Devangshu Dutta
May 18, 2006
When I am at the receiving end of expectations, business plans and such like, of companies that are looking to ride the current retail boom in India, one thing stands out, and scares me the most: the opening slides, paragraphs or pages that are devoted to the “opportunity presented by India’s booming middle class and its rising income”.
In the previous part to this column (“The Case of the Missing Millions“, 27 April 2006), we concluded that for most international companies looking at India, the potential target market was in the region of 18-19 million people, or over 3 million households. When international companies look at the “middle class” they may be looking at annual household incomes adjusted for PPP in the region of US$ 40,000 (Rs. 5 Lakhs, in absolute terms, not adjusted for PPP), and this population number is what appears on the radar.
Clearly, this less than a tenth of the figures around which many new businesses are being launched in the hottest retail market globally (as global comparative studies are stating). 200 million, 300 million – take your pick – they’re all in the mythical range!
So is it time to put out a missing persons alert for the hundreds of millions of so-called “middle class consumers”, on whose back the current retail boom is to be built?
Hang on – the trick is in changing the frame of reference. Let’s first define what the characteristics of the middle class should be.
In my opinion a good starting point is a simple one – look for a segment that is on the middle of the income scale.
Most marketers and their reference guides live in a high-income urban India paradigm (read, Mumbai, Delhi, Bangalore). Passing out of even a second-tier business school today, starting salaries can easily be over Rs. 20,000 a month. When you get into the middle-management segment, metropolitan salaries in the private sector can easily be Rs. 35,000 – 50,000 a month. This may not sound like much money when you live life from the Delhi-Mumbai-Bangalore paradigm, but trust me, it is still a very large sum of money as you go further down the list of cities and towns in India. In those towns and in semi-urban and rural India, the rupee goes a much longer way.
However, the income scale can be defined subjectively by different people.
So, to this evaluation I would add one other important attribute – this middle segment should be a substantial proportion of the total population. Clearly, a population that is only 2 to 3 per cent of the total is still very much at the narrow tip of the pyramid. We definitely need to move further down the income scale to find the real middle class.
The next annual household income range defined by NCAER is Rs. 2 Lakhs to Rs. 5 Lakhs. Now it starts to get interesting. In this income segment we are talking about approximately 9 million households or a little under 50 million people. An income of Rs. 2 Lakhs (US$ 4,500 in absolute terms) is equivalent to a little over US$ 16,000 by PPP, which is well below middle-class standards in developed economies. However, in India an income of Rs. 16,700 per month brings a number of aspirational and discretionary purchases within reach. This size of population is about the same, or larger, than many countries in Europe and will grow to 70-80 million by the end of the decade.
However, as far as my criterion of significant proportion is concerned, this still doesn’t cut it – we’re still only in the range of 6 per cent of the total population. We need to move further down the income scale, to the Rs. 90,000-200,000 annual household income range.
Bingo!
NCAER identifies this segment as having over 41 million households – that is over 225 million people – about 22 per cent of the total population. Large towns (population of over 500,000) have about 30 per cent of this population, while rural India has about half of this income group.
Earning between Rs. 7,500 a month to over Rs. 16,000 a month, this is the population that, in my opinion, is the real growth engine for the great Indian retail dream. This population has discretionary income, and yet it spends with discretion, if you will pardon the pun. It is a population that is only just beginning to be touched by cashless spending, a population that is beginning to appreciate the comforts and conveniences of modern retail, and its power as a driver of markets. It is possibly more firmly rooted in Indian traditions than aspiring to move to western standards. It is a population that is probably discovering the benefits of investing as much as it is the joys of spending thus reducing the free cash available.
Many brands are ending up planning for the 150-200 million real middle class population, while offering products and prices that are more appropriate for the ersatz “middle-class” of 15-20 million.
Consumer markets are structured around obsolescence, replacement and repeat purchases. If your product fits well within the price-value equation for repeat purchases, you have a winner. If you don’t, then what you get is a bunch of occasional purchases from most of your consumers, with long replacement cycles (or even, no repurchase).
The end result is the sales plateau that is the characteristic of so many brands in India.
If you want to volumes, prepare a product and price offer that makes sense to the real Indian middle class. The small shampoo packs make sense, the “chhota recharge” on the mobile phones makes sense. Does your product?
The missing millions aren’t really missing – they’re just invisible through our Delhi-Mumbai-Bangalore upper income blinkers. It’s time to take off the blinkers.
Devangshu Dutta
May 5, 2006
With the possibility of 51% foreign direct investment (FDI) in India opened up to foreign retailers, one of the questions arising frequently is whether this means the death (or at least a slow-down) of franchising in India.
