Retailing In India - A Government Policy Perspective
Retailing In India
A Government Policy Perspective
TABLE OF CONTENTS
. EXECUTIVE SUMMARY 5
2. INTRODUCTION 6
.1 EVOLUTION OF INDIAN RETAIL 7
.2 RETAIL FORMATS IN INDIA 8
.3 THE CHANGING INDIAN CONSUMER 10
.4 ANTICIPATED GROWTH IN THE RETAIL INDUSTRY 11
3. ISSUES IN INDIAN RETAILING 12
2.1 THE PROBLEM OF PRODUCTIVITY 12
2.2 OPERATIONAL PROBLEMS IN INDIAN RETAILING 12
2.3 POOR PRODUCTIVITY IN MODERN FORMATS 13
2.4 INDUSTRY DYNAMICS 16
2.5 EXTERNAL FACTORS AFFECTING PRODUCTIVITY 18
4. INDUSTRY STATUS TO RETAIL 24
3.1 PROBLEMS OF NOT BEING AN INDUSTRY 24
3.2 THE NEED FOR INDUSTRY STATUS 25
3.3 STAKEHOLDER BENEFIT ANALYSIS 26
5. FDI IN INDIA: AN ANALYSIS 30
4.1 GLOBAL TRENDS 30
4.2 INDIA'S SHARE 31
4.3 DIRECTION OF FDI INFLOW INTO INDIA 33
4.4 CAUSES AND REASONS FOR LOW FDI INFLOW INTO INDIA 35
4.5 FDI POLICY RECOMMENDATIONS 41
6. IMPACT OF FDI: THE GLOBAL EXPERIENCE 44
5.1 GLOBAL TRENDS 44
7. FDI IN RETAILING 51
6.1 INTERNATIONALIZATION: THE NEW RETAIL TREND 51
6.2 THE INDIAN RETAILING REGULATIONS 52
6.3 THE INDIAN ADVANTAGE 55
6.4 ENTRY ROUTES OF CURRENT FOREIGN RETAILERS 55
8. FDI IN RETAILING: THE DEBATE 57
7.1 FDI IN INDIAN RETAILING: WHY NOT? 57
7.2 FDI IN INDIAN RETAILING: WHY? 59
7.3 INCENTIVES FOR FDI IN RETAIL 62
7.4 REGULATING FDI IN RETAIL 63
7.5 WHAT SHOULD THE GOVERNMENT DO? 64
7.6 FDI IN RETAIL: AN IMPLEMENTATION FRAMEWORK 65
9. THE CHINESE EXAMPLE 66
8.1 CHINESE POLICY IN RETAILING 66
8.2 RETAIL FDI IMPACT IN CHINA 67
0. RECOMMENDATIONS 71
1. REFERENCES 74
. Executive Summary
This project is a critical analysis of the government policy in the Indian Retailing Sector. The report focuses on two primary issues: The granting of industry status to retail and the permission of FDI in Retailing. Apart from these the report also covers other areas of government policy that affect the growth and development of this industry. The report is focused towards the proposal of a set of policy recommendations to the Indian government that would facilitate the growth of the retailing industry and would also benefit the Indian economy as a whole. The report is based on extensive primary research, in the form of depth interviews with four categories of stakeholders: Retailers, Government Officials, Lobbyists and Real Estate Developers. The secondary research comprised of data collection and consolidation from various books, reports and consulting papers on related topics. The recommendations are developed in most cases on the basis of lessons learnt from policies and their impacts in other developing economies, especially China.
The first section of the report provides an introduction to the Indian scenario. It covers the status of the Indian retailing industry and tracks its growth over the years. We then discuss the various aspects of Indian Retailing that need improvement and analyze the inherent complexities involved in the Indian retail trade sector. Then we analyze the Indian FDI experience, and try to drive some conclusions from the experience we have had in other sectors. We then drive towards developing a comprehensive prescription for strengthening the Indian FDI policy framework.
The second section of the report begins with a summary of the findings of our study on the impact that FDI has had globally. Then we proceed ahead and critically analyze the issue of whether or not FDI should be permitted in retailing. The report highlights all the aspects of the debate. The debate is followed by detailed plan for introducing FDI in Retailing. This is followed by a case study on the Chinese experience and finally, the recommendations.
In broad terms, the primary recommendations of the report are that FDI should be permitted in Indian retailing in a phased manner, and the retailing sector should be granted industry status on a priority basis. Apart from these, the report also suggests several related reforms in areas like labor laws, real estate, bureaucracy, taxation and supply chain regulations.
2. Introduction
"Retailing in India could be as large as $450-500 billion and organized formats could account for a 20-25 per cent share of this."
CII-McKinsey Report "Retailing in India"
F
or the third year in a row, a retailing company has been declared as America's largest publicly traded company. The same retailing company also tops Fortune's list of top 500 Global companies. With annual sales at a whopping $220 billion, Wal-Mart symbolizes the immense potential inherent in the organized retailing industry. Retail, with worldwide sale of US$ 6.6 trillion, is the world's largest private industry.
In India too, the retail industry is large. Retail is the country's largest source of employment after agriculture, has the deepest penetration into rural India, and generates more than 10% of India's GDP. With close to 12 million retail outlets, India has the highest retail outlet density on the world. In spite of this, retail is also India's least evolved industries. In fact, it hasn't even been accorded the status of an industry.
Defining Retail Trade. The retail trade sector comprises establishments engaged in retailing merchandise, generally without transformation, and rendering services incidental to the sale of merchandise. The retailing process is the final step in the distribution of merchandise; retailers are, therefore, organized to sell merchandise in small quantities to the consumers and not for resale.
The Indian Story. For almost half a century, a paternalistic regime of control in India manifested itself in licensing laws that restricted the production of consumer goods and in regulations that limited the size of manufacturing plants. For a long time, the Indian consumer could by any car as long as it was an outdated Ambassador or a Fiat, any toothpaste as long as it was Colgate, any watch as long as it was from HMT, and any radio as long as Phillips produced it. The story is no longer the same.
The past decade has witnessed a tremendous revolution in the Indian Retail scenario. Market liberalization and an increasingly assertive consumer population is now sowing the seeds of a retail transformation that has started bringing in bigger Indian and multinational operators on to the scene. With the advent of these players, the Indian consumer is on his way to become what his counterparts in the more developed countries of the world have been for decades: The King of the market place.
.1 Evolution of Indian Retail
The concept of retailing in India dates back to ancient times when it was mainly in the form of weekly markets and the village fairs (Melas). Changing socio-economic patterns and consumption levels shifted the focus of retailing to mainly convenience stores (mom and pop stores) for daily needs with few prominent retailers on the high street in each city. While talking of Indian Retail, a special mention must be made of the role played by the PDS outlets, co-operatives and Khadi stores. The Indian government's PDS Outlet chain is amongst the largest retail chains in the world, but hardly does it find a mention anywhere in the Retailing literature.
Big commercial plazas with prominent nationwide and big city-based retailers were the next step. However, these complexes had nothing much to offer other than the all-important location. Shops offering wide variety of goods and services were merely clubbed together without any stress on providing any value-added services to customers. Shoppers had to cope up with lack of parking space, absence of toilets and improper maintenance observed in such places.
With the opening up of the economy in the early nineties, India saw the entry of the big international brands that opened their exclusive stores. Reebok, Nike, Lacoste, United Colors of Benetton were a few of the first retailers to set up their shops in India. This marked the beginning of the retail revolution in India.
Over the past decade, corporates, both Indian and Multinational, have started recognizing the immense potential that the Indian retail sector provides. But, due to government restrictions, most foreign players still haven't been able to enter the Indian market. Amongst the Indian corporates, there have been three categories of Indian businesses that have ventured into retailing as their business extension
a) Real Estate Developers
b) Corporate Houses
c) Manufacturers/Exporters
Due to scarcity of space and stringent provisions of rent control act, it was not possible for many players to start their operations from main markets or high street. This explains the natural progression of developers like Raheja's to kick start their retail venture Shopper's Stop, as they had understanding of real estate, one of the most critical component of the business.
Retail also presented an excellent opportunity for corporate houses like Tata, RPG, and ITC to profitably invest their excess funds as well as extend their business lines or brand reach. RPG's tie up with Dairy Farm International was the first Joint Venture in organized retailing in the country. It led to the establishment of specialty retail stores like Foodworld in grocery, Health and Glow in Pharmacy and Musicworld in music. The manufacturers and exporters also saw a potential for forward and horizontal integration of their respective business lines. This saw the emergence of the brands like Pantaloon, Provogue and Planet Fashion.
The past 6-7 years have been especially exciting for the Indian retail industry. Sweeping changes have affected both the supply and the demand fronts of the market. On the demand front, customer spending has been on the rise and brand consciousness has also increased substantially. Consumers have started demanding a better shopping experience as global media exposes them to different lifestyles. Consumer research shows that households in metropolitan cities are gravitating towards supermarkets and other modern retail channels.
On the supply front, a number of organized retailers have entered the trade in the last 5 years. These include large Indian business groups such as the Tatas, RPG, the Rahejas and Piramal, as well as MNC brands in apparel, footwear and durables. The entry into retailing by MNC brands has driven the growth of specialty chains and upgraded the standards of existing multi-brand outlets. South India - most notably Chennai, and, to a lesser extent, Bangalore and Hyderabad - has emerged as a centre of organized retailing. In fact in Chennai, nearly 20 per cent of food sales now flow through supermarkets and an equal share of "durables" is sold through specialty chains such as Viveks. Until now, competition in the sector has been largely local with large global retailers such as Carrefour and Wal-Mart absent.
.2 Retail Formats in India
Retailing in India can be classified under two heads: Organized and unorganized retailers. Unorganized retail is the dominant mode of retailing in the country with organized retailing contributing to roughly around 2% of the whole market.
The unorganized retail formats are typically mom-and-pop stores, with very basic offerings, fixed process, zero usage of technology, and little or no ambience. These are highly competitive outlets, drawing on free land (unregistered kiosks or traditional property), unpaid/cheap labor (family members or village children paid below minimum wages) and zero taxes. Many of them also leverage the low or no cost of family labor to provide services like home delivery that would be uneconomic for any organized retailer.
Traditional formats such as rural counter stores, kiosks, street markets and vendors have low productivity potential because of their unorganized systems and processes. These formats have emerged largely due to the absence of alternative employment and typically require employees with very low skills. These formats can, and do, serve to absorb agricultural1 labor. They are, however, very important as they account for two -thirds of the sector's output. There are four main transition formats in India:
Rural counter stores: Indian retail is dominated by family-run counter (kirana) stores that stock a range of branded/unbranded items. Rural counter stores are multi-purpose stores that sell items of essential need, both food and non-food. These stores are often located in rural homes and serve to supplement the family's income from agriculture.
Kiosks: These small, pavement stalls stock a limited range of food and beverage items. Kiosks are convenient for impulse or emergency purchases, and are located in busy commercial and market areas.
