industry in India, and needs to be treated with more respect. Even the local kiranawala adds significantly to the community and even the fragmented the market association keeps a vital part of the local ecosystem alive and ticking.
The other side of the story, the retail sector’s perspective of itself also needs to change. Retailers need to look beyond promoting short term consumption. As they grow larger, they are beginning to have a disproportionate impact on society, lifestyles, income distribution and the broader economic fabric of the country. In most developed markets retailers realise how much change they can drive, and many are using this power to benefit themselves and their societies at large. As Indian retailers grow in scale, I think it would be wise to build the “corporate social responsibility” gene into the DNA at this very early stage.
Looking to the Future
Given recent developments, some people may feel that the retail boom is over and it may already be too late to enter the Indian market. I beg to differ: I believe there is still a lot of steam, a lot of energy in the Indian market.
In fact, it would be most appropriate to quote Shah Rukh Khan from Om Shanti Om, “Picture abhi baaki hai, mere dost!” (“The movie isn’t over yet, my friend!”)
The road to modernising the retail sector in India is long, and we have only taken the first few steps yet. Economically difficult times are wonderful opportunities for shedding flab, challenging existing business models and assumptions, and also provide great frameworks for building efficient and lasting companies.
In closing, I would like to borrow a theme from the two great growth sectors in Indian retail: food, and fashion. Both thrive on change. Both thrive on freshness. And that could be the winning theme across the Indian retail sector.
Here’s to a fresh start in 2009!
Devangshu Dutta
October 14, 2008
If you’re like me, then at any given point of time you have a vague idea about what is in your refrigerator, but not quite. That must why we end up buying stuff that duplicates what is already in the fridge.
Here’s an example of what that translates into for me:
At other times, it is the semi-consumed half-loaf of bread that gets trashed half-way through its fossilization process. Or the new flavour of cheese spread, where the price offer may have been tastier than the spread itself.
I sure there will be at least some among you who would have similar stories. (I would be shattered if I’m told that I am the only one with these tales of inadvertent consumption!)
In the normal course, we would not call ourselves excessive consumers. For the most part, we believe we display rational shopping behaviour. We make our lists before leaving for the market and we generally know which shop or shops we want to stop in at. So, why do we end up doubling or trebling our purchases, when we aren’t actively “consuming” double or triple the amount of food?
Well, the lords of marketing spin have mapped their way into our minds. In a strategy that has been proven over centuries, we are offered things ‘free’ or at a significant discount. The very thought of getting something for free, or for less than what it is worth, is so seductive and irresistible.
(As an aside, just look at what has happened during the last few years in the real estate market and the stock market – everyone thought that they were getting a good deal because the stuff was “worth actually more” than the amount they were paying. Not!)
We believe we are being rational in buying the three packs of juice at the price of two – never mind the fact that juice wasn’t on the shopping list in the first place. The danglers and end-caps jump out and ambush us, as we walk through the aisles. The samplers entice in their small voices: “try me”.
You might say that the really traditional kiranawala is the customer’s greatest friend and also a barrier against uncontrolled consumption.
By keeping the merchandise behind the counter or in the back-room, he maintains a healthy distance between the addiction source and all us potential shopaholics. In fact, he goes beyond the call of duty, and even prevents us from stepping anywhere near the merchandise by delivering to our homes.
The enticing deals and offers that you can’t see won’t hurt you. You won’t call to get that new, exciting BOGO (buy one-get one) offer, because you don’t know that it’s there in the store.
Unless, of course, the sneaky brand with its accomplice – the advertising agency – sidesteps him, and puts out the temptation in your morning newspaper.
By now, surely, you’re wondering whose side I am on.
Well, as a consumer and a customer, I am only on one side – mine!
As someone who is intensively involved with the retail sector, I’m also on the side of the brands and the retailers.
And believe me, we are all actually sitting on the same side of the table.
The years in this decade, after the recovery from the minor blip of dot-com busts, have been like one mega party and most people have forgotten that parties seldom last forever. And the morning after the wild party can start with quite a headache.
Retailers and brands have recently acted as if there is no end to multiplier annual growth rates, and consumers have been only to happy to prove them right. Until now.
