(Published in “BusinessWorld SME Handbook 2012-13”, released on Oct. 29, 2012 in New Delhi, and “Indian Management”, the journal of the All India Management Association in January 2013, published by Business Standard.)

There are parallels between Christmas and the growth of modern retail. At Christmas much of the attention is fixed on Santa Claus, while the elves labouring away behind the scenes barely get any air-time. So also in the retail business, the focus very much is on the retailer; the bigger the better.

The Indian retail sector’s sales are estimated at about Rs. 26 lakh crores. Of this, more than 80% of the product requirements are estimated to be met by small or mid-sized businesses. We don’t usually think about these myriad manufacturing and trading companies that make up the retailer’s supply chain. Large branded suppliers – multinational or domestic corporate groups – are still able to make their presence known, but most others remain largely invisible. Many of these fall not just into the small-medium enterprise (SME) classification, but in micro-enterprises, even cottage-scale. Not only do the large retailers source from SMEs directly, those small suppliers in turn work with other upstream SME manufacturers.

Chicken or Egg?

Most of us are inclined to view the growth of modern retail as a precursor to the growth of the SME sector. Actually the reverse is equally true, perhaps even more so. Without a robust base of suppliers having taken the initial risk of setting up better-organised manufacturing facilities and supply chains, modern retailers would not be able to set up their businesses in the first place. We may view modern retailers as the catalyst for this development; however, they are first beneficiaries of SMEs, and only after they achieve critical mass can they catalyse further SME growth.

For instance, through the 1950s and 1960s, as the American and western European economies grew with the baby boom, it was the growth of manufacturing entities and brands – most of them SMEs – that led the charge. As these SMEs consolidated their growth, modern retail chains actually rode upon this. Subsequently, of course, retail chains have put most of their suppliers in the shade in terms of overall size and profitability. Japan in the 1960s and 1970s, Taiwan and Korea during the 1970s and 1980s, and China during the 1990s and 2000s also saw similar manufacturing-led prosperity and consumption, although their growth was driven initially by exports to the west.

In India, too, the tremendous social and economic changes in the last two decades have encouraged a resurgence of the entrepreneurial spirit. The consumer sector is specifically attractive to entrepreneurs as something that is tangible, provides visibility of the business fairly quickly and can be communicated and positioned well within the entrepreneur’s family and social circle, an important driver.

The Rationale for Supporting SMEs

We tend to ignore the fact that India has a workforce estimated at over 750 million, and which is growing annually by 9-10 million. Most of these people will not be employed by the government, or in large organisations or in the much-feted service sector. Allowing for a declining active employment in agriculture, it is manufacturing, trading and retail by small businesses that is needed to keep the economic engine running.

It is also important to remember that growth of SMEs raises prosperity rather more equitably than other sectors. Widespread growing incomes lead to growth in consumption, supporting retail growth, which in turn can feed back into further growth of SMEs. There are enough significant examples of such economic growth worldwide, whether we look at economies such as Western Europe and Japan recovering from the ravages of war, or at the Asian tigers, China and others emerging countries who’s GDPs are not overly dependent on extractive natural resources.

Innovation is another reason to nurture SMEs. Consumer needs are changing more rapidly than ever before in India’s history, with rising incomes, and evolution of life styles and social structures. Small companies are better at foreseeing or at least reacting to rapid changes. Large companies compete on the basis of their sheer scale and aim to maximise returns from every investment made, but small businesses have no choice but to be innovative in some way simply to enter the market or to stay in business. Experimentation with products, business models, service level and commercial practices is what SMEs thrive on. Differentiation is what makes small suppliers attractive to retailers. With the technology and tools available today, we should expect ever increasing amount of innovation to emerge from small rather than large companies in the consumer sector.

Small suppliers also provide diversification of supply risk for individual retailers, as well as for the market overall. Concentrating on a few large sources has, time and again, proven to be a risky approach, whether it is due to the balance of power tilting unduly towards a specific supplier, or simply the risk of product not being available in case the dominant large supplier’s business is affected. A mix of small suppliers is more like a supporting cushion – a bean bag, if you like – which can be adapted and moulded more easily to changing customer needs.

The Role of Modern Retail

There are three areas in which modern retail can be a significantly more important partner for SMEs than traditional channels.

Firstly, modern retail stores are possibly the most effective route to launch new products, or even entirely new categories. As a platform they offer a more consolidated and effective way to reach a new product to consumers, and to gain visibility and acceptability quicker.

