(This piece appeared in the Financial Express on November 26, 2011.)

The debate on allowing more foreign investment in retail reminds me of an incandescent bulb: producing more heat than light. With a variety of agendas at play, the heat has been generated by both sides, for and against foreign investment in retail. Conflicting views have emerged not just outside but from within the government and the civil services as well.

Much time has been spent, multiple studies and consultations carried out, even as behind-the-scenes negotiations have gone on.

We can now all let out our collective breaths. The Indian Cabinet has, with some caveats, approved foreign investment up to 100% in single-brand retail operations and up to 51% in multi-brand businesses.

However, the Cabinet “yes” to 51% foreign investment in multibrand retail and 100% in single brand retail doesn’t quite mean an all-clear to accelerated development of modern retail in the country. The debate is not really over—how can it be when it remains still alive and kicking in some of the most consolidated markets in the West? The states retain the power to allow or disallow foreign-owned retail businesses from operating within their boundaries, and local and regional political parties would certainly have an impact on retailers’ expansion strategies. It also remains to be seen whether this will only affect new stores, or affect investment into existing businesses, too.

Opposition to the expansion of Big Retail is not unique to India. There are enough places within the US where the American giant Walmart has faced opposition, not just in small towns but including large cities such as Boston. Similarly, Tesco has been opposed in several locations within the UK. In fact, there was a huge uproar in the UK in the late-1990s when Walmart entered the country with its acquisition of Asda. The details of such opposition vary from location to location, but the canvas of fears is similar: predatory pricing by large retailers, depressed wages, net loss of jobs in the medium to long term with closure of local businesses, as well as low sensitivity to local social issues when operational and financial decisions are driven from distant headquarters.

Though India is labelled a slow-coach when compared to China, it is worth remembering that China took over 12 years to liberalise its FDI regime, and in stages with reversals as well. It first allowed foreign direct investment in retail in 1992 at 26%, took another 10 years to raise the limit to 49%, and allowed full foreign ownership in 2004, but only in certain cities. It even revoked some previously granted approvals, to reduce the foreign retailers’ footprint.

Anyway, the “policy flywheel” in India has finally moved and is now rolling. Certainly there will be winners and losers in its path.

The losers will include simple intermediaries and low-value wholesalers who have a diminishing role in a better-connected economy. Large suppliers, including multinationals, will gradually find power slipping from their hands. However, the fact is that most of them would anyway be losing in absolute or relative terms to the large Indian retailers over the course of the next few years; it would be naive, even dishonest, to suggest otherwise. And I suspect also that landlords who may be rejoicing the FDI decision could be tearing their hair out when they sit down to negotiate rents with the big boys.

In the other corner, the beneficiaries obviously include the foreign retailers themselves. With a direct relationship to the consumer, retail operations are the most economically valuable link in a supply chain. Foreign retailers can now have access to this with a controlling stake in one of the fastest growing markets.

The second set of winners is the large Indian retailers. In a capital-hungry business, large Indian retailers can use foreign equity and cheaper foreign debt to reduce high-interest domestic debt, and infuse more funds into growing the store footprint. For some, this also allows a potential exit from the business, whether immediate (for instance from the current 51:49 single-brand ventures) or in the future.

There would be winners among suppliers as well, including packaged and processed foods for which modern retail is a great platform to reach the “income-rich, time-poor” urban consumers, technology companies and service providers including the larger logistics companies, as well as foreign suppliers who would benefit from the trust that they enjoy with the international retailers in other markets.

The government can certainly benefit in terms of indirect and direct tax collection, from these more structured, “on-the-books” businesses.

And the consumer would be at the receiving end of a much better product choice and better shopping environments.

Where India as a whole can potentially derive the biggest benefit from foreign retailers is in developing agricultural practices and supply chains that comply with global requirements. If channelled well, this can create tremendous export possibilities (‘agricultural produce outsourcing’), and help to propel rural incomes upwards, creating a wider economic impact.

However, I think the critical things that have been debated most hotly will also be the slowest to be impacted: foreign retailers contributing to bringing prices down, and on the other hand, potentially damaging local competitors.

