The Hindu Business Line : Twelve years on

The month of May is a milestone for organised retailing in India. It was in May in 1996 that Carnatic music icon, the late M.S. Subbulakshmi, had inaugurated the first FoodWorld store on C.P. Ramaswamy Road, one of Chennai’s busy thoroughfares, in a retailing revolution. Twelve years later, Chennai has the largest penetration of modern supermarket stores compared to any other city in India. In order to understand the impact of modern organised supermarket retailing, KiranaFirst, a not-for-profit organisation devoted to enhancing the competitiveness of kirana stores, undertook detailed research on this subject.

The outcome of the research has been serialised in three parts: status of supermarket retailing; emergence of super kiranas and impact on traditional kirana stores. This is the first of a three-part series that will be published over the next two weeks. The report incorporates research by members of faculty and students of a prominent business school in Chennai. A total of 304 kiranas from 30 stratified geographic hamlets in Chennai were chosen to study the impact of modern supermarkets on traditional kiranas.

The bad news is that modern supermarkets are still struggling and the good news is that traditional kiranas are reinventing themselves and becoming more prosperous.

In the past 12 years modern organised supermarkets have grown to more than 250 stores in Chennai. Subhiksha, Spencer’s Daily, Reliance Fresh and Aditya Birla More have all got more than 50 stores each. These modern stores are occupying about 7 lakh sq.ft. of street-front retail space and about 5 lakh sq. ft. of warehousing and distribution centre space.

While new stores are still being added, the current monthly beat rate (or revenue) is approximately Rs 50 crore for organised retail. One study puts Chennai’s household expenditure on food, groceries and other household consumables at about Rs 250 crore per month from 12 lakh homes. This would mean that modern supermarkets account for some 20 per cent of Chennai’s domestic expenditure. While specific numbers are not available, it is a fair assumption that supermarkets’ share of SEC A and SEC B-plus segments could well be between 30 and 35 per cent. This figure compares favourably with other developed retail markets in our region, such as Thailand, Malaysia and Taiwan.

Consumer proposition

The consumer proposition has not changed a great deal during the last 12 years. FoodWorld started off with a proposition of “Great shopping experience without a price penalty”, Subhiksha’s proposition was “No-frills shopping at best prices”. Reliance Fresh and More, which entered the market later, have largely adopted a similar proposition, mainly “Value for money, wide range, in a very good ambience”. Evidently, the overriding theme adopted by everyone is ‘price’.

Expectedly, consumers have taken very well to this proposition. A few of the supermarkets have tried to create some excitement by bringing in “schemes and promotions’ every month. Undoubtedly, they create a high degree of excitement. Lack of consistency and quality of fresh fruits and vegetables and regular stock-outs continue to be serious irritants which none of them are able to mitigate.

Business model

There is a joke that makes the rounds of London’s retail fraternity. It says, “Anybody who can predict the revenue of a retail store before it opens must get a Nobel Prize!” Notwithstanding the unpredictability, all retailers work on a business model. Retailers in the mid-Nineties worked with a revenue model of Rs 1,000 per sq. ft. per month in a mature state (6-12 months after opening). A typical 4,000 sq. ft. supermarket needs to yield a monthly revenue of Rs 40 lakh. On the cost side the assumptions were Rs 20 per sq. ft as rent, Rs 10 per sq. ft as utilities, Rs 25 per sq. ft as salary. Including other charges such as depreciation, interest, warehousing and logistics, the cost at store level worked out to about 15.5 per cent of revenue. Those were the days when kirana stores kept a gross margin of about 12 per cent. It was, therefore, legitimately assumed that once volume went up buying and supply chain efficiencies would throw up an additional six per cent and that gross margin would climb to about 18 per cent. The model thus assumed that at the store level profit before tax (PBT) will be approximately 2.5 per cent, which, in due course of time, will climb to about 5 to 6 per cent.

During the later half of the Nineties and the early part of 2000, the trend of gross margins inching up was observed. In fact, by 2003-04, supermarkets with more than 20 stores present in the city were operating above breakeven.

However, the entry of new chains in the market coupled with unprecedented increase in rentals changed their economics quite drastically. For once, intense competition seems to have resulted in the supermarkets eating into each other’s revenues. Revenue per sq. ft having peaked at about Rs 1,100 by 2004 seems to have steadily gone down to about Rs 700 per sq. ft now. The rentals have gone up from Rs 20 per sq. ft. to a weighted average figure of Rs. 50 per sq. ft — a whopping 250 per cent increase. At current levels of revenue, rent as a percentage of revenue has climbed from 2 per cent to over 7 per cent. At 7 per cent rental, Chennai looks more like Hong Kong and London rather than any of the South Asian cities! Notwithstanding gross margins between 19 per cent and 20 per cent now, Rs 700 per sq ft revenue is now yielding a loss of Rs 60 per sq. ft in an average supermarket. This model is clearly unsustainable. In order to return to profitability one of three things or combination thereof needs to happen.