As a follow-on to this, due to their innate need to scale-up successful initiatives, a product and or a service proven in one store or region would typically get included in buying plans for the retailer’s stores across the country. This provides a quicker and more efficient scaling up opportunity than the small brand or supplier trying to reach myriad stores across the country on its own.

Third, whether it is quintessentially Indian brands such as Fabindia, or Indian products through international brands and retailers such as Monsoon, Gap, Mothercare, Ikea, Marks & Spencer, these are but a few examples of the access route for small Indian companies to major world markets. In fact, B. Narayanaswamy suggested in an article titled “Opportunity Lost is Gone for Good” (July 2012), that the Indian government should negotiate hard with retailers interested in investing in India to open supply opportunities to the retailers’ businesses globally, rather than putting minimum sourcing requirements for the small Indian business alone which only act more as a constraint than an enabler. The government has, in the past, used such opportunities to allow investment in the consumer sector while enlarging the playing field for Indian businesses – Pepsi is a case in point.

For some companies, modern retail is in fact a launch pad for wider ambitions, as they evolve into building brands themselves. Mrs. Bector’s has grown from a contract supplier to the likes of McDonald’s to launching its branded products not only in India but also in international markets targeting Indian expatriates. Genesis Colors went from being a Satya Paul licensee for ties to being the owner of the brand, and then further to being a partner for many internationally established premium and luxury brands who want to be part of the India growth story. Others become growth vehicles for larger businesses after being acquired by them, such as ColorPlus by Raymond, Fun Foods by Dr. Oetker (Germany) or Anchor by Panasonic (Japan).

Making Business Easier

India is one of the few countries to have a Ministry dedicated to SMEs. However, India’s SME sector is very far from competing effectively with SMEs in other countries.

The German Mittelstand employs more than 70% of Germany’s workforce and is acknowledged to be at the leading edge of technology and efficient business management. Other western European countries such as the UK and Italy also have vibrant SME sectors. All these countries have not only been competitive globally as exporters, but have also co-opted into the growth of industries elsewhere including the BRICs.

Three enormous obstacles stand in the way of the growth of India’s SMEs, as a huge amount of entrepreneurial energy is wasted tackling these areas. The government certainly has a large role to play in all, but one of these is also the responsibility of large corporate groups.

The lack of adequate infrastructure is arguably the most recognised obstacle, followed by compliances that can hold SME operations hostage under outdated laws, many of which have not been reviewed since India had an Empress! Entrepreneurs and businesses lose millions of manhours annually managing these two areas.

However, the one area in which not just the government but large retailers can play a role is in ensuring that SMEs are funded adequately. Bank sources in the form of term loans and working capital limits is only the start. The rest comprises of actual cash flow, much of which are limited by the long credit period demanded by retailers. Payment can stretch as far as 6-8 months, and include sale-or-return terms which squarely place the burden of funding the retailer’s business on the SME supplier. Unless we can mandate better payment practices, the boom of retail giants will be created using millions of dead or barely alive SMEs as building blocks. And what we don’t realise is that the retailers’ own health is also at stake, because lazy payment terms create a maze of poor practices, from product planning at head office all the way to the retail store. For instance, products that will not sell get stocked for short-term margin through placement fees, and block shelf-space and cash flow that affects other suppliers. Promptness of payment to SMEs must become a metric to measure the health of retail companies – after all, what gets measured gets tackled. And for the proponents of “Corporate Social Responsibility” – what better way to promote CSR and wide-ranging economic well-being than by ensuring the the smaller businesses in the ecosystem are not starved of the funds that are rightfully theirs!

SMEs are not just the foundation, but also the beams and pillars on which the glass and steel cathedrals of modern retail are built, and a vital indicator of the economy’s overall health. The sector needs to be tended to proactively and holistically, both by government and by large businesses, as an investment in India’s economic future. Perhaps we will even create some world-beating companies along the way.

REVIEW: DISCORDANT DEMOCRATS: ARUN MAIRA (Penguin Books India)

As I read through Arun Maira’s book, the month unfolded with a number of high-pitched disagreements around the world. In India, quotas and reservations were a hot topic, as was an apparent divergence between the Prime Minister and corporate chiefs on executive income and distribution of wealth. Self-appointed moral police disapproved the expressions of a student of art, while, elsewhere in the world, suicide bombers expressed disapproval of foreigners on their soil.