Street markets: Held at fixed centers in urban and rural areas on a daily or weekly basis, street markets comprise multiple stalls (often more than 200) selling a wide range of food and non-food products. These markets compete on both variety and price, and also sell counterfeit goods and smuggled items. Street markets have traditionally acted as a place for social gathering. The bazaars in Poland and open-air wholesale markets in Russia are the foreign equivalents of this format.
Street vendors: These are mobile retailers, providing perishable food items (milk, eggs, vegetables and fruit) at the customer's doorstep. While their prices are higher than alternative retail channels, they compete on convenience.
Modern formats, such as supermarkets, department stores and specialty chains, have begun to crop up over the past few years. These formats have high productivity potential and are found in most developed and many developing economies.
Supermarkets/Hypermarkets: These are large (20,000 square feet plus) self-service stores selling a variety of products at discounted prices. The best practice chains in this format are Carrefour (France), Wal-Mart (US), Kroger (US), Tesco (UK) and Metro (Germany). Supermarkets tend to be located in key residential markets and malls, and offer competitive prices due to economies of scale in logistics and purchasing. This format is new to India and only three supermarket chains of note exist - Foodworld, Nilgiri's and Subhiksha. Indian supermarkets are smaller than those in other countries, with fewer cash registers and sizes that are at least a fifth of the global players' selling area (3,000-4,000 sq ft versus 20,000-25,000 sq ft).
Department stores: These large stores primarily retail non-food items such as apparel, footwear and household products. They stock multiple brands across product categories, though some of them focus on their own store label (e.g., Marks & Spencer's St. Michael). Department stores are found on high streets and as anchors of shopping malls. Several local department store chains have opened shop in India in the past 5 years (e.g., Shoppers Stop, Westside and Ebony).
Specialty chains: These retail outlets focus on a particular brand or product category, usually non-food items, and are located on high streets and in shopping malls. While most specialty chains compete on service, a segment called "category killers" offers price as an advantage (Toys 'R' Us is a good example of a category killer). Examples of specialty chains include Gap, Levi's and Benetton. This format has seen the highest levels of adoption in India, with several chains establishing a strong presence, typically through franchising, e.g., Lacoste and Benetton.
Urban counter stores: These small family-run stores dominate food and non-food retailing and are found in both residential and commercial markets in towns and cities. The food stores stock a wide range of branded and unbranded food items. They typically have a loyal clientele bound to them by personal relationships and the convenience of credit and home delivery. Non-food counter stores typically stock multiple local brands. Even though urban counter stores have existed for decades, we have included them in the category of modern formats given that they have more organized systems and processes (than kiosks) and provide stable employment.
.3 The Changing Indian Consumer
There is distinct evidence to suggest that the Indian Consumer, irrespective of her socio-economic origin, is on a self-appeasement mission. Greed is good and she wants more of the best that life has to offer. As she traverses this path, we find that she defines fulfillment "materialistically and emotionally" no different from her more monied counterpart. SEC-based classifications notwithstanding, the Indian Consumer is out to seek pleasure and lifestyle. 177 million households in India are at various stages of defining their "self" from the "common". The asset acquisition rate of the average Indian consumer has been on the rise ever since India opened its markets in 1991, and is expected to grow at an even greater rate.
Also, the Indian consumer is more discerning and demanding than ever, especially due to the increased levels of exposure to international lifestyles and better levels of education. Shopping is increasingly becoming a family experience, showing a clear shift from the need-based shopping trends of the pre-liberalization India. Also, a whole segment of post-liberalization children, constituted by a whopping 100 million 17-21 year olds is coming of age, and the segment is spending like never before.
One noticeable trend in this regard has been the rise in the spending capacity of the Indian middle class. The Euromonitor retail survey estimates that there has been close to a 20.9% growth in the real disposable income of the Indian Middle Class in the four-year period of 1999-2003. Complementing this growth in income is the rise in the middle and high-income population itself. This demographic segment, which is widely believed to be a main driver of the global retailing industry, has been rapidly growing at a pace of 10% per annum over the past decade.
Also of significant importance is the rise in the affordability of the Indian consumer. The Indian consumer's affordability has been facilitated by a host of other related factors like falling interest rates and easier availability of consumer credit. Also, the increasingly competitive nature of the Indian market in categories like FMCG and consumer durables has increased consumer spending, by ensuring availability of a greater variety and quality of products at never-before price points.
This change in consumer spending patterns has turned out to be a major driver of the rapid retail revolution that we have been witnessing over the past few years.
.4 Anticipated Growth in The Retail Industry
The retailing phenomenon that is currently sweeping across the country is here to stay. Retailing is not a standalone industry, and hence, the growth in this sector is closely linked to a host of other macro and micro economic as well as cultural factors.
Growth in Indian Retailing is likely to rest on the following key determinants:
a) Government Policy
b) Infrastructure development
c) GDP growth
d) The employment scenario
e) Changes in the retailing supply chain
The CII-McKinsey report "Retailing in India: The Emerging Revolution", makes a conservative estimate that the retailing industry is likely to grow to around $350 billion by 2010 and that organized retail would account for 10-15% of this market. This estimate is based on the fact that incomes and consumer demand are likely to grow at a faster pace as the economy performs well, lifestyles continue to change and better product and shopping options would become available. On the regulations front also, it is likely that several important changes will take place, e.g. foreign investment will be permitted into the sector bringing in global competitors, other regulatory constraints impacting the sector will be relaxed, etc. This transition is likely to be gradual.
Currently, the Indian retail sector is worth roughly $292 Billion, and roughly 2% of this is classified as organized retail. Of the 12 million stores in India almost 95% are less than 500 sq. ft in area. The retailing sector in India is expected to grow at roughly 8.3% during the next 5 years, with organized retailing growing at rates anywhere between 24 to 49%.
3. Issues in Indian Retailing
"Supply chain wastage in India, in fruits and vegetables alone, is estimated at RS 50,000 crore, that is the amount of fruits and vegetables which is wasted, (it falls off the truck, goes bad because of unhygienic conditions etc.). If we fix that, we can actually distribute, free fruits and vegetables to every person in this country."
Raghu Pillai, CEO, RPG-Retail
Indian retailing has come a long way from the scarcity driven days of the past. Availability of products is no longer a major issue in India. The Indian retailing system may be grossly inefficient when compared to global benchmarks, but it should be noted here that we have a system in place that ensures that products reach every nook and corner of this country. Considering the geographic and cultural diversity and complexity of India that is no mean achievement. But yet, it is now time for India to move onto the next phase of evolution. And for that we have to analyze what exactly is the problem with Indian retailing.
2.1 The Problem of Productivity
The McKinsey retail study reports that the Indian Retail Productivity is at around 6% of the benchmark US retail productivity. While most Indian retailers and industry experts disagree with this figure, the fact remains that Indian Retailing is grossly unproductive especially when compared with international productivity standards. There are a host of strategic, operational and external factors affecting the Indian retail productivity. And retailing productivity is a very important factor in determining the economy-wide productivity of a country. For example, retail trade constituted nearly one-fourth of the extra-ordinary productivity jump experienced by the USA towards the end of the last millennium.
Productivity is a key factor in retailing also because of the fact that retailing productivity is a key indicator of the health of the entire supply chain. A productive retailing industry is indicative of a strong and efficient supply chain backing it. On the contrary, a poor productivity performance, as is the case with India, indicates operational inefficiencies in all the related backend industries, and is an issue of grave concern.
2.2 Operational Problems in Indian Retailing
A large productivity gap exists in retail - 95 per cent in the case of food retailing and 91 per cent for non-food retail. This is driven by two factors - a format mix that is heavily skewed towards transition formats, and poor operational performance (productivity) of modern formats.
Unfavorable format mix
Modern retail formats such as supermarkets, department stores and specialty chains account for only 2 per cent of retail output. This leads to lower overall/sector productivity, as counter stores are much less productive.
Supermarkets and specialty chains are more productive than counter stores for two reasons - they leverage their volumes to drive costs down and possess superior skills. The larger volumes or scale of modern retailers make it possible for them to bargain for lower unit costs not only while procuring, but also while distributing and marketing. In addition, supermarkets and specialty stores possess strong skills supported by technology in the front end (i.e., merchandising and marketing) as well as in the back end (i.e., managing the supply chain and inventory).
A key reason why supermarkets have not grown share rapidly, especially in food retail, is the underdeveloped nature of upstream industries. The relatively higher price proposition of supermarkets versus counter stores will be a key determinant of the sector's evolution. Currently, supermarkets are not able to capture the benefits of larger scale due to a fragmented supply chain and a sub-scale processing sector. They are also penalized by the current operating environment, which favors counter stores (e.g., tax and labor laws). Consequently, prices in Indian supermarkets are slightly higher than those of counter stores - a quick survey in Chennai indicated that supermarkets were 2-3 per cent more expensive for a set of branded FMCG products than some of the popular discount based kirana/wholesale stores- while in other countries, supermarkets are about 10 per cent cheaper than counter stores. As large food retailers in India begin passing on the benefits of better purchasing to customers in the form of lower prices, they will be able to capture share more rapidly.
2.3 Poor productivity in modern formats
Supermarkets in India experience a productivity penalty due to:
) The fragmented and inefficient supply chain that raises the cost of procurement;
2) The need to maintain competitive price levels vis-à-vis cheaper counter stores.
This leads to a lower level of value add when compared with firms such as Wal-Mart, which source directly from processors. The supply chain for food in India (for both branded and unbranded goods) has two to three more intermediaries on an average, compared with similar chains in more developed markets. This is because of market regulations (constraints on food grain movement across states, inability to purchase directly from farmers, etc.) that slow down the growth of large processors and the fragmented nature of retail.
The following are some of the specific problems associated with a modern format retail store in India.
. Organization of functions and tasks (OFT): Most Indian retailers can double their productivity by improving the organization of tasks and rationalizing the workforce. The average retailer in India has many more employees than an US retailer due to the limited use of multi-tasking and part-time help to meet peak hour needs as well as non-standard layouts that reduce efficiency. In contrast, India's best practice supermarket ensures that its sales personnel play multi-faceted roles and undergo in-house training prior to joining. A quarter of the sales staff works only part time, putting in 4-6 hours a day during peak shopping hours. This supermarket also has a scientifically designed layout that they try to adhere across their chains. Consequently, this chain has a much better performance than its other competitors.
2. Merchandising and marketing: Poor merchandising and marketing skills and absence of private labels among Indian retail players have led to lower sales per store. Stores in India lack the skills to better align stocking patterns and promotions to consumer needs. Merchandising and marketing issues in Indian retailing pose problems at several levels and can be broadly categorized into the following categories
. Skills: Indian organized retailing industry does not focus on systematically understanding the purchasing patterns of consumers to determine the products to stock and the targeted promotions to undertake. The same applies to factors such as store layouts and ambience. A couple of players have begun to address this issue by defining clear strategies for pricing as well as building customer traffic and loyalty. For instance, a Chennai-based supermarket chain offers a price discount of 8-9 per cent on an average and seeks to keep its regular customers informed of good buys through fortnightly newsletters.