If the efficiency is simply a matter of scale, and if building up scale is simply a function of having deeper pockets from which to invest, it is obvious that the largest global retailers will squeeze their smaller Indian counterparts out of business, one way or the other. However, retail is not a global business or even a ‘national’ business: it is an intensely local business. Sheer financial muscle can be used to bulldoze competitors, but the consumer chooses to shop at a particular retailer for several reasons, many of which are not influenced by the size of the retailer’s balance sheet. So, local retailers have more than a fighting chance. Walmart, Carrefour and Tesco are the only three foreign retailers in China’s top-10, although two of them have been there for more than 15 years.

The growth of modern retail is an outcome of the development of the economy and a better supply chain, and a working population that is seeking food in more convenient and safe forms; it doesn’t necessarily drive supply chain improvements itself. Indeed, in India, during the last decade, modern retailers have deployed money and management more on opening stores in a drive to capture market share, than actually in supply chain improvements and operational efficiencies.

However, without investments in the supply chain, neither can the quality of products be significantly improved nor their cost significantly reduced. The new FDI policy partly addresses this issue, as it requires a minimum investment of $50 million in the ‘back-end, which cannot include land, rentals or front-end storage. While the final notification should be clearer on the exact implications, for now one can assume that this investment is envisioned in the storage, processing and transportation infrastructure. However, the impact this can have on a $450 billion retail market will be too small to be immediately meaningful.

Clearly, FDI in retail is not a panacea for growth and efficiency. There is much the government itself still needs to do.

The modernisation of retail doesn’t just lead to consolidation of sales turnover, but also enormous concentration of economic power. Therefore, a tilt towards modern retail must be accompanied by the government taking on the active role of a competition oversight body that can maintain an environment of fair competition. So far, the government has played this role mainly in consolidated industries; retail will require it to play this role in a fragmented market as well, and between buyers and suppliers also rather than only between direct competitors.

We also cannot run 21st century supply chains on dirt roads, with unpowered storage and a poorly educated workforce. The benefits of FDI in retail will remain largely unrealised for the nation overall if there is no simultaneous investment by the government in three key areas: transport infrastructure, electricity and education. The Indian government must be a ‘co-investor’ and active partner in developing and maintaining these aspects much more aggressively.

Lastly, several other regulatory changes are needed to unfetter domestic businesses, too. These include, among others, land and real estate reforms so that we are not constantly living with a mindset of scarcity and ridiculous real estate prices, rationalisation of tax structures, and simplifying the certifications and approvals needed to run business on a day-to-day basis.

Unless these aspects of governance are managed actively and consciously, Indian businesses — small or large — will not be completely free to grow and to complete effectively, and FDI could well turn out to be a Faustian bargain for India.

For many decades from the early 1900s onwards, retailers followed a ‘trader’ or ‘merchant’ model, largely buying from those suppliers who could provide the best prices. Of course other parameters were considered as well, such as desirability of the product, but price was the major driver. It was also rare for retailers to go out to look for suppliers – suppliers normally turned up at the merchant’s doors to sell their wares.

There was little, if any, strategy to selecting the ‘supply base’. Retailers were much too busy building their presence in the market, opening new stores, acquiring new markets, growing their product offer; in short, concentrating on the business of selling to consumers. International trade existed, as it has since the dawn of history, but was led by traders. Retailers, by and large, followed the domestic sourcing route.

The retailer goes abroad

The 1950s were driven by the need to rebuild war-shattered economies through trade and economic cooperation. Bi-lateral, and later multi-lateral, trade agreements were brought into force. An awareness of other countries around the world was also brought into sharp focus through two successive world wars, particularly the second. Retailers began to explore supply bases outside their home countries, and from the 1960s to the 1990s this international trade grew by leaps and bounds. Naturally, as the pioneers went overseas, so did their competitors – it is very hard to compete profitably, when your rivals are buying comparable merchandise at much cheaper prices.

As a result, by the early 90s the supply base of any large retailer in the major consuming markets would take in more than 30-35 countries from which products might be sourced. And as the number of supply countries grew, so too did the number of suppliers. It would not be unusual for 500-1000 suppliers to be dealing with a single retailer.