We are surely not the first to wonder why, after millennia of physiological evolution, societies around the world are still stuck in the same, predictable response: where disagreement (on an issue) translates into disapproval (of a person), more often than not leading to conflict that is frequently violent.

The need to accept differences and the use of democratic dialogue as a process to close the gap is the basis of Arun Maira’s Discordant Democrats. While the book is largely about democracy in India, Maira draws from events, personalities and initiatives around the world to make the case for democracy as the only reasonable mechanism to manage diversity in society, and dialogue as the only reasonable mechanism to sustain it.

This is embodied in a quotation that is commonly attributed to French philosopher Voltaire: “I disapprove of what you say, but I will defend to the death your right to say it.” In fact, Maira goes beyond free speech to the need for mass dialogue. While free speech typically stops at the “right to express different opinions”, dialogue is about the free “exchange” that can move people closer. Dialogue, unlike debate or argument, is not about sticking to one’s own point of view but about parties reaching a consensus through a process of mutual expression and understanding.

When comparisons are made between Communist China and democratic India, democracy is presented as the millstone around the neck of India’s development. India has a demographic diversity that is among the highest in the world, and a body politic that is among the most fragmented. It is the disagreements among the various segments, interest and pressure groups that some people often hold up as the biggest hurdle to India’s economic and social progress. On the other hand, the advocates of “democracy in action”; may hold up noisy debate as the true expression of desires of individuals and small, otherwise powerless, groups. And there is little common ground between these two groups.

But, as Maira writes in the preface: “This book is about democracy and about consensus: two ideas that cannot but be associated with India. Indeed, one must wonder whether India could be one country without democracy or without consensus.”

Maira takes a middle path, in differentiating between the “hardware” and the “software” of democracy. He describes the hardware as the mechanisms that we are all familiar with — the Constitution, devolved institutions and the framework of free and fair elections, whereas the software is dialogue and deliberations. The democratic hardware enables the freedom of divergent expression. But it is the democratic software that enables a convergence to consensus and the emergence of a functional rather than dysfunctional society.

This is an important distinction when we examine the relative success or failure of countries that are all apparently democratic in structure. Most elections may be free and fair, but are the results later really representative of the electorate’s wishes? From what we can see around us, the hardware of democracy is robust, but there needs to be greater emphasis on the software.

Maira devotes the latter part of the book to tools that he calls Weapons of Mass Dialogue. Using topical and real-life instances of the dialogue mechanism being applied, he takes the reader through the steps of creating a common aspiration, exploring and identifying the thought anchors of the parties in the dialogue, framing the situation and then arriving at a solution.

As a comparison, the example of a Native American tribe comes to mind. To resolve conflict between members, the tribe follows a structure that requires a member to silently listen to the other’s views and then express that person’s views back to him until he or she concurs that the listener has completely understood what has been said. Only then does the first listener get the opportunity to express his own views, while the first speaker only listens and then reiterates what he or she has heard.

This mechanism may appear lengthy in most modern debates, but when we are dealing with issues as complex as the evolution of our cities or the uplift of disadvantaged castes and socio-economic classes, do we really have any other option?

Our genetic response to crisis is hard-wired from our days in the wild: fight or flight. While the latter is clearly “escape”, the former is also an “exit” because it shows an inability to deal with a discord to a mutually satisfying result. We need to expand this to a trinity of responses that includes “unite” – an integrative process that can help cope with the complex and interrelated world we live in.

The tools may look contrived and slow to those championing the cause of “action” there are few alternatives to dialogue. But in a world where discordant democrats do not often listen to each other, Maira’s Weapons of Mass Dialogue are definitely worth a try. Here it is on Amazon.co.in.

EXCERPT:
We want action. And we want democracy. Sometimes, in despair, when that speedy action is difficult in democracy, he seemed willing to forsake democracy. But that is a cop-out. We have to find a way to have both – speedier action and more democracy. Once again, a very important “either-or” choice is raising its head. We must convert it into a ‘both-and’ solution. As Einstein said, we cannot solve the difficult problems that we face with the same thinking that led us into those problems. Rather, we must look into the theories-in-use that are causing the problem, and develop a new one. In this case, the problem with our theory-in-use of how people can work together to resolve problems that they are all part of. The call for an authority above them, “insulated from the intense pressure of democracy” – a dictator or expert that they would be willing to unquestioningly delegate upwards to – is giving up on the further evolution of humanity’s democratic enterprise.

