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Post-Mortem Analysis – What went wrong with Organized Retail

July 15, 2009


A sluggish economy coupled with a slowdown in consumer discretionary spending has resulted in muting retail industry growth. [Not all have turned around like Biyani’s Future Group]Retail cost structures and business models are going through the scanner. Some of the critical areas under purview are as follows.

Flaws in Business Model: Business Models for Modern Trade are weak being skewed towards low margin / high working capital which translates into their ROE’s being marginally above their cost of capital in good times and below their cost of capital in bad times. Retailers have incurred high expansion costs with highly optimistic projections of growth on the back of projected consumer off-take, which has seen a reversal. Malls are increasingly seen to be cost-inefficient and retailers now negotiating for rentals based on sales or moving out to other areas.

Expansion Plans: Retailing in India was personified by aggressive store expansions as well as entry of new players in the industry. This resulted in over-optimistic projections of an industry in its nascent stage of growth ensuing in increasing levels of leverage and progressively resulting in funding crisis.

Consumer Purchasing Power Buoyancy: Retailers have mis-judged the Indian consumer psyche with the preconceived notion that the Indian consumer like his western counterpart would expend a significant proportion of his income on discretionary spending. The first drop in consumer spending was in the post Diwali period when there was a lack of willingness on the part of consumers to spend whilst the next drop will most likely be in the Apr-Jun quarter wherein the reduction in income effect will set in.

Funding requirements: Organised retailers are currently hit by a liquidity crunch with equity funding drying up and debt funding becoming extremely difficult to service. Moreover most retailers are already highly leveraged and have difficulties servicing their existing debt. Their interest cost has increased affecting the net margins, primarily due to two reasons higher levels of borrowing to fund expansions.

Asymmetrical product portfolio: Certain categories have developed very well (apparels) whilst others still have some way to go. Apparels were 9.3% of total retail and 18.5% of organised retail. Food and Grocery was 59.6% of total retail and only 0.7% of organised retail.

Supply chain issues: Logistics and an effective supply chain infrastructure are indispensable for seamless and cost efficient operation in the current volatile times. Economies of scale by way of warehouses, distribution centers and transportation efficiency will be necessary for survival

Personnel: The cost of retail sector employees has been high with people recruited at extremely high salaries in the past.

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