2. Poor Competitive Scenario: Indian retailers have not faced the sort of competitive pressure that would force them to raise their standards. In other countries, to survive competition from supermarkets, counter stores have opted to focus on product or service niches. For instance, in France, gourmet cheese stores and farm-fresh vegetable stores thrive in the vicinity of supermarkets. In New York, Korean grocery stores stay open all 24 hours to provide added convenience to customers. In India, we see early signs in Chennai, where competition from supermarkets is the highest (17 per cent of sales) and larger counter stores have begun stocking imported or non-food items to differentiate their merchandise from supermarkets.
3. Private label/product mix: A second aspect of merchandising and marketing is the share of revenues from private labels. Supermarket chains in the US enjoy a larger share of sales from private/store labels that earn them higher margins. This factor, plus a product and sales mix skewed towards higher value items, earns them 3-4 per cent higher margins. Building a strong private label should be a key priority for supermarkets in India. Groceries, fresh fruit and vegetables and ready-to-eat items are the focus segments for this, and a couple of players are planning to set up kitchens to cater to this demand.
4. Scale: Retailers in India currently have a low scale of operations both in terms of number of stores and size per store, and this leads to a productivity penalty. The larger supermarket chains in India have 30-40 stores compared to the 1,000-store average observed in the US. Supermarkets in the US are also much larger than their counterparts in India. Higher scale makes it possible for retailers to use fixed labor (such as purchasing, marketing and administration) more expediently as well as use their bargaining power to buy cheaper and rationalize logistics upstream.
5. Supplier relations: Sourcing from multiple sub-scale suppliers is a key issue for supermarkets in India. Stores can increase productivity by buying more strategically and benefit from the simplification of the supply chain brought about by the entry of large retailers and food processors. Buying in bulk and availing of cash discounts can help improve margins.
6. Lack of strategic purchasing: Large food retailers in India can lower costs by rationalizing the vendor base, and undertaking strategic collaborations with processors and FMCG companies. Indian organized retail players procure from a large number of vendors, across regions. For instance, the best practice player has 1,600-1,700 vendors - over 400 per region. As a consequence, a retailer needs a large sourcing and quality control team, which raises the costs of procurement. Focusing on fewer national suppliers wherever possible can reduce the sourcing complexity, which will also help meet the cost/quality needs. McDonald's in India is a good example of best practice in supply chain management. The company works with one carefully selected vendor per item, sets quality and cost targets and helps the vendor upgrade operations systematically.
Supermarkets can also lower costs or increase value add by entering into strategic deals with upstream players. These initiatives include collaborating with food processors in purchasing as well as manufacturing private label goods, and engineering strategic relationships with branded goods companies aimed at increasing sales and reducing distribution costs (benefit shared by both parties). This is already beginning to happen. For instance, a supermarket chain purchases wheat along with an atta company to lower costs, and has succeeded in entering marketing/ promotional deals with several branded goods players.
7. Limited adoption of best practices by upstream players: Food processors in India are typically small and unorganized. The business systems of these processors as well as of the large FMCG companies are not configured to meet the needs of large retailers. This imposes a penalty on retailers, adding costs and forcing them to engage in additional non-core activities. For instance, most local processors as well as some national and multinational food manufacturers do not bar code their products. As this is essential for supermarkets, which use scanning equipment for billing, it becomes necessary for the retailers to ...
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7. Limited adoption of best practices by upstream players: Food processors in India are typically small and unorganized. The business systems of these processors as well as of the large FMCG companies are not configured to meet the needs of large retailers. This imposes a penalty on retailers, adding costs and forcing them to engage in additional non-core activities. For instance, most local processors as well as some national and multinational food manufacturers do not bar code their products. As this is essential for supermarkets, which use scanning equipment for billing, it becomes necessary for the retailers to undertake this activity, adding to their costs.
8. Inability to meet delivery schedules: Manufacturers are unable to meet the full delivery requirements of large retailers, which leads to stock-outs in stores (as retailers operate on a "just in time" basis). This occurs because the manufacturers also service larger buyers such as supermarket chains through their existing, multi-layered, distribution channel where product shortages and delays are frequent. This should change as organized retailers form an increasing share of FMCG company revenues.
9. Low demand/income: Lower income levels and, hence, lower consumption among Indian customers limit the size of average purchases, leading to lower productivity at the cashier.
0. Capital intensity: The service proposition of small stores in India involves a much higher consumption of labor hours than a mom-and-pop in the US. This is because an Indian counter store does much more in-store customer handling and home deliveries than a US mom-and-pop store, which focuses on providing a clean environment for self-service. The key reasons for this difference are the low labor costs in India, the small size of the stores and the sale of products such as loose grains and oil that do not lend themselves to self-service.
1. Low Entry Barriers: The low entry barriers for counter stores, combined with low-income levels, leads to low capacity utilization. Entry into retail for small players is relatively easy - licensing is not an issue, product sourcing is not restricted, labor is easily accessible and residential property can be used as the store. This phenomenon, however, does not affect supermarkets for which there is still latent demand.
2.4 Industry Dynamics
Competitive behavior in Indian retail is characterized by lack of exposure to best practice skills as well as an implicit subsidy for counter stores through differential enforcement of laws. In addition, despite a large number of players, we see an absence of price-based competition (particularly in food). Minimal high-quality competition and absence of skills have led to a lack of pressure to perform - resulting in low and relatively stagnant productivity levels compared to the potential.
. Low domestic competition
Low competition has contributed to low productivity and lower quality of service.
Food retailing: Competition among stores is limited because each counter store typically has an established clientele based on personal relationships and, often, credit. This situation is aggravated by a lack of competitive pressure from modern formats.
Non-food retailing: On the non-food side too, competition among retailers is moderate. Price is frequently used as a tool to increase sales, with even small stand-alone shops beginning to advertise locally. In this segment, the customer's ties to a particular retailer are weaker due to lower frequency of interaction. There is also greater organized competition in non-food retailing - from branded specialty chains - that is reflected in its superior productivity performance compared to food.
2. Lack of exposure to best practice
Competition in Indian retail is almost entirely domestic, and exposure to global best practice retailers is negligible. On the food side, only one foreign retailer - Dairy Farm - is present in India through a joint venture with a local player. However, none of the world's top 10 food retailers is present. On the non-food side, we have seen the entry of specialty chain stores such as Benetton, Nike, Reebok and Lacoste. The large discounters, category killers and best practice department stores (Toys 'R' Us, Circuit City, Macy's, etc) are absent.
The absence of best practice skills is critical, given the complexity of successfully managing a retail business. Retailers need expertise to manage back-end activities such as sourcing and inventory management, as well as the front-end functions of merchandising, promotions and customer service. The complexity arises when retailers need to manage a large number of SKUs and suppliers, as well as ensure no stock-outs while maintaining low inventory levels. The issue of skills is particularly relevant for India, as the majority of large format retailers have no prior experience in the industry.
Consequently, it is likely that in the absence of best practice experienced players, the retail transition will take a long time as players lacking skills and experience are less willing to take risks and will, therefore, take longer to ramp up operations. In fact this is already happening, with retailers opting for less investment-intensive and, therefore, less risky propositions.
3. Non-level playing field issues
Counter stores in India have several advantages vis-à-vis large chain retailers. This is due to differential implementation of laws (labor, taxation) and differential access to resources (both availability and price of real estate and labor, in particular). These factors have inhibited the entry as well as expansion of modern retailers. We discuss these issues in greater depth in the next section.
2.5 External Factors Affecting Productivity
Low productivity in the retail sector has been driven by restrictions on FDI, underdeveloped upstream industries, non-level playing field issues, the supply and cost of real estate, and India's low per capita income. Productivity has also been affected by secondary factors such as a rudimentary urban infrastructure, red-tapism and varied customer preferences.
. Restrictions on foreign direct investment (FDI)
FDI has been a key contributor to the rapid evolution of retail in other developing economies such as Thailand, Poland and China. In Thailand, seven of the top 10 retailers enjoy foreign equity and the list includes names such as Makro, Carrefour and 7-Eleven. Modern formats made their appearance in Poland and China in the '90s primarily because of the entry of global chains. Global retailers, with the benefit of their experience, can rapidly expand operations and tailor successful formats to the local environment.
In India, FDI is not permitted in pure retailing though MNC retailers can participate in wholesale trade as well as operate retail businesses through local franchisees (Benetton, Reebok, Lacoste). This impacts food retailing more, as franchising is tougher to manage in this segment given the bigger formats and larger number of SKUs that complicate sourcing and merchandising. In addition, the requirements of customer service in this segment are higher - need to manage perishable products, frequent promotions - and demand expertise of nature most Indian players have yet to acquire. Dairy Farm is the only foreign food retailer present in India and was permitted entry during a regulatory window (1993-95).
2. Underdeveloped upstream
The absence of well-developed upstream industries (e.g., processing and distribution logistics) raises retailing costs by 4-5 per cent. This, in turn, has been due to the reservation of large parts of food processing and garment manufacture for the small scale in the past6, which has also hindered the development of support industries.
Food: Here, two key problems exist - lack of large-scale processors and the poor quality of distribution infrastructure. Large, organized players account for only 25 per cent of the food processing output in India. The small-scale industry (SSI) accounts for 33 per cent of the output while the unorganized, traditional manufacturers produce the remaining 42 per cent. While SSI reservation has been progressively relaxed, some products remain restricted (including bread, confectionery, etc.,) and the legacy effect is strong. Food processors are, therefore, not able to reap the benefits of scale (cost) or invest in brand building. Also, food processors are absent in key segments such as fruit and vegetables and dry groceries.
Distribution of most food items involves multiple intermediaries, high cycle times and wastage during transportation and storage. The distribution infrastructure is the weakest in the fruit and vegetables chain, where the absence of a cold chain and convenient marketing channels leads to huge wastage. Also, the number of brands/ products available is limited. As a result, retailers need to deal with multiple, small vendors and undertake some non-core activities (such as cleaning groceries and bar coding products).
Global food retailers perceive India's underdeveloped supply chain as a critical barrier. They will not invest in India unless they can source a large portion of their requirements locally at the right quality. This is essential if they are to reap economies of scale and leverage their merchandising skills. For example, in China, Carrefour now has hypermarkets after just 4 years of operations, and sources 90 per cent of its goods locally.
Non-food: On the non-food side, large segments of domestic apparel and shoe manufacturing are reserved for small-scale manufacturers. Consequently, product sourcing becomes difficult for retailers of branded goods and own store labels, who have to deal with issues such as poor quality, low volumes and higher costs. Large formats such as department stores find it difficult to source sufficient brands to stock, as well as quality merchandise for their store labels.