Consolidation, conservation and conservatism

Retailers such as Wal-Mart in the USA, M&S in the UK, Carrefour in France and many others have had preferred suppliers who grew along with them. These suppliers were typically based in the home country of the retailer, and set up production units or sourcing organisations overseas from where they could supply goods to their customer at a competitive price. In some cases, their sourcing strategies were driven by their own analyses; in others the retailer led the way (such as M&S or Wal-Mart identifying the next preferred supply country).

In the 1990s a scientific sourcing principle began to be applied. It was good to cut down supplier numbers, since this reduced the management effort on the part of the buyer to constantly look for new suppliers and maintain current relationships. Terms such as ‘key’, ‘preferred’ or ‘strategic’ supplier came into vogue.

As an example, witness the dramatic supply base reduction undertaken by most large retailers in the UK. Some organisations even looked to supermarkets to understand and apply their supply base management principles, where product categories were dominated by, or completely split up between, less than four suppliers. In a few cases, it reached such extremes that one supplier virtually controlled a retailer’s entire product lines.

Some organisations even quantified the cost of moving into new supply countries in an attempt to understand whether it was worthwhile and how best to shape their sourcing strategy.

At the end of the 90s and into 2000, however, there seem to be rumblings among retailers about the need for some more diversity in their supply bases. Statements such as “we are uncomfortable with our overexposure to country X”, or “I wish I could manage to meet some more suppliers to get a feel for what is happening out there in the marketplace – otherwise our range ends up looking like everyone else’s”, or even, “sometimes we feel we miss out on innovative factories because we are so deeply bound with our existing supply base”, reflect the general consensus.

So, the question is, has supply base consolidation been taken too far?

Time for a new deal

The first step should be to acknowledge that the business of retailing needs a healthy balance between predictability and innovation. Predictability, as much as is possible in sourcing, could be represented by relationships with known and trusted suppliers. It would take a very strong individual, and a very large safety net, to work every season with large numbers of unknown, new suppliers. It would also require a lot of management time and effort to keep educating new suppliers about the business and its needs.

However, equally, it must be acknowledged that the fashion business is not like automobile or aircraft businesses where practically the entire market and supply base is known.

Nor is it as expensive to develop new products or product components. In the automotive industry new models cost hundreds of millions of dollars to develop – and with such high stakes, buyers tend to select their suppliers carefully and, once the relationship is established, stick to the relationship for a fairly long period of time, with both parties investing resources in it for mutual long-term gain.

In the fashion industry, on the other hand, most product development investment does not exceed a few thousand dollars. This is well within the capability of not only the largest preferred suppliers of the large retailers, but most of the supply base around the world. Whether design-led or technology-led, new products and new looks are constantly being created. Similarly, innovative business practices that generate more responsive factories, improve quality or reduce costs, are not the sole domain of large, old and established companies.

The two critical areas that need to be addressed by any retailer are:

1. A focus on cost/margin/profitability management: how can we make the management of sourcing more efficient in terms of effort and cost?
2. An eye towards innovation and risk-management: how can we tap into new suppliers without expending too much effort in development only to find that the relationship does not work out?

There are many answers to these questions. One of them, which provides a structure or framework in which to work, is the link between product-type and sourcing strategy.

In this, as a first step, a buyer must make a mental division between ‘largely predictable’ products and ‘fashion’ products. Largely predictable products include not only basic or staple items, such as the three-pack of underwear or a $150 suit, but also seasonal items (such as swimwear) for which sales vary dramatically from summer to winter but follow a rhythmic pattern, with some variation, over the same season from year-to-year. For one company such predictable products might be 80 per cent of the business, while for another it might be no more than 20-40 per cent of the entire range.

For such products, supply base hopping is almost certainly the wrong strategy to follow. The sensible strategy would be to concentrate energy on developing relationships with certain key supply bases and suppliers who provide a long-term sustainability or constant improvement in terms of cost, quality and other performance parameters.

On the other hand, there are other products that follow the dictates of changing fashion moods more closely. For these products, putting a long-term commitment on any significant proportion of this segment to specific suppliers can be counter-productive. It can create a sense of security in the supplier, or even the buyer, possibly reduce the drive towards product and service innovation, and maybe even make the overall sourcing-supply relationship relatively inefficient over a period of time.