After all franchising, in most people’s mind, has these alternate images of unscrupulous franchisers ripping-off the life-savings of the small retailer on the one hand, and shady landlords in the guise of retail franchisees gouging at the pockets honest businessmen who are trying to build national brands. There also haven’t been too many sustained success models in India where both franchiser and franchisees have consistently won.
Surely, with FDI opening up gradually, foreign retailers would want to set up joint ventures in which they have control, rather than go through the franchise route, where their brand is “at the mercy of another company”? So it is a legitimate question, whether FDI sounds the death knell for franchising.
However, jumping to that conclusion would be to ignore the fundamentals of franchising as a business. If the barrier to FDI was the only factor in the growth of franchising, there would be no franchise businesses in countries such as the USA (the largest retail market) or Australia (again one of the most dynamic albeit small markets for franchising in the world), which have negligible barriers against foreign retailers or service providers setting up their own outlets.
At its most basic, a franchise is an authorisation, granted to an individual or company by another company, to sell its goods or services in a specific territory. The motivations for entering such a relationship are as varied as the individuals involved in the business, but typically cover some common points.
For the franchiser, franchising offers increase in the business footprint and scale that can help to reduce costs per unit of sales, improve business visibility and the brand, and make the business a more likely candidate for investment or listing. Franchisees become a source of finance and additional management to grow the business, which otherwise would need to be provided by the franchiser himself. Franchisers also gain from the franchisee’s local market knowledge, existing infrastructure and real estate, which they would otherwise take time, money and effort to build. What’s more, each franchisee is an entrepreneur and “business partner” who directly gains from helping the franchiser grow, unlike employee managers – thus, potentially there is more energy and enthusiasm available to drive the business.
The big trade-offs for the franchisee are that the local (or regional) business ownership, topline (sales) and a chunk of the margin, are passed on to the franchisee.
The biggest motivator from the franchisee’s point of view is that, despite operating under another company’s brand and selling another company’s products, he is not an employee but an independent business owner. This is as important to an individual store franchisee as to a regional or national master franchisee. The franchise relationship also offers the umbrella of a brand under which to operate his own outlet(s) – the time, efforts and investment put into the brand across the various territories all converge to the benefit of the individual franchisee when the customer walks in with a prior knowledge and confidence in the brand. The franchisee also benefits from previously defined processes and systems, as well as structured training and business coaching.
However, if I were to identify two major hurdles in the path of growth of franchising, they would be the immaturity of the business model on the franchiser’s part, and lack of compliance on the franchisee’s.
The franchiser must approach the market with a well-structured model that makes money and can be replicated across locations, and with a system of training and transferring knowledge to the franchisees.
The franchiser must also have a clear control on the product stream, intellectual property or other key success factors without which the franchise reduces to a generic outlet. Given the overloaded courts in the country, litigation to stop a franchisee from misusing the Brand’s rights is only a very very remote last resort!
There are no hard and fast rules that can be generalised about whether franchising, joint-venture or direct investment is the correct model to follow – each situation is unique to the specific companies involved, and it comes down to previous experience with franchising, the feasibility of franchising in that specific product or service mix, and the business attractiveness (risk and investment versus the return). Franchising offers an attractive model of business growth, certainly a more collaborative one which is in keeping with the changing and entrepreneurial environment. Now that both models, direct investment and franchise, are available, companies can actually make decisions based on a balanced analysis.
India has literally millions of individuals who would prefer to be their own boss and run a business, rather than being an employee. There are joint-families, where resources may be available in the form of some real-estate and family members who can be part of the business. Personal loans are available from family and friends, in the close social fabric of our communities. Ideal ground for franchising to grow.
To close, I must quote a conversation with an international Brand about 30 months ago. I put across the premise that given India’s potential size and strategic importance as a market, surely the brand would consider setting up its own company rather than a franchise relationship. The Brand’s head of internationalisation looked ambivalent because at that time FDI in retail was nowhere on the horizon, but thought that they might consider it if government regulations changed. Well, the government allowed FDI earlier this year. And yet, this brand recently launched in India through a franchise relationship, for many of the reasons listed above.
Franchising lives!
(Guest Column in The Financial Express on 5 May 2006)
Devangshu Dutta
April 27, 2006
In my previous column (“Deal Ya No Deal“, 9 March, 2006), I raised a point about unrealistic volume expectations on the part of many marketers launching new products and brands in India.
In some part these are due to the marketer believing his or her own hype. However, a more insidious influence on the expectations are the unrealistic assumptions – a big factor being the incorrect assumption about the size of the market.