3. Non-level playing field issues
Tax and labor law advantages give counter stores a benefit (lower costs) of 3-4 per cent of sales, which translates into a 15-20 per cent benefit in gross margins. The advantages stem from four factors:
a) Differential tax payments: These arise due to higher tax rates for organized retailers as well as tax evasion by counter stores. Income tax rates differ for the two formats - large retail chains are taxed at the corporate rate and need to pay 38.5 per cent of their income as tax, while lower individual income tax rates are applied to the counter stores. Also, we find that most counter store operators do not pay income tax at all, and sometimes even evade sales tax. The non-enforcement of laws applies in other situations as well, such as in the control over the sale of counterfeit products and adherence to labor laws.
b) Varying tax rates across states: In addition to the benefits accruing to counter stores from non-enforcement of laws, the existing tax structure actually imposes a penalty on retail chains operating in multiple areas. The current sales tax structure is characterized by differences in rates across states plus the imposition of an additional central levy on interstate sales. On top of this, a tax (octroi) is levied on the movement of goods from one district to another. This practice negatively impacts retail chains, as a higher proportion of their merchandise is sourced from outside the state of operation.
c) Differential enforcement of labor laws: Labor laws in India limit the hours of work for a retail employee to eight hours, require that a shop be closed one day a week and suggest the minimum wages to be paid. Organized retailers typically adhere to these norms, while counter stores are open almost throughout the year with an average working day per employee amounting to 12-13 hours.
d) Non-payment of market rates for inputs: A critical cost advantage for counter stores arises from the fact that they typically pay lower rates for key inputs (i.e., land and utilities) than do supermarkets. Counter store operators either own the premises in which they operate or pay a nominal rent (set years earlier) that is far lower than the actual market value of the property. Most counter stores also save on power costs, paying residential rates that are nearly half the commercial rates paid by modern retail chains.
e) Supply and cost of real estate: This factor severely restricts the spread of the large, modern retail formats. Location is a key factor in deciding a retail outlet's success. In India, retailers find it difficult to acquire land of the right size at the right location, particularly in the large cities. This explains why many of the early entrants into retailing have been real estate players (Shoppers Stop, Globus) or players with access to property (Foodworld, Crossroads). Real estate issues impact larger formats more, which explains the slow growth of department store and malls relative to specialty chains.
Several issues distort the real estate market - laws heavily skewed towards tenants, restrictive zoning legislation, non-availability of government-owned land combined with fragmented ownership of privately held property, and disorganized transactions due to a lack of clear titles and transparency.
f) Pro-tenant laws: In the past, rent laws have favored tenants, making owners wary of renting out their property. It is difficult to recover rented properties from tenants or to increase rents, and land disputes stay pending in courts for years. The limited commercial land that is available is taken by counter store operators, who have been in the trade for generations and often lack alternative occupations (therefore limiting supply into the market).
g) Zoning laws: Zoning laws restrict the supply of real estate as well as attach constraints to property development for retail. In the master plans of most cities, land is clearly demarcated for various purposes - agricultural, industrial, residential and commercial - and it is extremely difficult to convert land earmarked for other purposes to retail/commercial use. However, zoning laws vary by state. So, while land conversions for commercial use is nearly impossible in Delhi, the governments in some southern states are more flexible.
h) Non-availability of government land, combined with fragmented private holdings: These factors make it difficult for retailers to acquire large plots of land both within the city and in the suburbs. The local authorities typically own large tracts of vacant land both in city centers and in the suburbs, and auction this land in lots only at infrequent intervals. This constrains supply and pushes up real estate prices. Meanwhile, private holdings are typically small, due to which real estate developers need to consolidate land owned by multiple individuals, which is an arduous task. In the suburbs, the absence of infrastructure further reduces the land available that can be used for commercial use.
i) Lack of transparency: The real estate market in India is extremely disorganized and is marked by a lack of information on prices and clearly established ownership titles. Since information about this market is disaggregated, i.e., with individual brokers, even similar, adjacent plots often command different rentals. Jointly held properties and complex sub-letting arrangements further complicate ownership rights. Finally, high property taxes drive owners to demand a significant part of the payment in cash and without records. All these factors make access to real estate for organized players a complex task. Real estate availability's impact on the development of retail can be judged from the experience of South India. A key stimulus for the retail boom in Chennai and Bangalore has been their lower property costs when compared to cities like Mumbai and Delhi.
4. Low income
India's per capita income is 6 per cent of US levels at purchasing power parity, leading to low consumption. On the input side, cash costs are low given that counter stores are typically family run (with some hired help), and family labor is either not assigned any value or lacks alternative occupations. This will change, as alternative employment opportunities emerge with economic growth and education.
Insufficient demand is likely to hold back the establishment of modern retail formats in rural areas. Currently, rural needs are met through small, general-purpose village stores and weekly street markets (haats). These haats are extremely low-cost formats atering to the requirements of about 15 villages and providing a variety of goods and services - from food grains to entertainment. A hypermarket/supermarket would find the daily sales potential from this catchment area to be low, and catering to a larger radius difficult, given the connectivity problems. In addition to low demand, modern formats would also find sourcing difficult as a large share of local merchandise (brands plus counterfeits) is consumed in rural areas. Finally, competing with the social/entertainment proposition of the existing channel would be tough.
5. Poor urban infrastructure
Most Indian cities suffer from bad roads, poor transport and face power and water shortage. This impacts the growth of suburban shopping options negatively, making it difficult for retail developments to come up and for consumers to get there conveniently. This factor is already important in cities such as Delhi and Mumbai where real estate costs in the city centre are prohibitive (causing a move to the suburbs). This trend is likely to spread to other urban centers as well.
The inadequate levels of urban infrastructure can be attributed to bankrupt local governments. The majority of municipal agencies in the country have limited funds to invest in infrastructure. Collections from property taxes and user charges, that are typically used to finance infrastructure, are low. In fact, most municipalities depend on the state government for 50-60 per cent of their expenditure. The low property taxes stem from low rental values as well as tax evasion, while political/social considerations have led to utility prices that are lower than the cost of providing these services. As a result, municipal authorities find it difficult to raise external funding for infrastructure projects.
The success achieved by a few municipal corporations in raising external funds can be attributed to their addressing the issues mentioned earlier, i.e. restructuring finances, privatizing utilities, and even obtaining guarantees from international financial institutions. A direct consequence of poor urban infrastructure is the slow growth in suburban shopping, even in cities such as Delhi and Mumbai where land prices in city centers are prohibitive. In fact, retail developers find that they have to invest in constructing approach roads and arranging for their own water supply, often without support from the local government.
This is very different from the experience of other countries. For instance, in Bangkok, where large retail developments have come up in the suburbs (due to lack of affordable land in the city), the government and private developers have jointly developed the necessary infrastructure. The local authority has provided the infrastructure up to the boundary of the housing and retail development, while the internal roads and power cables have been the developers' responsibility. Poor urban infrastructure in India also leads to retailers choosing "multiple small formats" versus "a few larger stores". We thus find 3,000- 4,000 square feet neighborhood supermarkets instead of the 20,000 square feet stores in developed markets.
6. Bureaucracy/legislation
Retail operations need to obtain multiple licenses and permits, ranging from basic trading licenses to product specific licenses to pollution clearances. Each individual retail outlet has to acquire these, even if it is part of a chain. These factors are irritants, and add time and cost to the process of establishing a retail chain. The following comments are indicative of the problem:
"There are over 12 licences to be obtained per store...we have a separate division handling this" - Head of a chain store
"The project time could have been reduced by 6 months if the local authorities had been more helpful" -- A mall developer
7. Customer preferences
Given India's size and the presence of diverse cultures, there are significant regional variations in product preferences. This tends to complicate sourcing. In addition, customers perceive modern formats as more expensive than the traditional, transition formats, especially in food retailing.
8. Archaic laws
A bulk of the laws governing retailing in India are very archaic and were framed decades earlier when organized retailing was unheard of in this industry. Labor laws governing the retail industry are extremely stringent and have been one major reason for the low productivity observed in this industry.
9. Factors affecting output
Some of the productivity barriers such as restrictions on FDI, unavailability of appropriate real estate and low income also affect output by slowing down the expansion of existing modern players and hampering the entry of new ones. Capital market barriers also affect output. Retail being a complicated business has implications on the availability of funds through nationalized banks (the bulk of supply). Lack of expertise on the part on banks in understanding the retail business leads to their shying away from lending to this business or else lending at a higher rate of interest.
4.
Industry Status to Retail
"Retailing in India is so disorganised that there are no benchmarks to evaluate viability and profitability."
Arvind K. Singhal, MD, KSA-Technopak
The Indian retail sector suffers from one fundamental problem: Technically speaking, it is not an industry. Inspite of being the second largest employer in India, the Indian retailing sector hasn't been recognized as an industry by the government.
3.1 Problems of Not Being An Industry
Not being granted industry status has led to a host of other complications for this sector. The following are a few areas in which the lack of an industry status hurts most.
Single Nodal Agency
Retailing does not come under the purview of any specific ministry. Retailing policy is currently in a state of mess. The finance, trade, industry and commerce ministries randomly regulate retailing on a random basis. There's no single body responsible for this industry. As a consequence, the growth of this industry has been severely impaired. There are no established norms and standards to be followed.
Operational Hurdles
Operating in the Indian retail market is the a bit like doing a 20-Km Oympic marathon with jump-hurdles all the way. Broadly speaking, the Indian retailer faces operational hurdles at four levels: The central, state and municipal governments and the financial institutions. The government factor especially plays a major role considering the fact that every government body has its own sert of clearances, and given the level of efficiency that we have in government bodies in India, the delay involved in procuring these licenses translates into huge operational and opportunity costs fo the retailers.
Lack of established lending norms
The financing of the activities by the non-corporate sectors, particularly in areas like trade (wholesale and retail) is mainly from the private money markets where the rates of interest are much higher, at least twice that of a nationalized bank. These are cash flow-based lending rather than asset-based and are undertaken more by the unincorporated type of financing agencies. The organized non-banking sector is more into asset-based lending for items like machinery, equipments, trucks, etc. This is one of the major reasons for the large margins seen in trade, both wholesale and retail. For many of the fast moving consumer goods (FMCG), the gap between the company balance sheet figure and the street price figures is more than 35%, and one factor in this is the "open market" interest paid by the trade channels. In case of cash crops and vegetables, the gap between producer prices and consumer prices can be as high as 70 to 80%. Here again, the financing cost both for holding and transport plays a major role.
In the recent past, the interest rates have been moving south and large corporates are in a position to access funds from banks at less than 10%. But the local kirana stores and other vendors get it at rates as high as half percent per day (returning half a rupee for hundred rupees borrowed in the morning). This works out to be more than 180% per annum. Several kirana stores and unorganized sector players get their funds at rates as high as 2.5-4.5% per month.
The segmented financial markets present an ironical (if not tragic) picture of huge funds being available with bankers on the one hand and prohibitive interest rates at which funds are made available to the non-corporate, unorganized sector on the other.
