Wholesale Hopes 

By VISHAL KRISHNA

Business World

11 July, 2009

When Martin Dlouhy, managing director of Metro Cash & Carry India – a 100 per cent subsidiary of the German firm – signed a Rs 900-crore agreement with the Punjab government earlier this year to set up six stores in the state over a fiveyear period, it seemed to reinforce the intention of global retailers wanting to penetrate the Indian market. Foreign direct investment (FDI) in multi-brand retailing is not allowed under the current policy regime; besides, most consumers in India still buy the bulk of their retail products from the neighbourhood kirana (mom-and- pop) stores. The cash-and-carry (C&C) business caters to the needs of these store owners.

But in their brief history of five years, C&C players have not been able to generate cash from the business in India. "They continue to bleed not because of the supply chain, but because the kirana store owner has to have a reason to buy from a C&C," says Devangshu Dutta, chief executive officer of Third Eyesight, a consulting firm in Delhi. Ninety-five per cent of the retail trade is dominated by traditional wholesalers, the backbone of India’s fast-moving consumer goods (FMCG) industry. "These wholesalers can give the kirana store the best price," says Ajay D’Souza, head of Crisil Research in Mumbai. He says traditional wholesalers continue to rule the roost because they manage to deliver goods at the doorstep of the kirana stores.

But this is just the beginning. Large global corporations – such as Metro – can burn cash and stay unprofitable for a very long time. They have deep pockets. Bharti Wal-Mart, a joint venture between Bharti Enterprises and US based Wal-Mart, has recently set up its first C&C store with an investment of nearly Rs 30 crore in Amritsar, and hopes to spend Rs 500 crore to set up 15 more stores over the next five years. Metro has invested over Rs 750 crore so far, apart from the Rs 900 crore mentioned earlier. Their plan is simple: to convert 12 million store owners into dedicated customers. This is not an easy task. The capital costs for a C&C are very high. According to Crisil Research, capital costs are close to Rs 3,700 per sq. ft, which is three times higher than that involved in setting up a hypermarket retail store.

The average size of a C&C is 100,000 sq. ft. To top it all, the real estate is owned by the company itself. Therefore, for Metro to turn cash positive is not easy in the short run. It takes at least 15 years to turn profitable and 11 years to generate cash in this sector (see ‘Long Gestation’ and ‘Wait And Watch’). Like any other retail business, it works on a high-volume, low margin basis. Sources in the industry say that Shoprite – a South African firm that has a C&C joint venture with Nirmal Lifestyle in Mumbai – was losing Rs 40 lakh a month at the back end, supplying to just one store in the country. An email sent to Nirmal Lifestyle did not elicit any response. Given the enormous challenges encountered by those trying to make a go of the retail business, will Metro and its brethren be able to survive the cash bleed?

New Avenues

Though kirana stores are the primary target customers for a C&C, business for the moment is coming mostly from others – hotels, restaurants and caterers, who buy in bulk from this wholesale format. A C&C can also gauge the quantity needed by understanding client demand and stock only as much required. Metro’s success has been supplying fruits, vegetables, meat and fish to its hospitality clients based on only demand. "Our strategy is to understand what our customers need, and then provide them a solution which offers quality product, right packaging size, and competitive pricing," says Dlouhy. The supply chain is not a problem for Metro as it worked with consolidators, farmers and fishermen to share knowledge on waste reduction, increase yield and produce high quality.

"The kirana guy will have to travel to a large cash and carry, usually located outside the city, and think twice if his transportation costs negates his margins," says Dutta of Third Eyesight. The other challenge is of scale. Most C&Cs have a bad kirana turnout because they never buy in bulk. More often than not, a kirana store owner will pick up the phone and call his distributor to send in the supplies. Metro or any other C&C does not provide such a service. But they believe their model can be successful, and they are serious about their intent, opening as many stores as they have.

For the kirana store owner, it is about saving on inventory costs. Analysts say that another reason why a C&C could work for a store owner is its ability to avoid stockouts for the customer. Metro serves as a warehouse and offers a selection of over 18,000 products. "We give the kirana guy a choice of products; with traditional retailers a kirana has to buy one product and in bundled quantities," says a spokesperson for Metro. In certain cases, Metro is also trying to specialise by sourcing from local manufacturers and stocking local brands, including an assortment of spices, rice and other food items. "This was earlier a forte of the traditional wholesaler. But we offer these solutions too," he adds.

