A development that is perceived to be a game changer for the retail business in India will depend a lot on retailers' adaptation to local tastes and preferences.
'Better late than never' - so has been the action from the recent reform measures the Government of India has undertaken. The much-awaited FDI policy for multi-brand retail has passed the hands of the Government and now the reaction of global retailers is awaited. Before we can analyse the potential impact of FDI in multi-brand retail, it is important to reflect on some of the important features stated in the policy.
According to Government of India's notification on 20 September 20121, 51 percent FDI in multi-brand retail is permitted, subject to certain conditions. Some of the top conditions cited are as follows:
- State acceptance: The stores may be set up in those states which allow FDI in multi-brand retail under this policy. Such stores will be subject to compliance with applicable state laws and regulations.
- Minimum investment: The minimum amount that a foreign investor has to invest is USD 100 million.
- Backend investment: At least 50 percent of the total FDI brought in shall be invested in 'backend infrastructure' within three years of the first tranche of FDI. 'Back-end infrastructure' includes capital expenditure on all activities, excluding that on front-end units; for instance, it includes investment made towards processing, manufacturing, distribution, quality control, design improvement, packaging, logistics, storage, ware-house, and agriculture market produce infrastructure, among others. Expenditure on land cost and rentals will not be counted for purposes of backend infrastructure.
- Procurement: At least 30 percent of the procurement of manufactured/processed products purchased shall be sourced from 'small industries' globally, with investment in plant and machinery not exceeding USD 1 million.
- Location: Retail sales outlet may be set up in cities with populations of more than 1 million, according to the 2011 Census and may also cover an area of 10 kilometers around the municipal/urban agglomeration limits of such cities. Only 53 cities in India qualify under this criteria.
- Agricultural produce: First right of procurement lies with the Government.
KPMG in India is optimistic about the development
These conditions clearly indicate an opportunity for global retailers to harness the vast potential of Indian markets. Meanwhile, from the economy's standpoint, investments in backend infrastructure and local sourcing are expected to create an efficient supply chain and boost small-scale industries. Additionally, the development is likely to generate increased employment opportunities in rural centers, where backend infrastructure is expected to be laid; in urban centers a front-end shopping unit will likely generate employment opportunities.
However, what remains to be seen is whether it will be simple for a global retailer to simply invest money and apply global best practices to initiate operations in India. Traditionally, retail has been a difficult terrain for most global retailers. Whenever global retailers have ventured out of their base country, their chances of success have reduced considerably. For example, Wal-Mart had to wind up its operations in Germany and South Korea; similarly, Best Buy had to retreat from China2.
There are several success stories as well, however. British retailer Tesco has been extremely successful in South Korea due to its localization strategy3. The prevalence of the Indian retail market’s unorganised nature is among the biggest factors perceived to attract foreign retailers such as Wal-Mart, Tesco, Carrefour and IKEA4. Similar logic has attracted a large number of Indian corporate houses to venture into retail operations. But most of these companies, which have around a decade of operating experience, are yet to devise a suitable business model.
One of the important factors cited for the viability of retail business is the availability of real estate at affordable prices and at suitable locations. Major Indian cities with retail penetration have witnessed a considerable increase in rentals in the last five years. Additionally, the majority of the primary Indian cities are crunched to provide quality and quantity of real estate to the likes of global retailers. Such constraints suggest a joint venture or joint-development kind of model with developers or land owners. To negate the effect of rising rentals, one entry approach that may find flavor with global retailers is scouting for stressed retail assets at an appropriate location.
The other important real estate play here is the creation of backend infrastructure, which suggests investments in assets such as cold storage and warehouses. Presently, very few players in India operate cold-storage chains or warehouses.
An interesting opportunity may be generated in such a situation, where foreign retailers are likely to approach developers to create and own backend infrastructure.
The indirect impact of investment in multi-brand retail is also expected to generate additional demand for residential real estate. In the wake of limited data points for retail, when investments in 1,000 square feet of office space are made, the result would be to create seven new jobs, of which five are expected to purchase residential apartments5.
The ability of global retailers to manage and sustain operations will, to a large extent, depend on the availability of an appropriate financing vehicle. Globally, retail assets follow a real estate investment trust (REIT) model to access finance. In the Indian context, REITs and real estate mutual funds (REMFs) have been discussed in the past without any logical outcome. However, it is a possibility that retail investments may attract the attention of decision makers in future.
Thus, foreign retailers are likely to adopt a measured approach initially for 18– 24 months. This may also be perceived as an ‘experimentation phase,’ where retailers increasingly seek local knowledge and try to evolve a scalable business model.
Sources:
1. “Cabinate Decisions on FDI in Single Brand Retail, Multi-Brand Retail, Civil Aviation, Broadcasting Sector and Power Exchanges Notified,” Press Information Bureau of India, accessed October 2012
2. How the retailing world stacks up globally and the challenges it faces in India,” via Factiva, accessed October 2012
3. “Korean retail therapy for foreign chains”, Business Standard website, http://www.business-standard.com/india/news/ram-garikipati-korean-retailtherapy- for-foreign-chains/475517/ , 28 May 2012
4. “FDI in Indian Retail Sector: Analysis of Competition in Agri-Food Sector,” Competition Commission of India, May 2012
5. ” How FDI in multi-brand retail will open up opportunities for real estate sector”, via Factiva, accessed October 2012