There is a sense of ‘supply dependence’ associated with supply consolidation, in comparison to the sense of ‘interdependence’ that comes from a flexible (even though not fully open) network of buyer and supplier relationships. A cosy ‘strategic’ relationship that assumes a two-way exclusivity also creates a relatively narrow channel of ideas and developments, and becomes largely process-driven at the cost of creativity. This is fine if you are selling the same product year-in, year-out; but certain suicide (or slow poison, at best) if you are in any part of the fashion market.

This is not to imply that strategic relationships can’t work in the ‘fashion’ arena. But make sure that in such a relationship the suppliers who are worried, nay paranoid, about their own survival. In the best organisations, uncertainty brings about creativity – pick a strategic supplier like that, and you’ve picked a winner!

Achieving the golden mean

Of course, a perfect balance between long-term strategic suppliers and new relationships is as elusive as the perfect business strategy. If one set of rules governed sourcing in the apparel and textile industries, the sector would have been consolidated around this many decades ago.

Previous experience is certainly a worthwhile guide to selecting suppliers and supply countries. But the competitiveness of supply bases is changing all the time, and suppliers are constantly developing new capabilities around the world. As someone once said, in business relying only on past experience is like driving a rally sports car blindfolded, while the navigator guides you looking through the rear windshield!

By using the tools to discover, build and maintain new relationships efficiently, most buyers should keep their doors open for new suppliers to walk in and display their capability. Closed doors mean closing the possibly to innovative products, significant margin improvement, and even new methods of doing business that might bring about tremendous improvements in ‘sourcing profitability’.

In a different context, a presentation at the National Retail Federation (NRF) seminar in the USA in 1999 by consultant Kurt Salmon Associates mentioned the potential need to move away from the ‘super-specialised’ and ‘super-analytical’ role of today’s retail buyer to bring in shades of the ‘merchant’ of the past.

The truth is that successful retailers have never really abandoned the merchant principle. This degree of freedom is essential to maintaining the healthy influx of new ideas that keep a retailer’s brand alive with the customer and keep it moving ahead in the market. During the selection process, smart buyers even look at the customer list of their suppliers with a conscious effort to imbibe product trends, technical knowledge and best practices from other companies in their own or other markets.

Managing diversification

The key factor that needs to be managed is the effort on the buyer’s part. If a buyer could manage more relationships with the same amount of time and effort, he would probably make more effective use of his own and his supplier’s capabilities to create a more dynamic product and service offer.

Two primary tools come to mind for creating and managing a more diversified supply base: collaboration and technology.

In ‘collaborating’ with the supplier, the idea is to see both buyer and supplier as part of the same demand-supply chain. In fact, take it right back to the supplier’s supplier. Understand that the processes run across organisations, rather than residing in any one – the buyer has as much responsibility and accountability in the sourcing process as the supplier. Information must be shared more transparently, and the overall sourcing process must be managed together, beginning from the product conceptualisation to final delivery. Brainstorming helps, ‘blame-storming’ doesn’t. This approach is as equally valid with a new supplier as with an old, trusted supplier. Good buyers already follow this approach, and it shows in their company’s market performance and financial results. And it does not even add lead-time; in fact, in many cases, it cuts down time.

Secondly, make use of emerging technologies. Don’t just depend on a company’s database or EDI systems. There are a number of tools available today which are relatively inexpensive and easy to use – from the basic supplier profiles available on the numerous marketplaces and exchanges around the world, to more advanced technologies that enable collaborative management of product development and sourcing process management.

There are even well developed systems that can act like virtual assistants, helping buyers and suppliers to keep track of order-specific tasks, and updating each other automatically of the status of these tasks. If you did not have to spend effort on fighting the fire caused by the task that you forgot yesterday, would you have a little more time available to speak to that new supplier whose profile you liked but just could not make the time to meet?

There is no quick fix, and each situation will be different. But I believe that for many buyers, the choices are becoming rather stark. Innovative or staid product? Market leadership, or complete loss of the pole position? Survival or decline? The choices that you make today have a habit of showing up in the profit and loss statements of tomorrow.

