Date: July 27th, 2008
Chat with Mr. Sandeep Saxena, CEO of 7to9 Retail
We had a very interesting chat with Mr. Saxena. He shared a very realistic view of Indian Retail industry and the challenges faced by Indian retailers. In his own words, he is running the marathon and not a 100 meters race. What he meant was that organized retailing in India is a long term game and the fundamentals have to be put in place before we get into growing the business leaps and bounds by opening new stores. The difference in attitude comes from the fact that a lot people who are blocking prime real estate properties or opening new stores rapidly but are not managing and running the stores come from the license raj mentality. They want to create huge valuation. Their concern is not to make a profitable business but to create a big valuation so that they can eventually sell this to big companies once the FDI opens up.
However, the fundamental organized retail business in India runs on 6 pillars
Cash flows: If you want to be successful in this business you need to have positive cash flows very soon from each of the stores.
Inventory flows: The organized retail is at a huge disadvantage compared to unorganized retailers due to reasons described later in this document. The unorganized retailers have margins much higher than organized retailers. However, the only way to sustain profitability in the business is to turn the inventory really fast. According to him Foodworld is the only retailer profitable today and that is because through 10 years of experience it has managed to learn to turn inventory every 15 days. The average unorganized retailer turns in 90 days and organized retailer turns in 60 days. Its this turn that is creating a huge drain on profitability of business. To understand more.. kindly read about GMROI. The GMROI of Foodworld is close to 240%, almost 4 times that of other retailers. That is the reason Foodworld is probably the most profitable retailer in India in food category today. It will take all the retailers a lot of learning curve, training and understanding their customers before they can achieve the kind of inventory turns, foodworld is achieving. And because foodworld understands and appreciate the complexity of this business and wants to do it right, it is not expanding at the mad speed of the new age of current retailers. That according to Mr. Saxena is very critical success factor in this business if you want to run it for next 30-40 years.
Margins: Getting you margins right and understanding all the components of your margins like shrinkage, age of inventory, discounts, demand and supply. This is closely related to another retailing concept called as Open to Buy. Read on about the same from here: Open to Buy and also this “How inventory controls can increase your profitability”. “Spending Wiser with an Open to Buy”
CRM: Running the loyalty programme and managing your memberships. This is going to be a huge pull factor going forward to maintain the footfalls in all major retail stores.
Warehousing and Logistics: Getting your supply chain right, having a good logistics and warehousing system and more importantly having the system synchronize with your marketing and promotion plans is very important. Currently there is a disconnect between these systems. As a result if you run a promotion but don’t have sufficient inventory on the shelf for the same or if you have stacked your inventory on shelves but the marketing and promotion plans are not coordinated with the same and as a result, your inventory is not moving as fast as it should, there is a mismatch in your business and it can lead to huge problems. So its important to get your IT systems in place and have them completely integrated from CRM to logistics and warehousing.
Consumer psychology: Most important success factor in retailing in India is the understanding of the customer’s psychology. Most people in small towns buy most of their basket of goods in the fist 10 days of getting the salary. It’s not like US or other countries where you have purchases everyday and so you need to manage promotions and inventories on a daily basis. In addition a good credit system so that retailers can sell to their customers on credit is going to be another important factor in scaling the organized retail sector to smaller towns. Currently all the big retailers are fighting for the same 20% customers. The real huge cash cows for retailers are bottom 80% of the populations which are currently served by unorganized retail sector. This is where the big growth will come for retail in next 10 to 30 years and that requires a fundamental change in the economy.
Importance of good credit system
Most retailers make their money in the first 10 days of a month. Similarly nearly 80% of Indians buy their retail requirement on credit. This is typically micro-credit provided by small kirana shops who know the customer base well and has the means and the “connection” to get back his money. The big retailers cannot lend on credit other than to those having credit cards.
According to him, there are 3 types of customers on any retail shops.