[Here’s the book on Amazon.co.in.]

In February, just before the mega-blitz of “India Everywhere” at the World Economic Forum, the Indian government took a step forward.  Amidst shrill outcries from its coalition partners and domestic anti-FDI lobbies, it finally decided to bell the cat, and let foreigners invest in retail again!

About a month has passed since the cabinet announcement, the dust has settled, and it is a good time to consider what has happened.

Since the initial euphoria of the early-to-mid 1990s when international retailers entered the market including companies such as Benetton (50% JV) and Littlewoods (100% subsidiary), this revised policy provides the first opportunity for large global companies to participate in the Indian market’s growth.

The key questions being raised are:

• Will the new policy bring in a rush of companies?
• Will domestic retailers be able to stand up to the competition from foreign retailers?
• What impact will it have on manufacturers?

What Is Allowed, and Who Might Enter?

Let’s first deal with what the government has actually allowed. In a nutshell, a foreign retailer can set up a company in India in which it holds 51% equity, the balance being held by an Indian partner. This subsidiary can operate retail stores in India under one brand name.  All products in the store must also carry the same brand name, and this branding must have been applied during the process of manufacturing.

This means that, as yet, a foreign department store selling multiple national and international brands cannot set up its own 51% owned operation in India.  Nor can a supermarket or hypermarket chain like Wal-Mart, Carrefour or Tesco, sell their wide range of products under any name but their own, if they decided to take a majority stake in a retail operation.

In theory, you could have a Wal-Mart store selling Wal-Mart cola (not Pepsi), Wal-Mart butter (not Amul or Mother Dairy), Wal-Mart chocolates (not Cadbury’s), Wal-Mart cookies (not Britannia or Sunfeast), Wal-Mart T-shirts (not USI or Duke).  You could have Tesco jeans (not Levi’s or Numero Uno) or Carrefour luggage (not Samsonite or VIP).  This obviously dilutes the consumer proposition of the store, which may then have to primarily focus on a single-point agenda – such as low prices – to draw consumer footfall.

On the one hand, the cabinet decision clearly allows companies such as Starbucks and The Body Shop to step in with a majority stake, provided the branding is clearly by the primary name (store name) – thus, you may not be sold the famous “Tazo Tea” in Starbucks, but get “Starbucks Tea” instead.

However, to a brand such as Starbucks, this policy change is significant as its international expansion is largely through owned operations, especially in potentially large and strategic markets such as India.  Starbucks would now have the option of not only controlling the retail operation through a 51% ownership, but also the raw material sourcing, storage and wholesale operation.

On the one hand, this may mean nothing to a retailer such as The Body Shop, whose international strategy in Asia has been largely driven through franchise relationships.  This is true now of India as well, as The Body Shop announced its master franchise arrangement with Planet Sports in India.

A retailer such as Gap would need to set up separate retail operations for Gap, Old Navy, Banana Republic and Forth & Towne.  There obviously are ways to consolidate operations even with the diverse retail corporate structure, but it does mean that the foreign retailer will be operating several corporate entities in India.

An existing company such as Benetton does not benefit from this change in regulation. In 2005 Benetton actually increased its stake in its joint-venture to 100%, but in the bargain had to forego the stores it was running. Its current network comprises entirely of franchise stores, and will have to remain so, unless Benetton reduces its stake to 51% in order to be able to run stores in India, which is highly unlikely.

Other existing international brands such as Levi Strauss, Adidas and Nike are not retailers in themselves, and are not dramatically affected by the change in policy at all.  All of them operate subsidiaries in which they have complete or majority ownership.  Brands such as Tommy Hilfiger, Wrangler and Lee are also present through licence or franchise relationships, and unlikely to change their strategy.

Will Global Retailers Come?

All of this obviously raises the question whether government regulations preventing foreign investment in retail were or are actually keeping foreign companies out of the Indian retail market.

The answer to that is both “No” and “Yes”.  The reason is that companies that are looking at international expansion apply criteria that are specific to their own business needs which can lead to very different evaluations by each company.

Laws allowing or preventing FDI in retail are only one of the several factors that any global retailer would look at, when considering a market.

Other factors, such as various market options possible at the time, the state of development in the market, existing sourcing and other relationships, scale and scope of investment required vs. the rate of return expected, the risk factors involved, and the retailer’s own business strategy, all play a part in their decision-making process.

Thus, in one company’s case India may be the hottest market in which it would like to open a store at the earliest possible date this year, while for another company India may be of interest only after 5-7 years.