3.2 The need for industry status
Industry status to retailing is the first basic step needed for reforming the Indian retailing sector. The following are the first order benefits of granting industry status to retailing in India.
Greater Focus on Retailing Development
Granting industry status to retailing implies that retailing wouild then come under the purview of a single ministry and would most likely have a nodal agency and an apex body dedicated solely for the retailing sector. This would ensure that this sector gets the very badly needed focus in development. Currently, retailing is quite a big buzzword and almost everybody connected with the industry keep talking on the changes needed in this industry. But the lack of clear focus has led to a situation where hardly any action has been possible in this highly discussed field.
Fiscal Incentives for Retailing Industry
One of the major problems with Indian retailing has been the fact that the levels of investment in organized retailing continue to be dismally low. Granting industry status may facilitate the provision of fiscal incentives to to this high potential sector. A parallel can be drawn here with the hotelling industry where investments improved significantly after the granting of industry status and the provision of fiscal incentices. Incentives for investments in cold storage chains, infrastructure and investments in the supply chain can go a long way in improving the current state of retailing in India.
Availability of Organized Financing
Drawing a parallel with the Indian film industry, one major benefit from granting industry status would be the easier availability of organized financing. Soon after the industry status, the IDBI established norms for lending to the Indian Film Industry. The benefits have been mulifold. The first benefit of easier financing has been the greater availability of capital for film producers at competitive rates. Previously, bulk of film financing happened in the informal money markets at sky-high interest rates. Another benefit has been the reduction of money laundering and hawala activities in this industry. Another indirect benefit has been the availability of another new option for banks to lend their increasing reserves. Similar benefits can accrue to the retail industry.
Establishment of Insurance norms
Insurance to retailers is still perceived to be a risky proposition. The main problem faced by insurance companies while insuring small retailers has been the absence of established norms and prior experience. Once the sector gets industry status most of these problems would get taken care of pretty easily.
Law Amendments
Most of the laws governing Indian retail are pretty archaic. Specifically, speaking some of the laws that need to be reviewed on a priority basis are
a. Essential Commodities Act
b. Weights and Measures
c. Agriculture product market act
d. Prevention of food adulteration act
e. Shops and Establishment Act
These are just some of the main areas that need attention. The fact is that the Indian legal structure as a whole is need of a review.
3.3 Stakeholder Benefit Analysis
There are four classes of stakeholders who stand to benefit if retailing is granted industry status:
. The government:
The government in this case would benefit from better tax income. Mainly because, granting industry status would both broaden the taxpayer base as well as reduce the amount of black money that goes into the market otherwise. Industry status would ensure greater transparency and accountability in this sector.
Tax collection will improve due to the reduction in incidence of:
* Sales without bills
* One bill for more than one consignment
* Under pricing/ under invoicing
* Alleged sales of exempted goods
* Purchase from bogus dealers i.e bill-trader
Industry status to retail will also facilitate the implementation of the Value Added Tax system that is currently facing several hurdles at the state level.
Specifically speaking the government's gains would be as follows:
Stakeholder
Key Buy-In Factor
Ministry of Finance
Increasing taxpayer base
Industry Ministry
Reduce supply chain costs and improve Indian Products
Commerce Ministry
Overall improvement in Trade and productivity
Home Ministry
Reduction in levels of money laundering
PMO
Demonstrate the PMO's commitment to reforms
State Governments
Reduce sales tax evasion by 30-50%
2. Retailers
The most obvious beneficiaries of industry status to retail would be the retailers. The retailers would benefit from simpler norms for setting up new stores and faster processing for most tasks that currently are bogged down by bureaucratic delays. Also, the retailers would benefit from easier availability of funds for financing their expansion and investment plans.
3. Small and medium enterprises
SME's would benefit from industry status due to reduced market access time. Faster processes, faster clearances, greater transparency all contribute towards a reduced time to access the market for SMEs.
4. Financial sector
The financial sector, including banks and insurance companies, benefit from established norms for lending to the booming retail industry. The retailing industry would give them a new area for expanding their scope of operations.
5.
FDI In India: An Analysis
"India has one of the most transparent and liberal FDI regimes among the emerging and developing economies.".... "Today, even a country like Botswana attracts more FDI annually than India."
Report of the Planning commission's Steering Group on FDI
Increased FDI inflow into the country has been cited by government after government as a major achievement. In this section we try to analyze the Indian FDI story in the sectors that have been opened up till date.
4.1 Global Trends
Global foreign direct investment (FDI) almost quadrupled between 1995 and 2000. However, FDI flows to developing countries grew at a much slower rate over this period, doubling to $240.2 billion their share.
FDI inflows into developing countries virtually halted in 1998 as a result of the Asian crisis. The share of developing countries in global flows reached a peak of 39.6 percent in 1996, declining rapidly thereafter to reach 18.9 per cent of total flows in 2000. Though absolute FDI amounts have declined in 2001, the share of developing countries has increased dramatically to 30 per cent.
4.2 India's Share
India's share in FDI inflows among developing countries reached a peak of 1.9 per cent 1997. It declined sharply to 1 per cent in 1999 and 2000 but has recovered sharply to 1.7 per cent in 2001. India's performance on the FDI front has shown a significant improvement since last year. FDI inflows grew by 65 per cent to US$ 3.91 billion during 2001-02 thus exceeding the previous peak of US $ 3.56 billion in 1997-98 (as per BOP accounts of RBI). This growth of 65 per cent is particularly encouraging at a time when global FDI inflows have declined by over 40 per cent. The upward trend in FDI inflows has been sustained during the current financial year with FDI inflows during April-June 2002 about double that during the corresponding period of 2001 (as per DIPP data).
In 2000, China with 17 per cent had the highest share of developing country FDI followed by Brazil with 13.9 per cent of developing country FDI. The gap between the shares of these two countries narrowed during the nineties with Brazil gradually catching up with China, but has again widened in 2001. Though the share of Argentina, South Korea, Singapore, Malaysia and Taiwan is much lower than that of China and Brazil, it was, till 2000 two to five times that of India's measured inflow. The most remarkable transformation has occurred in South Korea, whose share in developing country FDI inflows was identical to that of India in 1993, and which fell below that of India in 1994 and 1995, but was four times that of India's in 2000 (Figure 3.2). Because of the Asian crisis in 1997-98 and the effect of sanctions on investor's sentiment, India's share of developing country FDI fell at the end of the nineties. There has however been a significant improvement during 2001.
India's measured FDI as a percentage of total Gross Domestic Product (GDP) is quite low in comparison to other competing countries (Table-3.3). India the 12th largest country in the world in terms of GDP at current exchange rates is able to attract FDI equal only to 0.9 per cent of its GDP in 2001. In contrast FDI inflows into Vietnam were 6.8 percent of its GDP in 2000. Even Malaysia, which has recently developed an image of being somewhat against the globalisation paradigm, receives FDI equal to 3.9 per cent of its GDP. Similarly China attracts FDI equal to 3.8 per cent of its GDP. Thailand, which has a relatively low FDI-GDP ratio among the major developing country recipients of FDI, had a ratio four times that of India in 2000. This gap probably narrowed in 2001 and could narrow further in 2002 if the recent acceleration in growth of FDI into India can be sustained.
4.3 Direction of FDI inflow into India
Engineering, Services, Electronics and Electrical equipment and Computers were the main sectors receiving FDI in 2000-01. Domestic appliances, finance, food & diary products which were important sectors attracting FDI in the early nineties, have now seen a downtrend in the latter half of the nineties. Services and computer have seen an increasing trend in the latter half of the nineties. The inflow of FDI into computers increased from 6 per cent in 1999-00 to 16 percent in 2000-01. On the whole there have been significant changes in the pattern and composition of FDI inflows with few clear trends over the decade as whole.
4.4 Causes and reasons for Low FDI Inflow into India
This section highlights some of the weakness and constraints on achieving higher FDI inflows into India. The review presents broad generalizations based on the perceptions of potential foreign investors and independent consultants who interact closely with them.
Image & Attitude
Though economic reforms welcoming foreign capital were introduced in the nineties it does not seem so far to be really evident in our overall attitude. There is a lingering perception abroad that foreign investors are still looked at with some suspicion. There is also a view that some unhappy episodes in the past have a multiplier effect by adversely affecting the business environment in India. Besides the "Made in India" label is not conceived by the world as synonymous with quality.
When a foreign investor considers making any new investment decision, it goes through four stages in the decision making process and action cycle, namely, (a) screening, (b) planning, (c) implementing and (d) operating and expanding. The biggest barrier for India is at the first, screening stage itself in the action cycle. "Often India looses out at the screening stage itself" (BCG). This is primarily because we do not get across effectively to the decision-making "board room" levels of corporate entities where a final decision is taken. Our promotional effort is quite often of a general nature and not corporate specific. India is, moreover, a multi-cultural society and a large number of multi-national companies (MNC) do not understand the diversity and the multi-plural nature of the society and the different stakeholders in this country. Though in several cases, the foreign investor is discouraged even before he seriously considers a project, 220 of the Fortune 500 companies have some presence in India and several surveys (JBIC, Japan Exim bank, A T Kearney) show India as the most promising and profitable destination.
On the other hand China is viewed as 'more business oriented,' its decision-making is faster and has more FDI friendly policies (ATK 2001). Despite a very similar historical mistrust of foreigners and foreign investment arising from colonial experience, modern (post 1980 China) differs fundamentally from India. Its official attitude to FDI, reflected from the highest level of government (PM, President) to the lowest level of government bureaucracy (provinces) is one of consciously enticing FDI with a warm welcome. They recognise the multifaceted and mutual benefits arising from FDI.
All investments, foreign and domestic are made under the expectation of future profits. The economy benefits if economic policy fosters competition, creates a well functioning modern regulatory system and discourages 'artificial' monopolies created by the government through entry barriers. A recognition and understanding of these facts can result in a more positive attitude towards FDI.
Policy Framework
Most of the problems for investors arise because of domestic policy, rules and procedures and not the FDI policy per se or its rules and procedures. The FDI policy, which has a lot of positive features, is summarised first, before highlighting the domestic policy related difficulties that are commonly the focus of adverse comment by investors and intermediaries.
FDI Policy
India has one of the most transparent and liberal FDI regimes among the emerging and developing economies. By FDI regime we mean those restrictions that apply to foreign nationals and entities but not to Indian nationals and Indian owned entities. The differential treatment is limited to a few entry rules, spelling out the proportion of equity that the foreign entrant can hold in an Indian (registered) company or business. There are a few banned sectors (like lotteries & gaming and legal services) and some sectors with limits on foreign equity proportion. The entry rules are clear and well defined and equity limits for foreign investment in selected sectors such as telecom quite explicit and well known.