Back in the early days of economic liberalisation, during 1993-94, I remember figures being thrown about that talked about the 200-300 million middle class. Multinational and Indian consulting firms, in the slick presentations on behalf of Indian clients pitching partnerships to foreign companies, fed the legend. (Hey, let’s face it, for a while I, too, was part of that game!)
Well, for the last two to three years, those times have been upon us again. The difference is that, instead of hiring consultants, Indian companies have smartened their act, hired a few (or a few dozen) young MBA’s, who are making the exact same pitch to potential international partners again.
As a fall-out in my own small little corner of the world, I have been severely troubled by several international clients and associates whose first question is: “Just how big is India as a market?” and I must say that not many of them like the answers I have given them.
Foreign companies’ first attraction to India is the billion-plus population. Brands from countries which have domestic markets of 50-300 million salivate at the prospect of 1.2 billion Indians starving for their particular make of biscuit or coffee or the latest backless cropped blouse. The thinking goes, “If we can capture even 2% of the market to start with…
Let’s stop dreaming and tell the truth for a change. And I promise you, the truth is still very palatable – you just need to shift your perspective a bit.
The simple fact is that, if we were to evaluate incomes, spending and consumption the way they are evaluated in the developed markets, even allowing for purchasing power parity, the Indian “Middle Class” is possibly less than 20 million individuals.
“What?! But that’s less than 2 per cent of the Indian population,” has been the anguished reaction of many international marketers that I have spoken to in the past year or so. Followed by, “Where are you pulling out these figures from?”
The answer to the first question is: “that’s correct”. And the answer to the second question is: the sample survey carried out by the National Council for Applied Economic Research (NCAER) over the past few years focussed on household income.
Let’s consider the figures that NCAER has been coming up with. In its figures for 2001, NCAER estimated that approximately 2.5 million households earned above Rs. 500,000. The reason I see the Rs. 500,000 figure as important is because, in absolute terms in the Indian, context it is a good benchmark – about Rs. 40,000 per month – by which to categorise the middle class. Also, in relative terms, adjusting for PPP (say a factor of 3.5), this is an annual income of about US$ 40,000.
After allowing for mandatory household and other expenses, these (or higher) income levels do leave a good margin for discretionary spending. This population has much greater access to the stimuli and information that international marketers rely on to build a brand presence across borders. Other sources of brand and product influence include overseas travel (or relatives travelling in from overseas).
NCAER has dubbed the class earning between Rs. 500,000 and Rs. 1,000,000 as “the Strivers”, and that I believe is the most apt definition of the middle-classes across the world.
Currently, the estimate for this population would be over 3 million households, or about 18-19 million individuals. That then, my friends, is the size of the middle class, to be targeted by international companies and premium Indian brands.
Ouch! that was the sound of thousands of dreams shattering and hundreds of business plans going into waste-bins!
Come, come, let’s pick the pieces up and look at them afresh.
Firstly, a population of 19 million is no small market by itself. Many of the international brands’ home markets are about the same size – Australia’s population is a little over 20 million. Italy’s total population is estimated at about 58 million and UK’s slightly above 60 million, and so on. The problem is that when you start with a reference point of 1-billion, a figure in the vicinity of 20 million looks very uninteresting. So, the first solution is to shift one’s initial perspective on the Indian market.
Secondly, a significant part of this target population in India is concentrated in a few large cities in the country. This makes it easier to target this consumer group, rather than dispersing the budget and management effort across a very large number of locations. The reality is that most national brands can achieve a bulk of their sales from the top 8-12 cities in the country, and there is no reason why the story should be any different for international brands looking to create a new presence in the market.
Third, and very important, I would challenge you to show me another similar population anywhere else in the world (other than China), which is growing at the rate of 11-12% a year i.e. doubling every 6-7 years. This is certainly not because the upper income classes are producing babies at a more prolific rate – it is the rise in real incomes and the wider distribution of wealth through greater business opportunities for businesspeople and increases in salaries for the employed.
So, as an international brand, or as a premium Indian brand, by the end of this decade you’re looking at a potential market of 30-40 million consumers.
Now, that number is a respectable market anywhere in the world. What’s more, on the back of the growing market, if you launch your products now, you’re looking at very healthy business growth rates over the next few years.
“But where is the mythical 200-300 million middle class?” was the third painful question raised by our clients and associates, “Do they really exist and how do we reach them?”
But that, my friends, is the next column.
Devangshu Dutta
March 3, 2006
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:
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.
admin
January 1, 2006
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