Over the past few years, the Internet has been revolutionising the way we interact with each other, as individuals, as companies or corporate entities, providing a mass of information keeps growing with no end in sight. With cheap and direct access, we can quite simply move around with a few clicks, most of the time locate what we want, make an informed (and even comparison-based) decision, and exit. Surely, as many pundits forecast, the Internet should bring an end to intermediation of any sort. Well, yes. And no.

Yes, the Internet makes information more easily accessible to everyone. Every week there are literally thousands of websites, hundreds of portals and at least a few dozen exchanges that spring up. These get hit upon either directly, or via the many search engines that, in turn, are also constantly updating and fine-tuning their search algorithms, pushing to create sensible shortlists that are useful for the researcher. One is even named after the butler created by P. G. Wodehouse, with the implicit claim that it will anticipate your needs even before you know of them! However, these are only attempts at generating intelligence (at best), more often just information, quite a lot of which is unintelligible, and very far from the “knowledge” that we human beings seem to create in our minds quite automatically as we go about doing our tasks. Just a few days ago, I was searching for hotels in the US – what I downloaded was a morass of information, and I spent a whole day sorting through it. In this case I could have just as well requested a trusted travel agent to come up with a few appropriate options for me, from which I could have booked my choice.

Our minds are, yet, the best-known computer to man, in terms of versatility. Our minds can store enormous amounts of data – a surprising amount remains in long-term memory (despite the fact that often we can’t seem to remember the name of the person that we just met in the lift!). More importantly, we can connect and inter-relate seemingly unrelated items of information, for example, creating travel itineraries covering flights, hotels and various other details into a plan that is most effective and efficient keeping in mind the time constraints, costs and our objectives for travelling. We are still not fully-there from robot programmes which will automatically find you the best prices, and the most convenient locations or times, let alone do that for hotels AND flights AND trains and any other items that your itinerary contains. Travel is actually probably one of the simpler examples – you could still create parameters which, provided the base information about price, time or location is provided by the service providers, can be used in programmes that can analyse patterns of new and past data, and revert with some shortlisted options.

Let us think of a more complex example – the textile and apparel supply chain. It is one of the most fragmented industries, and possibly one of the most global in terms of trade flows. There are multiple layers of raw materials and intermediate products, most of which pass through some sort of intermediaries (such as commission agents, stockists, importers etc.). In such a form the industry is a prime candidate for opening out to the Internet, where suppliers can create their websites, or store their information through other platforms (such as “exchanges”) which can be accessed by buyers from around the world – easy to set up, independent of time zones and very very low cost. Get rid of the multiple layers that mostly add costs, book orders directly, get rid of stocks… sounds like a heaven-sent opportunity!

Well, that is how it is being seen by the 70-80 exchanges that have come up around the world, or are in various stages of being set up. Some of these have been set up by existing industry players, some by technology companies, and yet others by people who have set up exchanges in other sectors who believe that similar business principles can be applied to the textile and apparel supply chain as they have applied in the other sectors. This should dramatically raise the direct access between suppliers and customers – be the end of agents and other intermediaries – and basically make millions for the companies promoting the exchanges!

Yet, around the world, retailers and brands that buy finished products and raw material do not seem to be rushing to stake any significant proportion of their purchases to web-based sourcing. And there are multiple reasons for that.

Firstly, such a proliferation of exchanges seems to be only a reflection of the fragmentation, and there does not seem the likelihood that any clearly dominant player will emerge in the next few months. There is little or no differentiation between most of these exchanges – most of them offering a sophisticated yellow pages capability, while others offer possibly a few add-ons such as functionality that allows buyers to bid for stocks, or suppliers to quote for products.

Secondly, in certain areas, buyers or suppliers themselves have got involved in setting up exchanges. Some of these are private web-based initiatives (such as Wal-Mart or Littlewoods on the retail end, or LiFung.com or TheThread.com on the supply side), while others apparently are more public and collaborative, such as World-Wide Retail Exchange.

Closed web-based systems are excellent for the company that is initiating it, because it enables the company to streamline operational processes. However, it does create another platform for people to adapt to, though web-based systems are less painful certainly than EDI or other proprietary systems, which require specific investments. Also, occasionally it brings up the question of conflict of interest. For example, how comfortable would one supplier feel in sharing internal information with another supplier who has taken on an additional role?