1. People who pay cash.
2. People who pay by credit card because they want convenience and not because they really need credit
3. People who buy on credit. In this category also, there are people who have steady salary incomes and they will repay the retailer at the start of the month after getting their salary. This type of people can be easily converted from unorganized sector to the organized retail sector through the prevalence of credit cards. But there are also people who do not have steady income and rely on credit for their day to day sustenance. These people are the hardest to convert because a organized legal retail player will never be able to get the credit repaid whereas the unorganized kirana shop will develop and leverage all the “connections” (the kinds that ICICI and Citibank use for credit recovery) to get his credit recovered. This is where a major portion of their customer base comes from. And in small towns and cities this forms 80% of volumes and is a big challenge to convert. (Rural is totally another market and there is no scope for it in near term and so is better ignored by big guy for some time)
Once the income level of the people rise, some of these problems will get alleviated and retailers can expect a lot more turns from unorganized sector to the organized sector.
Why is the market in favour of small retailers in India even today:
A typical organized retailer will have to abide by all the laws of the land. That means they have to pay mandi tax in every state they move their good through, inter state octroi, 100% sales tax and VAT etc. An unorganized retailer will bypass all these legalities and purchase directly from the trader without paying any mandi tax or VAT or Sales tax. Typically they pay taxes only on 20% of their real revenues. They manage through corrupt red tape in the country without paying all the taxes. Thus there is a parallel economy through which they operate and this gives them 50-60% savings in costs. So even if the gross margins are 10% in branded and 15% in unbranded food category, the retailers enjoy additional benefit to the scale of 50-60% through this measure which a organized retailer will never get. So even if the organized retailer improves the supply chain efficiency and reduces costs, it is reducing the cost only in the 10-15% margin bracket. The only way then for an organized retailer to make money in this business is by turning the inventory. So if they can turn the inventory faster, then on the same amount of money invested, they manage to get a much higher return at the end of the year. This is how foodworld manages to get nearly 4 times the yearly margins (GMROI) and will be more profitable then the unorganized retailer. However FMCG companies are the one who play a very important role in giving the customer preference and sales forecast data.
A retailer needs consumer data and preferences to forecast sales efficiently and keep their inventory low. However currently in India the consumer data is with the FMCG companies and not with retailers. Only FMCG companies have the information about what product is sold in which part of the country at what time of the year through their vast and experienced distribution channels and that is their core IP. This information is not available for retailers freely and they will have to gather that through experience. This is in stark contrast to US and other developed countries where it’s the retailers who have the market intelligence data.
Most of the FMCG have a very vast distribution system in India and do 98% of their business through their distributors and dealers and only 2% through organized retailers. The retailer typically will take delivery of goods in a central warehouse in a particular region from where it’s distribution system will begin. However the current infrastructure of India is not suitable for the retailer to achieve the same efficiency that the FMCG distribution system has developed over years. As a result the retailer cost is typically higher than the cost at which a store gets the good in smaller towns. In addition the FMCG companies use retailers as their cash cows to make money.
Here is an example of the same:
Why Reliance fired its top management 2 years back.
Reliance entered a deal of nearly 250 crores with HLL for get huge inventories for fueling its stores in Gujarat in 7 to 10 days. It bought these stocks on paper and spreadsheet projections of volume. The deal was to get the goods at 30% discount and reliance planned to sell these to their customers at 10% discount. Since HLL cannot practically produce fresh stock of such large orders, it pooled all the dead stocks from various distributors all over India and supplied to Reliance. The top managers sitting in corporate office did not actually physically verify the stock. This stock did not move in the reliance stores since it was either damaged or out of season. As a result reliance could manage to sell only 10 – 15 crores in most categories and suffered huge losses. After they realized that HLL made a huge fool of them, they fired their top management but it was too late. In essence since the distributors make upto 90% of the HLL volume, HLL and all major FMCG companies will always act in favour of their distributors and not retailer in near future.
In essence, the unorganized retail sector is going to benefit in the next few years because of following advantages:
Information of the customer
Distribution network of FMCG in their favor
Cost structure in their favor due to bypassing of various legalities like Mandi tax, sales tax, etc
Location advantage, etc
Only way for retailers to make money in this scenario is through better inventory turns and finding ways to increase their customer base by innovative credit policies, etc.
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