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What Plagues FDI in Retail in India?

by Neelima

November 5, 2013

 

K. Sudhir, the James L. Frank Professor of Marketing, Private Enterprise and Management, Yale School of Management
K. Sudhir, the James L. Frank Professor of Marketing, Private Enterprise and Management, Yale School of Management

 

FDI in retail in India is a prickly issue. For years, the proposed policy to allow foreign retailers to set up shop in the country was in limbo. Finally in 2011, the government eased the rules governing foreign direct investment (FDI) in both multi-brand retail as well as single-brand retail. Foreign retailers were allowed to establish joint ventures with local partners and own up to 51% in multi-brand stores or supermarkets, and single-brand retailers like IKEA were finally given the green light to set up wholly-owned stores in the country (as opposed to the previous investment cap of 51%). There were other clauses—they were allowed to open stores only in cities with a population in excess of 1 million, they had to make a minimum investment of $100 million, and source one-third of their merchandise locally.

There was a catch too: these rules were framed by the central government. It was up to individual states to choose to implement them.

Despite the relaxation in the rules, foreign retailers haven’t made a beeline for what is one of the biggest consumer markets in the world. While some retailers are rethinking their India plans, others like American supermarket chain Wal-Mart are now exiting the market.

What really ails India’s retail sector and why has foreign retail been slow to take off? In an interview conducted on the sidelines of the 2013 China-India Consumer Insights Conference co-organized by the CKGSB and Yale School of Management (Yale SOM), K. Sudhir, the James L. Frank ’32 Professor of Private Enterprise and Management and Professor of Marketing at Yale SOM, elaborates on India’s retail FDI policy, the challenges and the opportunities. Sudhir, who is also the Director of the China India Insights Program at Yale SOM, feels that there is a lot of work that still needs to be done on the ground for retail FDI to deliver the right results.

Excerpts:

Q. The Indian government has allowed foreign multi-brand retailers to set up shop in the country through joint ventures with local partners. What do you think of the policy itself?

A. The policy of joint ventures is generally a good one. India has much to learn from foreign retailers. There’s a lot of technology transfer and capital infusion is needed. Indian retailers do not have the money to expand at the scale that they want and expand the technologies that they want to. So this could be a good outcome for both countries.

It also recognizes the fact that we do not want to give our markets away for free. Most countries around the world have done this. It is not an unusual thing that India has done. Almost every country that has not done this the right way, where they have allowed free multinational reign, has lost that retail sector to multinationals entirely, which has not been good for that country.

Then you have the other cases where they have kept it so tight, like in Japan, where multinationals are not able to succeed, but the consumers pay the price by paying extremely high prices because the traditional infrastructure and the competition has just not been there.

So this is not a bad model. I generally think of it as ‘our markets for your technology and capital’. As long as you can drive a good bargain on that, it is good for the country. The policy should recognize this. The policy is trying to drive a decent bargain and make it attractive for the multinationals to come, but at the same time make it good for the country.

Watch the video below:

Q. It’s been a while since the policy was announced, but we haven’t seen any uptake yet. On the other hand we have companies like Wal-Mart that are reconsidering their India plans. Why do you think companies have been slow to latch on to this?

A. There is obviously a lot of work on the ground that needs to be done in order to be successful. Given the policy pressures that have been there, I think multinationals are justifiably worried about how successful they can be. More broadly, the success of all retail requires a lot of other environmental changes. In Indian retail, there is a lot of opportunity and a lot of efficiencies that have to be had. But we have not really set up all the taxation systems, the VAT (value-added tax) system, the local taxes… Our market is set up in such a way that you can take the efficiencies you have in chain retail because this is global or national procurement, and be able to take those advantages or economies of scale as you send your materials across to the front parts of your supply chain.

Those kinds of issues are definitely a problem in the sense that do you really believe this can be profitable? So again, we can think about a lot of different reasons why the efficiency of organized retail is not at a stage where it could be.

