The Hindu Business Line : Buzz areas in Indian retail

Forming joint ventures, raising private equity (PE) capital, and growing inorganically, to garner scale and market positioning, are the three things that will propel corporate activity in the fast-rising Indian retail segment, forecasts K.V. Ramanand, a retail expert with Ernst & Young.

The substantial growth potential of the sector has generated serious interest from first-generation entrepreneurs as well as large established corporates, he says. “More importantly, this has also caught the attention of the PE funds, which are more than willing to finance a sound business proposition,” observes Mr Ramanand, in an e-mail exchange with BrandLine.

Driving the heightened activity in the organised retail sector are big numbers. The Indian retail market is estimated at $300 billion, but the share of the ‘organised’ segment is pegged only at 3-5 per cent. Too small when compared with the US market, which has the highest element of organised retailing (reportedly 85 per cent), though industry research forecasts talk of a quadrupling of the business, from the current $12 billion (in 2006) to $45 billion by 2010.

K.V. Ramanand, a retail expert with Ernst & Young

Ramanand, who is the Regional Director of Transaction Advisory Services in Ernst & Young with regard to the retail sector has over 12 years of experience in the M&A (mergers and acquisitions) space and fund-raising activity. He has assisted entities in raising equity and debt funds from both the public and the private markets, and has worked on domestic and cross-border M&A transactions in the life sciences, retail, FMCG (fast moving consumer goods) and IT (information technology) segments. Excerpts from an interview:

First, can you elaborate on ‘the three activities’ propelling corporate activity in the retail industry?

We see tremendous amount of activity in three distinct areas. First, the joint ventures. Indian players are set to expand and grow. In addition, there is significant amount of interest from large international players.

We have heard reports that large international players such as Carrefour and Starbucks are keen on entering this market. Tesco has already expressed its intent. Australian retail major Woolworths is rapidly finalising strategies for an Indian retail foray. They may enter the Indian market either directly or through ventures with local partners.

Large Indian entities with sustainable strategies are keen to align with these global names. There are bound to be hectic parleys between the international players and domestic entities in finalising joint venture strategies.

The second area buzzing is PE. We have PE capital abundantly, and it is pursuing good investment options in this rapidly growing market. There are different types of transactions in this space.

In addition to minority investments, there are multiple incidences where the PE funds took controlling or significant minority stakes like Navis did when it invested in Nirulas.

Besides, within the retail space, niche opportunities such as Flemingo Duty Free shops also attracted serious interest and Citicorp invested funds in it. Similarly, Digital Shoppy attracted investments from IL&FS Investments. We believe this is just the beginning and there is substantial interest and scope for investment in good retail sector deals.

Thirdly, the inorganic route _ the ultimate resort for any player that wants quick growth. Reliance acquired the retail business of the Adani Group to quickly ramp up its operations. The AV Birla group made a similar entry in the retail segment through the acquisition of Trinethra. Incidentally, a PE fund along with the promoters made an exit in this transaction.

What strategies are corporates adopting to participate and grow in the retail segment?

Traditionally, retailing was more or less a small-scale neighbourhood business. However, in order to be competitive and profitable, players embarked on expansion programmes to improve efficiencies and derive benefits of scale to compete effectively. This has resulted in the emergence of regional organised players such as Subhiksha, Trinethra and Vivek’s. Some of these players soon emerged as national players with presence across the country.

Organised retail is capital-intensive and a long-gestation business. Start-up investments along with real estate costs in some instances are prohibitive. Besides, this business also necessitates sizeable investments in strong procurement systems, warehousing infrastructure and IT infrastructure. But over a longer time frame, after achieving break-even, scale determines profitability.

However, first-generation entrepreneurs naturally have limited resources and have to rely on partners to fund expansion or gravitate towards large established players through consolidation strategies. This has resulted in significant traction in fund-raising from PE funds and also generated active interest from large organisations with deep pockets.

