Booming economy, favorable demographic patterns, increasingper capita income and urbanization gave rise to a new sector in India: Organized Retail. Opening up of retail sector for FDI can be considered as the primereason behind the blooming organized retail sector. Sensing this opportunityseveral companies ventured into this sector, including Reliance, Bharti andPantaloons.


Despite the Government allowing only 51% of FDI in singleformat retail segment, global retail giants like Tesco, Wal-Mart and Metro AGare making inroads indirectly through franchise agreements and cash and carrywholesale trading, thus giving some serious competition to domestic retailers.Nevertheless, growth opportunity in this sector can be judged by the fact thatonly 3% of the total retail sector is organized and 97% of the sector stillconsists of local mom and pop stores.


Unfortunately, the growth strategy used by all organizedretail players of increasing their number of stores backfired when rentalsdramatically shot up following the global economic melt down. Profitability isseriously hampered and almost all major retailers are now struggling tomaintain their bottom line. Average operating profit margin declined from 9.5%in 2007 to 7.9% in 2008. The worst part is that such a drastic growth in thenumber of stores was backed by significant leverage which is expected tofurther hurt these organized retailers' liquidity and profitability levels.


Retailers are correcting their over enthusiastic strategiesof the past and focusing on improving their business model. This section willreview some of the challenges these organized retailers are facing on bothmacro as well as local levels.


Aggressive Expansion


Over the last few years Indian retailers most preferred modeof expansion was to increase their number of outlets across metros. Outletswere built wherever real estate was available and not where they were actuallyrequired, which led to 'Clustering'. Following credit crunch in 2008, severaloutlets were cast strapped and had to be closed down simply because they wereoperating in unfeasible locations.


Poor Supply Chain Management


One of the major challenges for retailers is to reduceshrinkage which includes short-weighing, pilferage and poor product handling.While the average shrinking percentage of inventory in developed countries is1% to 2% of Cost of Goods Sold, it is estimated to be much higher for Indianretailers, primarily due to the lack of focus on supply chain management. Theexisting supply chain is not devoid of inherent weakness of India's infrastructure, besides being corrupted along the entire chain. Tracing shrinkageis a Hercules task as almost all the transactions still continue to be based onpaper system. This gives rise to the need of third party logisticsorganizations that can provide services at competitive prices. Third partylogistics is a concept still absent from the Indian retailers' value chain.


A large part of shrinkage takes place within the retailer byits employees. Moreover, tracking an employee's track record and backgroundchecks is difficult. Retailers are now joining hands to fight this battle bycreating a database of employees and share it amongst themselves to avoidshrinkage from within.


Employee training and retention


The most common strategy applied by retailers to keep laborcost at minimum was to employ fresh graduates with no experience in retailsector. They have now realized that in difficult market situations, experiencedand talented employees that have sound understanding of ground realities couldgive retailers a competitive advantage. Despite a downturn, need for skilledmanpower still continues to be a major concern across the sector.


Managing working capital


One of the most important factors affecting a retailer'sprofitability is the way it handles its working capital. Lower footfalls,resulting into lower sales has directly impacted Indian retailers' workingcapital position. Discounting is now the most common technique used to turnslow moving inventory.


Besides lower footfalls another factor which is hurtingretailers' liquidity position is the significant amount of leverage they arecarrying which was used earlier for aggressive expansion. Banks are nowreluctant to finance retailers given the falling demand and plummetingprofitability. Retailers are therefore finding it difficult to finance theirworking capital requirements.

 

Diversifying into untapped rural areas


Experts believe that the next phase of growth for organized retail sector will come from rural areas that account for half of the $300 billion domestic retail market. Retailers will have to focus on the previously untapped lower income strata by providing them access to credit facilities. On the back of souring commodity prices and improving productivity, rural economy is set to boom in the next decade.


Backward Integration


One way to improve efficiency and profitability is to remove unwanted intermediaries which eat into the already stressed margins. To improve rural economy, Indian Government approved Contract farming and Leasing. According to KPMG, this will bring about technology transfer, increase capital inflow and assure market for crop production, besides eliminating intermediaries. Pepsico and ITC's E-chaupal are already benefiting from contract farming in Northern India.


Despite the above mentioned challenges, long term prospects of organized retailers are still very attractive. Important consolidations and partnerships can be expected soon for improving operating and cost efficiency. Focusing on supply chain management and partnering seem to be the need for an hour for organized retailers so as to leverage their expertise and financial muscle.


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