Most of the manufacturing sectors have been for many years on the 100 per cent automatic route. Foreign equity is limited only in production of defence equipment (26 per cent), oil marketing (74 per cent) and government owned petroleum refineries (26 per cent). Most of the mining sectors are similarly on the 100 per cent automatic route, with foreign equity limits only on atomic minerals (74 per cent), coal & lignite (74 per cent), exploration for oil (51 per cent to 74 per cent) and diamonds and precious stones (74 per cent). 100 per cent equity is also allowed in non-crop agro-allied sectors and crop agriculture under controlled conditions (e.g. hot houses).
In the case of infrastructure services, there is a clear dichotomy. While highways and roads, ports, inland waterways and transport, and urban infrastructure and courier services are on the 100 per cent automatic route, telecom (49 per cent), airports (74 per cent), civil aviation (40 per cent) and oil and gas pipelines (51 per cent) have foreign equity limits. India also has a clear policy of FDI in services, with 100 per cent automatic entry into many services such as construction, townships/resorts, hotels, tourism, films, IT/ISP/email/voice mail, business services & consultancy, renting and leasing, VCFs and VCCs, medical/health, education, advertising and wholesale trade. The financial intermediation section has sectoral caps like banking (49 per cent), insurance (26 per cent), as do some services like professional services (51per cent).
Subject to these foreign equity conditions a foreign company can set up a registered company in India and operate under the same laws, rules and regulations as any Indian owned company would. Unlike many countries including China, India extends National Treatment to foreign investors. There is absolutely no discrimination against foreign invested companies registered in India or in favour of domestic owned ones. There is however a minor restriction on those foreign entities who entered a particular sub-sector through a joint venture with an Indian partner. If they (i.e. the parent) want to set up another company in the same sector it must get a no-objection certificate from the joint-venture partner. This condition is explicit and transparent unlike many hidden conditions imposed by some other recipients of FDI. There are also a few prudential conditions on the sale of shares in unlisted companies and the above market price sale of shares in public companies.
Domestic Policy
The domestic policy framework affects all investment, whether the investor is Indian or foreign. To an extent, foreign companies or investors that have set up an Indian company or Joint Venture have become indigenised and thus can operate more or less competitively with other Indian company. They adjust themselves to the milieu. This is not, however, true of foreign direct investors who are coming into India for the first time. To the uninitiated the hurdles look daunting and the complexity somewhat perplexing.
Among the policy problems that have been identified by surveys as acting as additional hurdles for FDI are laws, regulatory systems and Government monopolies that do not have contemporary relevance. Illustratively, the outdated Food Price Order (FPO) and Prevention of Food Adulteration Act is a major hurdle for FDI in food processing. The latter makes even a technical or minor violation subject to criminal liability. As a Task force had recommended some years ago, that we need to formulate a single integrated Food Act (including weights & measures). This should also make provision for a modern Food Regulatory system with a single integrated regulator. Based on the announcement in the last budget a Group of Ministers has been constituted to evolve a modern food law. The Essential Commodities Act adds to the difficulty of entering the food processing industry by making the procurement, storage and transport of agricultural produce subject to many vagaries and undermining the competitive advantage that India possesses. The Central government has recently taken steps to reduce the ambit of this act and eliminate controls on movement and storage of food grain. Initial steps have also been taken in the direction of putting this act into suspended state to be invoked only by a Central government notification to be applied only to well-specified emergency conditions like drought, floods and other natural disasters for a specific area and duration. Other simplification measures announced in the last budget were the amendment of the Milk and Milk products Control Order to remove restrictions on milk processing capacity, decanalisation of the export of agricultural commodities and phasing out of remaining export controls, expansion of futures and forward trading to cover all agricultural commodities and amendment to the Agriculture Produce Marketing Acts to enable farmers to sell directly to potential processors.
Similarly labour laws discourage the entry of green field FDI because of the fear that it would not be possible to downsize if and when there is a downturn in business. Labour laws, rules and procedures have led to a deterioration in the work culture and the comparative advantage that is even beginning to be recognised by responsible Trade Unions. Pursuant to the announcement in the 2001-02 budget that labour laws would be reformed, a Group of Ministers was set up to work out the modalities. The Labour Commission has in the meanwhile also submitted its report. The Group of Ministers will suggest specific changes in the laws for the approval of the Cabinet. SSI reservations further limit the possibility of entering labour intensive sectors for export. De-reservation of readymade garments during the year 2000 and de-reservation of fourteen other items related to leather goods, shoes and toys during 2001 is a welcome development. About 10 per cent of the items on the list of items reserved for the small-scale sector have been freed over the past few years. These two policy constraints are particularly relevant for export oriented FDI. More flexible labour laws that improve work culture and enhance productivity and SSI de-reservations will help attract employment generating FDI inflows of the kind seen in South East Asia in the seventies and eighties and in China since the nineties.
The Urban Land Ceiling Acts and Rent Control Acts in States are a serious constraint on the entire real estate sector. This is another sector that has attracted large amounts of FDI in many countries including China. Like the labour-intensive industrial sectors it can also generate a large volume of productive employment. These Acts need to be repealed if a construction boom is to be initiated that would reverse the decline in overall investment, attract FDI, generate employment and make rental accommodation available to the poor. The Centre has already repealed the Urban Land Ceiling Act but each State has to issue a notification to repeal the Act in that State. Rent Control is a State subject and each State would have to reform its Rent control Act. The Central government has set up an Urban Reform Facility to provide funds to States that repeal the State Land Ceiling Act, reform the Rent Control Act and carry out other urban reforms.
Weak credibility of regulatory systems and multiple and conflicting roles of agencies and government has an adverse impact on new FDI investors, which is greater than on domestic investors. All monopolists have a strong self-interest in preventing new entrants who can put competitive pressure. In the past, government monopoly in infrastructure sectors has slowed down policy reform. FDI was discouraged by the fear that pressure exerted by government monopolies through their parent departments would bias the regulatory system against new private competitors. As regulatory systems and procedures move up the learning curve, initial problems stemming from lack of regulatory knowledge/experience in sectors such as Telecom have been gradually overcome. Similarly, in the past, strategy and implementation problems connected with dis-investment created great uncertainty and increased policy/regulatory risk, resulting in a lack of interest of FDI investors in bidding for these companies. With a much clearer strategy and effective implementation over the past year and a half, there should be better inflow on this account.
According to some consultants, in the banking sector, controls on activity dampen FDI inflows. It is alleged that persistent fears of impending "fiscal crisis" is another constraint, and that a well articulated strategy for medium term fiscal consolidations would address these concerns. The absence of product patents in the chemicals sector has reduced inflows into the drugs and pharmaceuticals sector.
Though the foreign trade and tariff regime for Special Export Zones (SEZs) approximates a genuine free trade zone, the other elements of the policy framework and procedures remain virtually the same as in the Domestic Tariff Area. The SEZs are therefore still not fully on par with the Export Zones of China with respect to Labour Intensive production.
Procedures
According to Boston Consulting Group, investors find it frustrating to navigate through the tangles of bureaucratic controls and procedures. Mckinsey (2001) found that, the time taken for application/bidding/approval of FDI projects was too long. Multiple approvals, excessive time taken (2-3 years) such as in food processing and long lead times of up to six months for licenses for duty free exports, lead to "loss of investors' confidence despite promises of a considerable market size."
Bureaucracy and red tape topped the list of investor concerns as they were cited by 39 per cent of respondents in the A T Kearney survey. Of the three stages of a project, namely general approval (e.g. FDI, investment licence for items subject to licence), clearance (project specific approvals e.g. environmental clearance for specific location and product) and implementation, the second was the most oppressive. Three-fourth of the respondents in the survey indicated that (post-approval) clearances connected with investment were the most affected by India's red tape. According to a CII study, a typical power project requires 43 Central Government clearances and 57 State Government level (including the local administration) clearances. Similarly, the number of clearances for a typical mining project are 37 at the Central Government level and 47 at the State Government level. Though the number of approvals/clearances may not always be much lower in the OECD countries such as the USA and Japan the regulatory process is transparent with clear documentation requirements and decision rules based largely on self-certification, and generally implemented through the legal profession.
The Government has set up an inter-ministerial Committee to examine the existing procedures for investment approvals and implementation of projects and suggest measures to simplify and expedite the process for both public and private investment. The Committee, which was set up in September 2002, has submitted Part I of its report (dealing with Public sector projects) to the Government, which is under examination. A sub-Group of the Committee is specifically looking into simplification of procedures relating to private investment.
The respondents of the ATK survey also indicated that the divide between Central and State governments in the treatment of foreign investors could undermine the FDI promotion efforts of the Central Government. The FICCI (2001) study similarly cites centre-state duality as creating difficulties at both the approval and project implementation stages. These studies find that the bureaucracy in general is quite unhelpful in extending infra-structural facilities to any project that is being set up. This leads to time and cost overruns. At an operational level, multiple returns have to be filed every month.
One effect of these bureaucratic delays is the low levels of realization of FDI inflows vis-à-vis the proposals cleared (CII). Although the realization rate has improved to 45 per cent in 2000-01 compared to 21 per cent in 1997, it remains a matter of concern. The precise reason for the low levels of realization is the post approval procedures, which has in the past played havoc with project implementation.
Foreign Investment Promotion Board
It should be noted, that the delays mentioned by foreign investors are not at the stage of FDI approval per se i.e. at the entry point whether through RBI automatic route or FIPB approval. The FIPB considers application on the basis of notified guidelines and disposes them within a 6-8 week timeframe, as has been laid down by the Cabinet. The entire process of FIPB applications, starting from their registration through to listing on FIPB agenda and their final disposal and despatch on official communication is placed on the website, which adds to the transparency of decision-making and enhances investor confidence. Similarly, the underlying advisory support in the form of online chat facility and dedicated email facility for existing and prospective investors has created an investor friendly image. A FICCI Study on, " Impediments to Investment" (January 2002) has acknowledged that the Central level FIPB clearances have been successfully streamlined. The FIPB approval system has also been rated as world class by independent surveys conducted by CII & JICA.
The FIIA framework has also been strengthened recently by adoption of a six-point strategy. This includes close interaction with companies at both operational and board room level, follow up with administrative ministries, State Governments and other concerned agencies and sector specific approach in resolving investment related problems. The major implementation problems are encountered at the state level, as project implementation takes place at the state level. FICCI in its study on "Impediments to Investment" has observed that the Regional meetings for foreign investors under the FIIA chaired by the Industry Secretary are now turning out to be problem-solving platforms.
Quality of Infrastructure
Poor infrastructure affects the productivity of the economy as a whole and hence its GDP/per capita GDP. It also reduces the comparative advantage of industries that are more intensive in the use of such infrastructure. In the context of FDI, poor infrastructure has a greater effect on export production than on production for the domestic market. FDI directed at the domestic market suffers the same handicap and additional costs as domestic manufacturers that are competing for the domestic market. Inadequate and poor quality roads, railroads and ports, however raise export costs vis-a-vis global competitors having better quality and lower cost infrastructure. As a foreign direct investor planning to set up an export base in developing/emerging economies has the option of choosing between India and other locations with better infrastructure, India is handicapped in attracting export oriented FDI.