The need to occupy ideal locations and build brand awareness has seen corporates adopting both the organic and inorganic route for entry and growth strategies. We have seen the emergence of large retailers such as the Future Group and have seen existing large groups like the Tatas make big inroads into the retail scene with stores such as Westside.

We believe the industry will witness significant consolidation as stand-alone or regional players without a national presence are a ripe target for a national player that wishes to enter new markets. We also see the interest of PE funds in retail business to continue and grow and in instances buy out attractive businesses to consolidate their portfolio. This will see heightened levels of activity once regulations pertaining to participation of international players are further relaxed.

Besides, there is a symbiotic relationship between the real estate and retail industries. The emergence of real estate-focused funds is a clear indicator of the potential for retail growth as they are investing heavily in shopping malls and commercial centres. For example, Gurgaon has emerged as the city of malls. Other cities are not far behind with malls sprouting in almost every neighbourhood. This provides a good platform for retailers to market their products in a chic environment.

Does store differentiation become tough when there are so many players in the retail game?

To put it simply, the ability to manage costs while offering a wide range of quality products at attractive prices, at a convenient location, and in a pleasant shopping environment, is the ideal success model. However, this is almost impossible to achieve.

Location has become less of a differentiator with stores opening next to each other. Therefore, along with pricing and spread of products, the in-store experience has become a critical differentiator. Space and shelf management strategies that ensure larger visibility and involvement by a customer have become critical success factors.

A very critical but less highlighted aspect is the back-end part of the business. This plays a decisive role in sustaining quality and consistent delivery of products as well as in containing costs. Therefore, a company that invests in back-end infrastructure has a strong competitive advantage.

Above all, ignoring the initial periods of novelty, the intended catchment area for a food and grocery store is around 2-2.5 km. Considering the limited target market size, store profitability is based on mining more from the wallet of a limited number of customers while retaining them.

Companies have embarked on customer loyalty programmes to gain insights about their preferences and also better manage inventory. The extent of wired networks one has within an organisation to capture and process data at distributed locations is a clear differentiator.

Stores are also aggressively pursuing the private label route to enhance profitability and attract investor attention to fund future growth.

How attractive is the funding of retail industry from an investor perspective?

In the initial years, returns are limited due to the high real estate costs, large and sustained capital expenditure to create scale, and start-up costs for store infrastructure.

However, investors with longer investment horizons are beginning to recognise the potential for long-term value appreciation of investing in differentiated businesses with large-scale plans and able execution teams.

Apart from the traditional sources such as banks and financial institutions, there are multiple avenues including PE funds. Companies have even successfully approached the IPO (initial public offering) route to raise funds.

We have seen many PE investors taking stakes in retail ventures. For example, Subhiksha raised PE from ICICI Ventures, while Actis took a controlling stake in Nilgiris. After the initial rounds of PE funding, companies such as Vishal Megamart and Koutons approached the public for capital through an initial offering of shares. Large players like Shoppers’ Stop, Trent and Pantaloons are already listed on the stock exchanges.

On the regulatory environment related to funding and the avenues available for international players to participate in the Indian retail market …

Currently, there are no serious regulatory restrictions on domestic funds investing in the retail segment. However, the Government has introduced regulations with regard to foreign investments in the domestic retail segment. Currently, FDI (foreign direct investment) is not permitted in retail business, with a few exceptions. Hundred per cent FDI is permitted in cash-and-carry wholesale stores with restrictions on end-customers for these stores. Also, 51 per cent FDI is permitted with approval in single brand stores.

Innovative structures have been devised for facilitating FDI in back-end retail activities such as technology, procurement, warehousing and logistics. This was witnessed in the Bharti Group-Wal-Mart transaction.

In other instances, entities such as Nike, Pizza Hut, Swarovski, Reebok and Tommy Hilfiger have explored the franchising route, or have obtained approvals under the single-brand route.

Metro AG of Germany and Shoprite have entered the cash-and-carry wholesale trading segment, while Bata has the right to operate front-end retail stores as it also manufactures its product in India.