Currently, we are passing through a fairly serious global economic correction which started in 2007. But it has only really hit hard in the last couple of months, as the headlines have increasingly started talking about recessions and depressions. Naturally, there are some people who have really lost money, others may be looking at the possibility of lower income. But even those people who sustain their current incomes are “feeling poor”, just as they were “feeling wealthy” when the markets were booming.
Of course, superfluous or discretionary expenditure such as movies in multiplexes, eating out etc. are the first to get hit. But should grocery retailers rest easy – after all, people still have to eat, right?
And how about deals, and multi-buy discounts – isn’t this the scenario where “more for less” will be the strategy which will work?
Well, I don’t believe it is quite so cut-and-dried, or quite so simple. The grocery shopping lists will not only become tighter, but will also be more tightly adhered to. Anything that looks like it may be a wasteful expense will be unlikely.
Remember the deals in the fridge? What you are throwing away now starts looking like money being put into the trash.
Pardon the seemingly sexist remark, but men: your wives will not let you get away with driving your trolleys irresponsibly into aisles where you are not supposed to be!
So how should retailers and brands respond?
Well, a good starting point would be to understand what the real market is. Let us not infinitely extrapolate growth figures on a excel spreadsheet on the basis of the early-years of new businesses. Let us not extrapolate national demand numbers from the consumption patterns of select suburbs of Delhi and Mumbai.
When we have the numbers right, let’s look at the business fundamentals at those basic levels of consumption. Is there a viable business model?
Is the business full of productive resources, or are we overstaffed with “cheap Indian labour”?
Is your modern retail business or your food / FMCG brand really providing value to the Indian consumer? For instance, two very senior people from large retail companies were very vocal this last weekend in stating that the value provided by local business to the value-conscious consumer was grossly underestimated by the industry.
I believe that best filter for business plans is the filter of business sustainability. How sustainable is the business over the next few years? What is the real demand? What are the true cost structures, and can these be supported on an inflationary basis year-on-year, or will you be squeezing the vendors for more margin at every stage until the relationship goes into a death spiral?
Let’s look at macro-economics. Are you actively looking at generating and spreading wealth and income around, or is your focus only on stuffing that third pack of juice into the fridge for it to go stale? If your strategy is the latter one then, to my mind, that is neither a sustainable economic model nor a sustainable business.
There’s more about the current and developing economic scenario, “realistic retailing” and other such issues, elsewhere on the Third Eyesight website and blog, including a presentation made at the CII National Retail Summit in November 2006 (download or read as a PDF). (The article based on that presentation is here.)
I really look forward to your thoughts and would welcome a dialogue on how you believe retailers and brands should work through the next few years as we unravel the excesses of the recent past.
Devangshu Dutta
May 25, 2008
A few days ago, I wrote about the possible “Dis-economy of Scale”, when we start to add up the hidden costs in industrial agriculture.
I’ve just found an interesting article from Fortune about Jason Clay, described as a “thinking environmentalist”.
He calls for intensification of agriculture, and “economies of scale”. However, the critical departure from usual proponents of industrial farming, his view is to make agriculture “both more productive and sustainable” (i.e. “generating more output from fewer inputs”).
I wonder if that means using truly fewer inputs through the entire chain. That is really the key, since the current intensive and industrial model of farming actually seems to use more input (fuel and production) calories to produce fewer output (food) calories. Unless that changes, the model of industrial agriculture is unsustainable over time.
(The earlier post is here: The Dis-Economy of Scale)
And while we are on the subject of sustainability, it’s always good to remember that human beings haven’t suddenly become rapacious in the industrial and post-industrial age. We’ve displayed similar behaviour of overdoing things over centuries – a good book to pick up is Jared M. Diamond’s “Collapse: How Societies Choose to Fail or Succeed”. (Here’s his profile on Wikipedia, and book on Amazon).
Devangshu Dutta
April 2, 2008
I had the privilege of bringing the Prime Source Forum in Hong Kong (April 1-2, 2008) to a close. As in the previous year, the Forum had senior executives from companies based in the Americas, Europe, and Asia, as well as government officials and highly respected academics. The discussions covered wide-ranging topics, and with the variety of people on the panels, there was also some amount of difference in opinion.
8 issues came to my mind as key themes for the global industry, as I was preparing my closing speech, and I thought that those who were not present at the event may also be interested in these. Some of these are views expressed in the panel discussions, others are just my musings. Hopefully thinking through these 8 things can improve the fortunes of the industry around the world (8 being a lucky number in China).