Poor infrastructure is found to be the most important constraint for construction and engineering industries. "Law, rules, regulations relating to infrastructure are sometimes missing or unclear e.g. LNG and the power sector is beset with multiple problems such as State monopoly, bankruptcy and weak regulators" (Mckinsey 2001).
State Obstacles
Taxes levied on transportation of goods from State to State (such as octroi and entry tax) adversely impact the economic environment for export production. Such taxes impose both cost and time delays on movement of inputs used in production of export products as well as in transport of the latter to the ports. Differential sale and excise taxes (States and Centre) on small and large companies are found to be a deterrent to FDI in sectors such as textiles (Mckinsey 2001). Investments that could raise the productivity and quality of textiles and thus make them competitive in global markets remain unprofitable because they cannot overcome the tax advantage given to small producers in the domestic market.
Globally the service sector received 43 per cent of total investment in emerging markets in 1997 (ATK 2001). As this is a State subject, the States have to take the lead in simplifying and modernising the policy and rules relating to this sector.
At the local level (sub-state) issues pertaining to land acquisition, land use change, power connection, building plan approval are sources of project implementation delay. The State level issues are also being considered by the Govindrajan committee with a view to seeing how they can be alleviated.
Legal Delays
Though India's Anglo Saxon legal system as codified is considered by many legal experts to be superior to that of many other emerging economies it is often found in practice to be an obstacle to investment. One of the reasons is the inordinate delay are the interlocutory procedures that characterise judicial procedures. As a result the "Rule of law," which has often been cited as one of the attractive features of the Indian economy for foreign investors, is found to be a significant positive factor by only 3 per cent for FDI in India. In contrast, 26 per cent of all those surveyed by ATK (2001) cited this as an important factor in their global investment decisions.
4.5 FDI Policy Recommendations
An ideal FDI policy would have to be based on four fundamental principles: clarity, transparency, adequacy and stability. And Indian FDI policy needs to go a long way in terms of all of these parameters. Transparency implies that there should be a set of very well defined, clearly laid out ground rules that regulate FDI in the country. The Indian system has traditionally suffered from a high degree of ambiguity. Indian FDI policy decisions also severely suffer from a huge degree of ad-hocism. For example, the FDI policy in the power sector has been in a state of flux for a long time now.
Adequacy in FDI policy implies that the overall policy mix should be adequate to achieve the overall policy objective. The Indian policy mix is quite inadequate. Stability in Indian plicies also has been a major area of concern. Critical policies change dramatically with every government change, and even at a per-budget level. The following are some changes that are vital in the current Indian FDI Policy:
Change in Focus: The current Indian FDI policy lays too much emphasis on export promotion and efficiency-seeking FDI only. There has been a belliegerent neglect of market seeking FDI with the apparent objective of trying to protect the domestic industry. This neglect of market seeking FDI alienates a huge section of potential investors.
Simplification of Processes: In FDI and in a lot of other areas, the Indian system is bogged down by excessive bureaucracy and complex processes. There is tremendous scope for a huge amount of simplification in the existing processes and systems.
Exit Policy: Most foreign firms state that the absence of a clear exit policy is a mjor issue while setting up business in India.
Apart from these, companies also require the Indian Government to allow a hire and fire policy at work, but this seems unlikely in the near future.
6. Impact of FDI: The Global Experience
"The single biggest impact of multinational company investment in developing economies is the improvement in the standards of living of the country's population, with consumers directly benefitting from lower prices, higher-quality goods and more choice. Improved productivity and output in the sector and its suppliers indirectly contributed to increasing national income. And despite often-cited worries, the impact on employment was either neutral or positive in two-thirds of the cases."
McKinsey Report on Global Impact of FDI
In this section we will try to capture and summarize the effect that of foreign direct investment in developing economies across the globe.
5.1 Global Trends
The process of globalization is not uniform across all industries, and there are large differences in the extent to which developed and developing countries have been integrated into a single global market. We define five horizons that describe the different ways in which industry value chain can be restructured across locations. These horizons are not exclusive of one another, nor necessarily sequential, and can often be mutually reinforcing. Market entry: Companies have entered new countries in order to expand their consumer base, using a very similar production model in the foreign country to the one they operate at home.
Product specialization: Companies have located the entire production process of a product (components to final assembly) to a single location or region, with different locations specializing in different products and trading finished goods.
Value chain disaggregation: Different components of one product are manufactured in different locations/regions and are assembled into final product elsewhere.
Value chain reengineering: After moving value chain steps to new location, processes can be redesigned to capture further efficiencies/cost savings - most importantly, to take advantage of lower labor costs in developing countries through more labor-intensive methods.
New market creation: By capturing full value of global activities, firms can offer new products at significantly lower price points and penetrate new market segments/geographies.
Market Seeking and Efficiency Seeking Investments
The 1990s saw a real boom in multinational company investment in developing countries. This boom included both market-seeking investments made in order to gain access to the host country markets - still the dominant motive for international expansion for companies; and efficiency-seeking investments made to reduce global production costs of multinational companies. We make a further distinction within market-seeking FDI depending on whether government policy barriers preventing imports created an incentive for investing within the host country.
Efficiency-seeking FDI is motivated by multinational companies seeking to reduce costs by locating production to countries with lower factor costs.
Pure market-seeking FDI is motivated by MNCs looking for revenue growth by expanding their operations in other countries.
Market seeking FDI to overcome policy barriers - or tariff-jumping FDI refers to cases where import barriers limit foreign companies' capacity to supply local demand through imports, and as a result they end up investing in plants for domestic production only.
Large Economic Value Creatoion through FDI
Worldwide, the observation has been that FDI has created substantial economic value within host countries. In most cases, FDI has had an overall positive or very positive economic impact. This strongly suggests that many of the criticisms directed at foreign operations in developing countries - e.g., that they act as monopolies, lay off workers, without generating spillover effects on the rest of the economy - are not broadly warranted. And while we found a positive impact across the different sectors and varying policy regimes, there also seems to exist a clear pattern by type of FDI.
Efficiency-seeking FDI overwhelmingly has a positive impact on the host countries. It consistently has a positive or very positive impact on sector productivity, output, and employment. At the same time, focus on exports meant that these investments did not have significant costs to incumbent domestic companies. This explains the focus of many developing country policy makers on boosting export-oriented FDI - even while keeping domestic services closed to foreign investors (e.g., India). This overwhelmingly positive impact goes against the view that efficiency seeking multinational companies are exploiting their host countries because they pay low wages and provide fewer benefits than they would at their home markets. In fact, beyond the positive economic impact, in almost all of cases - both efficiency and market seeking ones - foreign players paid a wage premium above their domestic competitors, and they were more likely to comply with labor regulations than domestic companies within the same sector.
Market-seeking FDI also has a generally positive impact on sector productivity and output, the improvement coming in most cases at a cost to domestic incumbent companies. There are some differences in outcomes depending on the policy and competitive environment of the sector however. In pure market-seeking cases, FDI tends to improve sector productivity. In cases where FDI is motivated by tariff jumping, FDI has a consistently positive impact on sector performance. Given the protection provided to the sector, a very low level of performance was typical, allowing for significant positive impact even when the tariffs or other regulations limited FDI's full potential impact. When policies to FDI were liberalized and foreign players entered to supply the protected domestic market, increased competition led to improved productivity of the sectors.
The biggest beneficiaries of foreign players' entry into the protected markets were consumers who saw declining prices, broader selection, and increasing domestic consumption. As a result of output growth, the impact on employment was neutral in most cases, as sector growth helped keep employment levels stable despite increases in labor productivity. However, the remaining protected policies kept prices higher and domestic sales lower than they would be with more liberal policies.
FDI Entry Leads To Positive Supplier Spillovers
In addition to the clear positive impact on sector performance, foreign player entry has positive or very positive impact on suppliers in most cases. The stage of industry restructuring of the sector determined the potential supplier impact, with some variance on outcomes depending on sector initial conditions.
Consumers Have Been The Big Winners
Among all the constituencies within the host country, consumers are the major beneficiaries as foreign player entry leads to direct improvements in their standards of living. Consumers get a positive impact through price reductions, improved selection, or both, and these led to increased output or domestic consumption in most cases. These benefits are present across both market seeking and efficiency-seeking cases. This impact on domestic standards of living is the great success story of FDI - but one that is seldom heard because of the fact that consumers are a fragmented, less vocal political body than, say, incumbent domestic companies.
In market-seeking FDI cases, prices to consumers declines in most cases, and selection available to consumers grows tremendously. As we would expect, efficiency-seeking FDI cases have a more limited impact on host country consumers as most production is for export and benefits global consumers. Furthermore, many countries have imposed policy barriers that prohibit export-oriented FDI players from participating in the domestic market. But even in these conditions, we found the presence of foreign players benefits domestic consumers - either in the form of broader selection enabled by local production, or as in the case of Mexican auto sector, by FDI players introducing innovative financing options in the Mexican market that they probably would not have done without having local production facilities.
Foreign Investments Bring Capital, Technology and Skills
The positive impact of foreign direct investments in developing countries can be attributed to the combination of three things that foreign players bring in tandem to the domestic markets: capital, technology, and skills. In many cases, the three are closely integrated - as in automotive plant investments that combine the capital, technology, and operational and managerial skills needed. In most successful cases however, these MNC global capabilities were complemented with deep local market expertise provided either by local partners or locally hired managers.
Capital: Capital inflow from foreign investors is critical for sector performance. In Brazil food retail, formal domestic players were cash constrained and needed foreign capital for the productivityimprovements that would enable them to be more competitive against the low cost informal players; In Mexican banking, domestic banks had been severely undercapitalized after the financial crisis of 1997, and foreign capital infusion was critical for capitalizing and maintaining the stability of the Mexican financial system; in Indian auto and IT/BPO cases, foreign capital was needed to finance the investments required for sector growth. In addition, supplier spillover effect in many cases was driven by foreign player financing: auto OEMs are a main source of financing for local parts suppliers in all country cases, and in China consumer electronics, financing from Taiwanese entrepreneurs were a significant source for Chinese companies supplying to or competing with other foreign investors. Yet the need for capital (either for investments or operations) was not a necessary condition for foreign player entry - there were cases like Wal-Mart's Cifra acquisition in Mexico food retail that were pure transfer of equity from a domestic owner to a foreign one.
Technology: Access to proprietary or foreign technologies and design capabilities was a key factor that foreign OEMs provided in all auto and consumer electronics cases. The more complex and rapidly evolving the technology required, the more difficult it is for domestic companies to acquire without foreign investments. So within consumer electronics, access to foreign technology was most important in mobile phones and least important in white goods like refrigerators and stoves.
Skills: Foreign investors brought a broad range of skills that enabled them to improve domestic sector productivity and grow output. We have grouped these skills into four categories:
Operations/organization of functions and tasks (OFT): Large foreign players coming from more competitive home markets brought with them global capabilities in operations in most of our sectors: examples include supply chain processes and inventory management in food retail; plant operations and distribution in auto; business operations in BPO; and credit work-out skills in retail banking in Mexico.