Revenue per sq. ft needs to climb back to Rs 1,200 or Rs 1,300. This can only happen if more and more new supermarkets do not open up in the already crowded areas. We see no sign of this.

Cost per sq. ft comes down drastically

Even though rentals might stabilise at Rs 50, it is unlikely to come down significantly. Quite surprisingly, the cost of manpower seems to be flattening out as a percentage of revenue.

Gross margin climbs from 19 per cent to 25 per cent

This is possible either by charging consumers more or specifically improving supply chain efficiencies. Unfortunately, we have not seen great evidence of retailers working seriously on their supply chain. Some retailers, however, are seriously toying with the idea of changing their merchandise basket to only cater to SEC A-plus with a fond hope of recovering through higher prices. As of now, it is only a fond hope.

The small-format, supermarket business model needs a drastic overhaul along with more efficient supply change management and better use of technology. More of it later.

Use of technology

When one walks down the aisle of a supermarket one would observe certain SKUs (stock keeping units) and price description as well as barcodes on the shelf edge. The technical terminology for this is “shelf edge sticker”. This in many ways is the starting point for use of technology beyond scanning at the till. Management of shelf edge stickers lead to efficient management of stock turns, seamless management or supply chain from suppliers to warehouse as well as warehouse to the stores.

We find that three out of four supermarkets in Chennai have not got into the discipline of shelf edge stickers. Our obvious interpretation is that technology enabling of both store management as well as supply chain management is far from mature. It is a pity, since a few kilometres down the road are at least 5,000 software engineers working at OMR that enable retailers such as Target, Circuit City, Best Buy, Home Depot and Woolworth to work more efficiently. Our observation is that use of technology can lead to a margin efficiency improvement of at least 2 to 3 per cent.

Supply chain management

We find that in every retail conference in India and in most media interviews, retailers are talking about sourcing products directly from farmers. Even on cursory enquiry, we find that supermarket chains are sourcing their grains and pulses as well as fruits and vegetables from the wholesale markets exactly the way they did a decade ago. While we find evidence of better management of the fast moving consumer goods supply chain, we still do not find enough evidence of retail companies taking delivery in truckloads from the manufacturers. As a result while they benefited from early gains of higher margins due to better negotiations, the true impact of world class supply chain management is yet to be felt.

Private labels

We find considerable work having been done by the retailers in enhancing their merchandise spread and more particularly, introducing private labels. During the decade, there has been a significant improvement in the general merchandising range both in depth and quality. Undoubtedly, the general merchandising range has added to the gross margins.

Conversion of unbranded grains and pulses to private label is almost complete. However, private labels in the areas of packaged food lack imagination and have not gone beyond ketchup, sauces and pickles. It is therefore not surprising that private labels other than pulses and grains are still stuck at a low single digit percentage of revenue. Imagination and grit hold the key in this area – neither is plentifully visible.

Employment and training

Supermarkets need to be given credit for creating job opportunities for a category of people who would have been otherwise unemployable. During the first flush of retailing, companies were serious and diligent about training of their frontline service staff. We understand that the turnover of frontline staff as indeed supervisory staff in the retail industry is far higher than even the IT industry. Supermarkets, therefore, have given short shift to training of frontline staff.

We observe a two-pronged impact. One, the indifference of store staff towards the customer is palpable. Gone are the days that store staff could recognise frequent shoppers. We also observed a significant drop in the hygiene standards. One could observe store staff uniform shabby and in need of cleaning. The shopping experience which was intended to be a critical differentiator for supermarkets has clearly been thrown out of the window.

Refurbishment

This is a double whammy for retailers around the world. First one more round of capital has to be infused into the store and second the store has be closed or partially closed for several weeks. The first round of stores in Chennai are now getting refurbished. We hope the new retailers who have gained enough experience know that maintaining higher standards of hygiene can keep refurbishment costs low and customers satisfied.

In conclusion

At a 20 per cent market share supermarkets have clearly made an impact in the city of Chennai. However, the economics is now so adverse that they need to seriously create a new business model. Dropping service standards to save on costs and increase in prices for better gross margin are clearly not the answers. The answers seem to lie in better use of technology and better management of the supply chain. If supermarkets do not get forewarned they would be responsible for creating more and more standalone “super kiranas”. More about them in the next article.

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