That said, the partnerships that have been announced, like Tata going with Tesco, I think are just not ready yet. They are not ready to take advantage of this because all the systems are not yet in place.

Q. Do you also think it’s a question of politics here because people are really wary of policy U-turns?

A. There is definitely an element of uncertainty, but that is part of the business risk of doing this. People are in negotiations with companies and I think companies like the Future Group, which were planning for this a long time ago, have been able to work out partnerships early on. They need the capital really badly; they had liquidity constraints and had really expanded in the hopes that this was going to come much earlier.

Some of the other chains may not be as ready for these kinds of transitions, so I think some of this will take negotiations and time. Policy paralysis is definitely one source of uncertainty. The other thing that people worry about is that many states have (different regulations)… Then this is not something you can take advantage of at a national scale. My view of that is Indian states are sufficiently large enough that if you can get some segments of the northern region, it can be a very profitable business compared to many other countries that they have entered. Having said that, it is very problematic if contiguous states do not allow you to take advantage (of economies of scale) because sometimes if you set up, you really want to take advantage of all the contiguous states. And (if) contiguous states tell you that one can do it and another cannot, then that clearly is a disadvantage. It really reduces the opportunity for efficiencies and scale economies that you can get.

So there is a problem, but that said, I’m not sure why that would be to such a level of lack of investment. It would mean that the expansion of these chains would be slower, but not necessarily that they would not participate at all. So that’s one element. The second element is that even if you get into a partnership, you can only work in a subset of states where these guys are, which can also be somewhat tricky, because now you have to have two levels of systems. So yes, those things do create a problem, but on the other hand retailing is a place where you learn and experiment and nothing happens overnight.

My belief is that as states see the value of this, other states will want it, because consumers will demand (it). The same thing has happened in China. China opened up retail in only seven cities, people found that this was great, and then other areas said, ‘Why can’t we have the same thing that these guys have?’ Right now for political points, the states have decided that saying no is a way to gain popularity. If these people are forward looking, they should anticipate that the friction should go away over time rather than increase over time. So uncertainty is an issue. It doesn’t make it easy, but I see that as a reason why we should not see investments.

Q. The policy has different stipulations as well. For example, it says there must be a minimum investment of $100 million, of which 50% should be in backend infrastructure; 30% of the product should be locally sourced from small-scale industries, and foreign retailers are allowed to open stores in cities only with a population in excess of a million. To your mind, are these reasonable conditions?

A. They are not reasonable across the board—that would be the short answer. We saw that with IKEA, they had to negotiate and change things. These restrictions in general are well intentioned and I think some of it probably should be in place because there is always a trade-off. The long-run benefits from (them) may be helping small industries to survive, because it is not necessarily always the right thing to do because you may not get scale economies. But I think it also helps you get political buy-in from different constituencies. So it might not be the most efficient, as small-scale economy is often inefficient, but it can be a way to buy in certain political goodwill.

That said, it’s not always feasible, and many of the retailers have begun to point out that this 30% might be very difficult to do–you cannot do this in every category. It will depend on what categories you are participating in. There has to be some level of negotiations between the firms and the people making the policy to be able to carve out exceptions. With IKEA all was well, but another retailer might not have the same clout. I would expect with the bigger chains there might be certain exceptions to be made. Hopefully the government will be willing to refine these policies. Given the level of political opposition, they needed to have enough sweeteners in there to make it somewhat more palatable. While we can criticize the government for that, I think it was also necessary for them to get the law passed.

Q. Are there any lessons here from a country like China, in what it did in terms of policy?

A. The standard strategy has always been open up the market, give some time for the local retailers to develop, and when you feel like they have enough knowledge of the market, give them some time to partner with others. Hopefully (when) the joint ventures dissolve, the local retailers will still be able to compete because of their superior local knowledge.