Opening single-brand retail to foreign direct investment, therefore, is at best an encouraging signal that the government has provided.  It is unlikely to prompt international retailers to look at India any sooner than they might otherwise have.

The second key issue is whether FDI itself is of any consequence to whether the retailers enter India.  This again is related to the individual retailer’s own strategy and business context, as well as how they perceive the risk-return ratio.

Thus, while China may not have any restrictions on foreign investment in retail, western retailers may still prefer to go with a local partner due to the differences in cultural and market nuances.  Even in other unrestricted markets international retailers may prefer to enter through licensees or franchisees because the effort and investment in setting up their own company may not be compensated by the size of the opportunity, or their own investment strategy may not be in line with setting up international subsidiaries.

Some companies such as Wal-Mart, Tesco, Gap and Starbucks prefer to invest in international operations themselves, as ownership gives them a higher degree of control over the business.  Of course, both Tesco and Wal-Mart have set up joint ventures in markets that are starkly different in cultural and business norms from their home markets but, by and large, where feasible these companies prefer majority or 100% stake in the business.

Other companies, such as Mothercare, Debenhams and The Body Shop, have expanded their international presence through franchises.  Their premise is proprietary product and an enormously powerful brand that translates well across cultures.  These companies have taken the less intensive route of franchise.  In India, too, they have signed master franchises. Mothercare has assigned master franchise rights to the Rahejas’ Shoppers Stop. Debenhams and The Body Shop have both signed up with Planet Sports (soon to be renamed Plant Retail), which is also the franchisee for Marks & Spencer.

Thus, while allowing FDI may help some companies, it is unlikely to have investors beating down the door in a rush to enter.

What Does FDI in Retail Mean for India?

Permission for foreigners to invest in retail businesses in India obviously mean different things to different stakeholders in India.

For real estate owners, especially shopping centre developers, new entrants are always welcome, since it provides a wider basket of brands to present to the consumer, and the opportunity to differentiate one shopping centre from another.

To existing retailers, it does mean potentially more clutter in the market, possible higher marketing expenditure for them to maintain their position.  However, it also means that more players can encourage the growth of the market, which otherwise can end up looking stale and in-bred.  Brands that are entering the market for the first time can also bring fresh ideas in terms of merchandise, store planning and display, advertising etc.

To the question of whether Indian retailers are prepared to handle the competition, I would say that, while global best practices help, retail is a uniquely local business.  Indian retailers who bother to listen to the consumer and constantly upgrade their own business are possibly in a stronger competitive position than a foreign brand that wants to impose its own alien sensibility on the market.

For suppliers, new brands bring in new avenues for business growth.  Many of the international brands will look to increasing their sourcing from India, to take advantage of local labour costs and skills, or to down-play the disadvantage of duties on imported merchandise.  Thus, especially for suppliers of fashion goods this is definitely a growth opportunity.  Retailers might even prefer to work with the supply base from which they already source for their operations in other markets.  Thus, the growth opportunity exists for exporters – the question is how many of them are willing and able to make the transition to begin supplying locally.

Not only do new retailers bring the prospect of increased business, but also the possibility of better systems and skills, improved product development, and in all, an opportunity for the supply base to upgrade itself.  This will certainly have a positive fall-out for exporters, since their business is likely to become overall more competitive globally, too.

Let’s consider another stakeholder, who we tend to miss – the government itself.  Organised retailers, including global companies, tend to be more constrained by law than a retailer from the unorganised segment. Based on that assumption, a large international retailer (and his Indian counterpart) will set up a local company that will carry out business by the book, recording all sales and purchase transactions.  All local sales and purchases will be subject to VAT and sales taxes, while all imports would be documented and therefore subjected to import duties. All of this means more revenue for the government.

On the other hand, do foreign retailers pose a threat at all?

Well, there is certainly a threat to those retailers who insist that the market needs to remain structured the same way that it has been for years, and who refuse to upgrade their own business. There may even be a threat to the large Indian corporate retailers who are competing on the basis of their scale relative to the rest of the market.  With the presence of global retailers with deeper pockets, these large Indian retailers will no longer be the big boys on the block.  But the positive outcome for the many seems to outweigh the negative outcome for the few.

What I would certainly like to see is how quickly the government translates the promise of opening into a concrete plan that can benefit the Indian consumer, the Indian supplier, the Indian real estate market and the government itself.