Such a strategy of sourcing local products is also being employed by Bharti Wal-Mart. The C&Cs have their own private labels, which are selling well with the stores they have tied up with. Fifteen per cent of the sales of Bharti’s front end stores – called Easy Day – are in the form of private labels sourced by their backend partner. Bharti Wal-Mart is also selling honey, pickles, fruits and more under the private label name Great Value, which is also the international private label for Wal-Mart. Metro sells items under its international private label Arro.

"Their processes help reduce operational costs, which are very low, and they also have lesser employee cost per sq. ft," says D’Souza of Crisil Research. This is also why foreign brands such as Tesco and Wal-Mart sense opportunity in the Indian market with their back-end expertise. Tesco has already announced it is investing £60 million (Rs 474 crore) in the Indian market and has tied up with Trent, one of the retail arms of the Tata Group.

"While FDI is held up in the front end, the C&C business allows foreign retailers to sort out supply chain issues," says Pinakiranjan Mishra, partner and national leader for the retail practice in Ernst & Young (E&Y) in Mumbai. "Once that opens up, they will create efficiencies that will set the tone for building modern retail." Raj Jain, managing director of Bharti Wal-Mart agrees: "The whole Wal-Mart business revolves around saving in every aspect of that supply chain," he says. "It is not just about negotiating better prices with the suppliers, but actually about working with suppliers to remove any inefficiency in the supply chain." Bharti Wal-Mart is currently working with suppliers on packaging, stock control and inventory management.

Breakthrough Ideas

So what is eating into C&C margins? Simply put, there are not many kirana store owners walking in on a regular basis. For a C&C to make a dent in the Rs 2 lakh crore FMCG industry, it has to beat the traditional wholesaler who has been around for years. A C&C can help a retailer reduce the problems of dealing with multiple wholesalers, but cannot wipe them out. The distribution system in India has been built by the FMCG companies themselves to get their products off the ground quickly. Analysts say this multi-layered system takes a product to the smallest of stores in a village. "It makes sense for a C&C to find large buyers; they will burn cash if they focus on small businesses," says Dutta of Third Eyesight.

There has also been concern about how C&Cs can sell to their customers. Although a C&C is typically seen as a wholesale trade supporting small businesses which possess a trade licence, many point out that there have been sales to individuals who do not own businesses. The average threshold billing is Rs 1,000, and then it does not matter what you purchase in the C&C, or if it is personal purchases. This flouts the FDI norms that prohibit C&Cs from selling directly to consumers. As Businessworld noticed in a certain C&C recently, a man shopping with his wife had bought many single items. The only items they bought in bulk were brooms.

But Metro and Bharti Wal-Mart maintain that they have checks to avoid such a situation. "It is difficult for C&Cs to monitor every customer who buys because he will be a member who has a trade licence," says Mishra of E&Y. "This implies they are legitimate business owners, but it is not the job of a C&C to check their background." Stopping a customer and questioning him about the particulars of his purchases could create customer service problems that are avoidable.

Bharti Wal-Mart has about 30,000 primary members and about 75,000 total members registered in a particular trade area, around a 30-40 km radius of where its first store is opening in Amritsar. "There has been a very rigorous programme to control processes in our stores. People have to possess a trade licence," says Jain of Bharti Wal-Mart. If they do not have a trading licence, they need to have a trading association licence. "We will continue to renew that licence every year to ensure that only businesses are dealing with us, which is the law," Jain adds. Metro follows similar processes.

These hiccups, however, do not appear to slow down the C&Cs, at least the international ones. Metro Cash & Carry has opened 40 stores across the world in 2008, taking their global store portfolio to 655 wholesale stores. Their focus lay on growth markets such as eastern Europe and Asia. Officials say that group sales rose by 5.8 per cent to €68 billion (Rs 4,62,400 crore) last year. Its bigger rival Wal-Mart has even greater staying power. All of them appear to have enduring faith in the adage that only the strong will survive.