In general, that is the same spirit that India has. India added more restrictions in certain ways, partly due to political interest and not necessarily (because of) what is good for the retailing sector. That makes it somewhat tricky. Those constraints might have been more limited in China and they could have done what is necessarily good for retailing interests.

There are other real challenges that India has compared to China. Real estate in India is extremely expensive. (In China) when the government decides it wants to support the retail sector, because they basically own all the property, they can give prime real estate at a relatively cheap cost whereas the Indian retailer has to pay extremely high (rent). That is one of the biggest disadvantages that India has compared to other areas. The cost of land has gone up. In an interesting way, if India had relaxed retail norms about 15 years ago when the market and land prices had not gone up, before the growth had really taken off, that could actually have been much better. So timing can be very important. Before the growth hits, you need to actually allow for the relaxation of retail.

Q. The argument we often hear in India is that allowing foreign retailers will hurt local kirana stores (mom and pop stores) and they won’t be able to compete. Is this concern overhyped?

A. The question as to what happens to the kiranas is obviously an important one. The reality is that in any kind of innovation, it is going to replace traditional industry. And I think the kiranas are no different. The question of course is how long does it take. And the longer it takes, the more time the kiranas will have to readjust themselves into new occupations and better performing occupations. I look at it in two ways. We all will glorify the kiranas because they live a pretty difficult life. The one thing people say about kiranas is, ‘if I lose my job or if I can’t produce, I will (set) up a store and I will sell.’ So when there is a threat it is not just to the kiranas but to everyone who almost feels like this is an option. So that creates a lot of angst amongst people and some of the concerns and the hype that you hear about is raised from the feeling that you are taking away an option from me. The reality of it is that this is not a great job. In a growing economy, there are many, many jobs that they want. And if you ask the kiranas what they want their kids to do, it might not be run a kirana store. They probably have a better lifestyle with better pay when they work in organized retail. And even perhaps better hours compared the 16-hour work days that they have right now. The reality is in the short-run if everybody has to shut down the kiranas, it lead to a huge social unrest given the number of people who are employed in this. If this change is going to happen over 20 years, I think society will adapt and readjust to this fairly well.

Q. To your mind, what is the future of modern retail in India?

A. There is only one way to go–it will grow. There really is no consumer who wants to go back and buy in the old-fashioned shop where they won’t get the assortments or the best prices. It’s inevitable–you can stall it or slow it but eventually it will grow. The reality of it is that I think it is good for the country. Ultimately a strong retail sector which makes it easy and accessible for people to consume goods is good for the country. I think it will grow from tier-one cities down through tier-two and tier-three towns. Everyone has aspirations. There is no reason to prevent people from being able to consume what the rich have been able to consume by preventing them from accessing these kinds of products. As with any kind of interest group that is going to suffer, the kiranas are no exception. They are going to fight it. Ultimately in the interests of the efficiency of the country, modern retail has to grow.

So the speed is an issue. And I just don’t see the kirana stores all shutting down in the next five years because modern retail is going to take over. But will it happen in 10-15 years? Yes. I think many of them will shut down.

Q. And what about the future of foreign retail in India?

A. The future of foreign retail depends a little bit on policy. Again I think these are sufficiently large markets. We can’t predict whether it will be a Wal-Mart or Tesco or Carrefour. Some of them might develop cold feet and leave. But eventually it is such a large market that if they don’t succeed, it is perfectly fine. If our domestic retailers became very successful, that would be a good outcome.

But I do still believe that there is value in having foreign retailers in India because there is a lot of innovation going on around the world. Having them in the competitive space in India accelerates the diffusion of those technologies into our country, which really helps everyone. Because once those technologies are available with one retailer, it will diffuse through other retailers through shared employees and employees switching and so on. It is shortsighted to think that shutting down foreign retailers is good for our country, it is actually bad in the long-term. But if it is because domestic retailers are leading-edge and state-of-the-art, that would be a wonderful outcome.

 

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