1. Costs vs Prices – Rising costs were a big theme, running through the various panels. Chinese labour costs, power costs, the increasing costs of fuel, new costs of doing business (compliance) – more cost heads were discussed than I can possibly remember.
Once upon a time prices used to go up when costs went up. But that has not been the case for at least the last couple of decades. Even as costs have climbed, retail prices and FOBs have remained steady or even declined. Clearly, the question is whether this is a sustainable situation – though consumers and retailers have been winners so far, how long can factories and labour be squeezed without impacting the very survival of the business?
The interesting contrast is luxury goods, where production costs have come down due to outsourcing and manufacturing in low labour cost countries. (So even in that area, prices and costs don’t show a correlation!)
2. Where next? – Dr. William Fung (Li & Fung) clearly struck a note with most of the audience in his opening keynote address, as he tackled the BIG question: with costs significantly rising in China, and the risks of a concentrated sourcing basket, which other countries could companies look to. According to him, “within the next 3 years, the follow-up country to China is…China”.
After all, which other country’s industry has poured billions of dollars in up-to-date manufacturing capacity and supply chain infrastructure? So even while the Chinese government’s move to push factories to the north and west of China may be producing results as quickly as they may have hoped, buyers clearly have limited options on the table.
Certainly, other countries such as India and its neighbours, as well as Indonesia, Vietnam etc. are an option, but a lot more needs to be pushed through. According to Dr. Fung, India shows higher product differentiation and development skills that make it a logical place for buyers to invest time and energy.
I believe that what buyers did in China 15-20 years ago, is probably what is needed in South Asia and other supply bases now. At that time, China had neither the production capacity nor the supply chain and other infrastructure that it has now. But intrepid buyers opened the Chinese frontier and created the demand pipeline which pulled the supply base up. Would retailers have a similar focus on the other supply bases today, to balance their exposure in China? This is not a new question – in fact, in the last few years it has come up several times when there has been a hurdle or barrier to cross with China (quotas, SARS etc.). But now, with the Chinese government also wanting to turn the industry’s focus away from low-value products such as clothing and textiles, could this be the opportunity for buyers to push their initiatives in other countries ahead?
3. Fashion is about change…but are we prepared for change? – Speed to market is not just about producing quickly and shipping fast, it is about responding to change in the market. The very nature of the fashion business is “change”.
Though benchmarks of 2-week turnaround and even 2-day turnaround exist, by and large the industry works over a lead time of months rather than weeks. We know that it is humanly impossible for even the best buyer to predict with 100% accuracy as to what will sell 6-12 months in the future.
So the answer, especially in these uncertain market conditions, is to take product decisions closer to the sell-date, rather than try and forecast accurately. The only way to reduce the risk is to respond to market needs, rather than to try and predict what the market will need in the future.
4. Neither free nor fair! – There was enormous debate (although mostly in polite terms), about whether free trade and fair trade meant anything.
What is very clear is that trade barriers continue to exist. Even as import tariffs fall, non-tariff barriers remain in place. While thousands and tens of thousands of people around the world are actively working to bring trade barriers down in all countries, within their own markets there are others who are actively lobbying to keep trade barriers up, or to erect new ones. A very interesting perspective shared by one of the panelists was that to a protectionist, “protectionism” isn’t a dirty word! Such a person will have a clear justification for keeping or putting up trade barriers.
So while the vision is that of free trade between nations, we are probably some way off from that.
5. CSR & compliance pressures – “Compliance pressures” are here to stay. Yet, even after years of debate and discussion, it is evident that there are wide gaps between the perceptions of the various players.
Ever since the industrial revolution in the 1800s, talk of more humane conditions in factories has been prevalent. It took European and American companies decades (at the very least) to move up health & safety and labour standards. However, the industries in the current supply countries do not have that luxury any more, since the pressure on prominent brands and the risk to their image is too high – whether you like it or not, compliance standards are being and will be pushed through aggressively.
The key is to understand how to do it most efficiently, and a critical element in getting there would be to have a set of common standards and database of audits and certifications.
However, let’s not underestimate the challenge in getting diverse interests and competitors to agree to sign on to common standards, and to share information about their suppliers.