Other initiatives, such as the WWRE, have got off to a good start, but here internal stumbling blocks are inevitable due to the composition of the groups. Consider the WWRE: 27 retailers currently, in four separate areas of operation (as diverse as food and clothing), with different geographical bases, which make the business imperatives very different for the various participants. Add to that the fact that people are loath to share knowledge that is considered proprietary by them, whether process knowledge or supplier contacts. It is a long-drawn process of consensus management in such a large initiative.

Thirdly, what kind of a service offer is the best? As of now, there is are options available from various B2B service providers, offering varying areas of benefit, from listing services to “software solutions” for various applications, to loose working relationships. Not only do the service offerings actually vary, there are varying degrees of claims and counterclaims that muddy the waters further.

The scenario is actually as confusing as it seems to be – players, whether exchanges, portals or any other kind of company, are dynamically evolving their business models, with changes seemingly almost every week, and new players emerging all the time. In such a scenario, buyers (who are early-adopters) will get into as many exchanges as possible to get the maximum choice, and to hedge their bets. On the other hand, the majority – which comprises of buyers who adopt new technologies later – will hold back to see which exchanges come up as the most widely accepted or most appropriate for them.

Finally, whether we like it or not, textile and apparel products are inherently emotional products. They are, of course, driven by specifications, and those specs can be defined fairly precisely. But what the specifications cannot ever completely convey is how a buyer feels instinctively about including a product in a range. Or, indeed, what the impact would be of making some minor adjustments that can be visualised, discussed and decided in an interactive session between a buyer and a supplier. Or, for that matter, what is the best way to reconfigure a supply chain, under pressure of a new order, or an unforeseen delay in the process. Intermediation is something that has become ingrained in the textile and apparel supply chain.

In such a scenario, it is unlikely that intermediaries will disappear immediately. What is certainly happening, however, that while previously buyers were willing (or forced) to pay for having access to information, pure information itself is being made a commodity. In this frame of reference, companies are seeking out “genuine value-for-money” before they will shell out a buying or selling commission. Process or domain knowledge is an absolute must – only this can enable web-based companies to create unique and genuine value-adding web-solutions. Simply putting up a ‘telephone directory on the web’ will fetch very little in return. Even though a telephone directory has hundreds thousands of entries, how much do you pay for it? Relationship-management and process-management capability will remain in demand, and many of the existing intermediaries certainly show a lot of that.

Vertical integration

One of the most important developments that will certainly be an accelerated outcome of the internet, will be the vertical integration of the textile and apparel supply chain. While, in the past, the very diverse nature of the stages of the supply chain has created and maintained multiple layers, web-based technologies are now enabling companies to structure and manage the apparel supply chain from as early a stage as they wish to, be that fabric, yarn or even fibre. It is more feasible to exert control, without actually physically owning the different bits of the supply chain.

Breaking down size barriers

Another significant outcome is that the web breaks down “size” barriers. Large retailers typically bought from large suppliers, while small retailers typically did business with small suppliers. Any “criss-crossing” (i.e. small companies dealing with larger companies) needed middlemen – individuals or companies that broke bulk or consolidated orders, for small or large retailers, respectively. This had more to do with operating systems, management capabilities and the scale needed for relationship management than it did with actual barriers. Now, however, web-based systems can allow some parity between organisations of different size, because at a low cost the same level of functionality is available to companies of all sizes, This is significantly changing the balance of power, and the overall structure of the industry. Scale was never the only surrogate measure of capability in this industry, but the correlation between actual scale and perceived or actual capability is getting even more vague over the Internet.

The impact of the web on the textile and apparel industry is not going to be immediate – it will take a while to permeate the hundreds of thousands of companies that make up the supply chain – so there is some breathing space.

But surely, in the next five years, the textile and apparel supply chain that we shall be seeing, will be structured quite differently from the existing supply chain. There will certainly be some casualties. What is important is that you – whether you are a supplier or a retailer – should start taking cognisance of the changes to come, and begin changing your own business to avoid being one of the casualties.