6. Consolidation (?) – Consolidation may be a model among mature retailers and mature suppliers, but there is enough organic growth in the market to attract and sustain smaller companies, especially in the case of the “emerging economies”.
Developing markets are breeding grounds for new businesses, each of which feels that they can be the next big thing, and in such an environment, being acquired by another company is the farthest thought from the management’s mind.
Another factor against consolidation on the supply end, comes from the inherent development-oriented nature of fashion products – excellent and innovative product development is not the privilege of large companies, and the cost of entry remains low. So we should question the logic of viewing consolidation as an unstoppable juggernaut.
7. Vertical Integration / Control (between suppliers, brands and retailers) – When companies sit across the negotiating table, they are clearly vying to gain the most margin. Retailers are closest to the consumer, and they have the most margin. The downside is that they also bear the most risk or markdown. So when manufacturers look at becoming brands, and brands look at becoming retailers, they need to keep in mind, there is a cost to moving downstream, even with the extra margin being available.
Over the last few decades retailers have also tried to grow their private label to gain extra margin (in effect, to replace some of their suppliers) – but there is a cost to doing that as well. It is not as simple as just stripping out an intermediary’s cost, since the product development and sourcing operation still needs to be managed.
Vertical integration is the holy grail – perfect vertical integration is what people wish for, but it’s impossible to achieve. The best one can hope for is as much vertical control as possible over the chain from raw material to consumer.
8. Victims of our own success – We treat globalisation as a new phenomenon – the fact is that many thousands of years ago, the Egyptian civilization was trading with the Indus Valley civilization, the Chinese and the Romans had discovered each other way before US department store buyers landed in Hong Kong and Korea.
As Nayan Chanda describes in his excellent book – Bound Together – traders, preachers, adventurers and warriors have created bridges across continents for tens of thousands of years. So retailers and importers in the west, are only following in the footsteps of those pioneers, albeit helped by the communications and travel revolution in the last 30 years.
However, lately, companies’ business models are victims of their own success.
Too much has been outsourced too far. Where earlier, buyer and supplier were next to each other, today there is a physical and cultural distances between them, that sometimes seems impossible to bridge. Where earlier, a buyer and designer could pop around the corner to the pattern room to check the fit, and discuss the quality with the factory, today they sit at opposite ends of the earth, and work in a phase difference of day and night.
The costs related to bringing the skills back certainly are prohibitively high. But clearly bridges do need to be built.
Recreating or transferring the skills that have been lost, or are being lost in the US and Europe is absolutely vital for the industry to survive profitably.
Through training & education, through more frequent travel, through internships and gaining work experience in each other’s environment, or through technology, buyers and suppliers need to invest in reaching something of the sort of understanding and close collaboration that used to exist when buyers and suppliers lived in the same city.
A lot to chew on, and many unanswered questions, which I am sure will bring hundreds of industry executives together again next April at Prime Source Forum 2009 in Hong Kong.
Sharmila Katre
March 5, 2008
“Social entrepreneurs are not content just to give a fish or teach how to fish. They will not rest until they have revolutionized the fishing industry.”
– Bill Drayton, CEO, chair and founder of Ashoka, a global nonprofit organization devoted to developing the profession of social entrepreneurship
One of the exciting by-products of the increased awareness and practice of corporate social responsibility has been the emergence and growth of social entrepreneurship as a serious social and ‘business’ trend in the last two decades. The potential of successfully marrying the competencies of business generating sources and markets, with solutions to social and environment issues is the main principle that underlies the concept of successful social entrepreneurship.
Today’s social entrepreneur is a dynamic, committed and driven individual who is able to identify sustainable solutions to social problems. He uses earned income strategies to pursue a social objective, and the outcome is directly connected to his commitment to resolve the social or environmental malaise he chooses to address through this enterprise. The profitability of a social entrepreneurship is driven by both financial and social returns, with the financial returns being redeployed into the enterprise to further its growth and sustain the ‘business’.
The future of permanent and lasting social change lies in the ability of these social enterprises becoming independent and self sustaining, moving away from philanthropy and becoming financially independent.
Modern day social entrepreneurship therefore, is actually about sustaining social change and growth through self-sufficiency instead of charitable contributions and government grants and subsidies.