Marketing and product tailoring: Foreign players also introduced improvements in marketing: for example, in food retail, foreign players introduced competitive pricing practices in Mexico and improved in-store marketing and merchandizing in Brazil; in consumer electronics China and India, some MNCs tailored products to suit the domestic market.
Interestingly, the most successful examples combined the global capabilities of foreign players with deep local knowledge provided by their domestic partners (e.g., Cifra management in Mexican food retail, Maruti in Indian auto), and where we saw some failures among foreign players as a result of insufficient local knowledge (e.g., OEMs targeting high-end segments in India auto, or attempts of foreign retailers to sell ski boots in São Paulo or sit-on lawn-mowers in Mexico).
Managerial and organizational skills: In all our cases, foreign players brought new organizational and managerial skills to the domestic market. These ranged from introducing more professionalism in company culture and increasing accountability, to more specific management tools like performance measurement or wage structures and other incentives. Again, we saw examples of MNCs benefiting from local knowledge through employment of local managers and supervisors particularly on the customer service segments of Indian BPO.
We found broad variance in the specific management approaches, as we do among high-performing companies within any developed economy, and did not find a correlation between, say, level of de-centralization and MNC performance. The example of Mexican retail banking illustrates the case: after acquiring domestic banks, MNCs have chosen a broad range of management approaches ranging from Banco Bilbao Vizcaya Argentaria's (BBVA) strictly top-down approach to Citigroup's decentralized approach through management mentoring.
Global market access: In efficiency-seeking cases, foreign players provided access to the export market through their global distribution networks, market position, and brands. This was the case for all consumer electronics export segments in Mexico, China, and Brazil, as well as in automotive in Mexico and Brazil, where foreign OEMs were able to increase exports to compensate declining domestic sales during economic crises. This can often be a major barrier for domestic players - yet they can potentially benefit from FDI entry as well: in Indian IT/BPO case, the example of leading global players like IBM locating their off-shoring operations to India established the credibility of the Indian sector, opening the door for India companies to follow suit.
Additional Impact through competition
We found competition within the host country sector to be a critical driver of improvements in sector performance as a result of FDI. The impact mechanism, therefore, was not very different from any domestic economy. However, FDI's potential for impact can be greater because of the combination of scale, capital, and global capabilities that allowed MNCs more aggressively to close existing large productivity gaps. And this potential of FDI impact was demonstrated in three ways:
. FDI can be a powerful catalyst to spur competition in industries characterized by low competition and poor productivity. Examples include the cases of consumer electronics in Brazil and India, food retail in Mexico, and auto in China, India, and Brazil.
2. Competition is also key to diffusing FDI-introduced innovation across an industry. In Brazilian food retail, high competitive intensity caused by informal players forced all modern retailers to rapidly increase productivity; in Mexican and Brazilian auto cases, increasing competition from imports induced foreign players themselves to increase their productivity.
3. And last, competition is critical for ensuring that the economic benefits from improved productivity are passed on to consumers through lower prices. The best example of this is the case of consumer electronics in China, where aggressive competition has kept supplier margins razor thin and brought rapidly declining prices to both Chinese and global consumers.
Increasingly, foreign direct investment are integrating developing countries into the global economy, creating large economic benefits to both the global economy and to the developing countries themselves. Industry restructuring enables global growth as companies reduce production costs and create new markets. For the large developing countries, integrating into the global economy through foreign direct investments improves standards of living by improving productivity and creating output growth. The biggest beneficiaries from this transition are consumers - both global consumers that reap the benefits from global industry restructuring, and consumers in the host countries that see their purchasing power and standards of living improve. The more competitive the environment, the more benefits FDI can bring - and the more benefits that are passed directly on to consumers.
7. FDI in Retailing
"The sheer size and potential of India's consumer market is enough for the big international retailers to have an interest in setting up stores in the country, despite the obstacles they might face. The growth prospects of this sector seem to be very positive."
PricewaterHouseCoopers Report on Indian Retailing
Though direct FDI is still not permitted in the Indian Retailing Sector, several foreign retailers have entered the Indian market through various indirect riutes. In this section we will comprehensively analyze the issue of permitting FDI in the Indian market.
6.1 Internationalization: The New Retail Trend
Internationalization is the latest trend in the global retail industry. Bogged down my saturating and small domestic markets, and stagnant domestic opportunities, retailers across the world are looking more and more towards international locations to expand their operations. The following exhibit explains the reasons behind the increasing degree of internationalization in the retailing industry.
The Internationalization of retailing has been especially rapid in the past 7-8 years. The diagram below shows the growth and expansion of some of the world's best-known global retailers.
As can be seen, major retaile players are increasingly looking towards international locations. In this contaxt, on account of huge markets, china and India figure prominently in the radars of these retailers.
6.2 The Indian Retailing Regulations
Under the current FDI regime in India, foreign investment is not permitted in the retail trade sector, except in the following cases:
• Hi-Tech items / items requiring specialized after sales service
• Social sector items
• Medical and diagnostic items
• Items sourced from the Indian small sector (manufactured with technology provided by the foreign collaborator)
• 2-year test marketing (simultaneous commencement of investment in manufacturing facility required)
Foreign owned Indian companies cannot own and run retail shops to sell to other category of goods to consumers in India. 100% FDI is, though, permitted on specific approval basis in case of trading companies in India for carrying out
• Export trading
• Bulk imports with sales either through custom bonded warehouses/high seas sales
• Cash and carry wholesale trading
• Sales substantially to group companies
FDI upto 100% is allowed for e-commerce activities subject to the condition that such companies would divest 26% of their equity in favour of the Indian public in 5 years, if these companies were listed in other parts of the world. Further, these companies would engage only in business-to-business (B2B) e-commerce and not in retail trading, inter-alia, implying that existing restrictions on FDI in domestic trading would be applicable to e-commerce as well.
With respect to cash and carry wholesale trading, it is being allowed not only for players setting up grocery markets but also to players who wish to undertake wholesale trading of their products through various distributors, franchisees and resellers. Metro Group of Germany and shoprite checkers of South Africa have been allowed to carry out cash-and-carry wholesale trading though the proposal faced strong opposition.
The entities that established a presence in India prior to 1997, when liberal policies were prevalent and there were no FDI restrictions in the retail sector, have been allowed to continue with their existing foreign equity components. Foodworld, which is a 51:49 in joint venture between RPG and Dairy Farm International, which was established during this period, is one of the leading food retailers in India.
The Government has been debating the issue of allowing FDI in retail trade sector for long. The Report of the Steering Group on FDI, headed by Mr. N.K.Singh, issued in September 2002, has not recommended lifting the ban on FDI in retail trade as the sector is currently dispersed, widespread, labour intensive and disorganised in India.
Property Regulations
There is a shortage of good quality retail space and rents are high for what is available. Compounding these shortages are the following problems:
• Very high stamp duties on transfer of property - varies from state to state ( 12.5% in Gujarat and 8% in Delhi)
• The Urban Land Ceiling Act and Rent Control Acts have distorted property markets in cities, leading to exceptionally high property prices
•The presence of strong pro-tenancy laws makes it diffi cult to evict tenants. The problem is compounded by problems of clear titles to ownership
• Land use conversion is time consuming and complex
• Very time consuming legal processes for property disputes
• City urban planning projected smaller commercial plots and this, together with rigid building and zoning laws make it diffi cult for procurement of retail space
• Non-residents are not allowed to own property except if they are of Indian origin. Foreign owned Indian companies can own property for business purposes
• Foreign investment in Real Estate business is prohibited except for integrated township development, wherein 100% FDI is allowed with prior Government approval
However, the Government is focusing on resolving these problems by removing Urban Land Ceiling Act, Rent Control Legislation and reducing stamp duties.
Other Regulations
Domestic taxation system
Different sales tax rates across different states in India make supply chain management an immensely diffi cult task for the retailers:
•Inter State sale attracts Central Sales Tax
•Multi point octroi is levied in some locations
•For certain categories of products certain States levy import taxes namely entry tax on entry of goods into the territory of the respective States. Simultaneously states levy export taxes when the goods are moved for sale outside the territorial barrier of the respective States
•Sales tax evaded by smaller retailers to offer lower prices / fetch higher margins • With the introduction of Value Added Tax (VAT) in 2003, certain anomalies in the existing sales tax system causing disruptions in the supply chain are likely to get corrected over a period of time. However, its implementation has again been deferred
Imports
Though the maximum rates of import duties have been reduced from the original 40% rate, typically most of the products still attract duties at 25%. This is in addition to countervailing duties being levied on imports equivalent to excise duty levied on local manufacture of such products. This reduces the product choices available to the end consumers by making imports costlier. Restrictions on imports have been substantially reduced with the quantitative restrictions on tarifs reduced as per commitments made under the WTO agreement. With the implementation of WTO norms within the next three years' span and further removal of restrictions from the import regime, the retailing sector outlook appears bright.
6.3 The Indian advantage
Why is it that foreign retailers are looking at India? There are several reasons. First, the huge potential inherent in this coutry is too attractive for retailers. India is the second most populous nation on the face of this planet. But it is not the population alone that is attracting these retailers. The Indian advantage is that it is amongst the least saturated of all major global markets in terms of penetration of modern retailing formats. An ATKearney study on global retailing trends found that India is the least competitive as well as least saturated of all major global markets. This implies that there are significantly low entry barriers for players trying to set up base here, in terms of the competitive landscape.
Also investor confidence in India as a FDI destination has been consistently on the rise. Due to a stable and surging economy, and a booming IT industry that has become a national showcase, India is increasingly coming under the investment radar of major foreign players. The ATKearney global FDI Confidence index recently upgraded India to 6th rank as compared to the 15th rank we had last year. The significant aspect of this improvement is the fact that, in Asia, India is second only to China and is ahead of all the far-eastern economies.
Aiding these factors has been the sudden explosion in retailing in India. Malls are coming up at a tremendous pace at centers across the length and breadth of this country. There is increasing retail awareness among the Indian consumer class. Also of significant importance are the increasing spending power and burgeoning upper-middle and high-income population.
6.4 Entry Routes of Current Foreign Retailers
In spite of the ban on FDI, several international players have entered the Indian market through alternate routes. In this section we will analyze the entry strategies of some of the major multinationals into Indian retailing.
Franchisee Operations:
In the franchisee route, the international company lends its name and technology to a local partner, and gets royalty in return. In case a master franchisee is appointed at the national or regional level, he gets the right to appoint local franchisees. Nike, Marks and Spencers, Pizza Hut and Mango are some of the best-known foreign players who have adopted this setup of operations.
Joint Venture
In a typical joint venture, the international partner provides equity and support to the Indian investor. The Indian partner provides the local knowledge that is typically needed in such a venture. Mcdonalds and Reebok have adopted the joint venture route in India.
Manufacturing
In this route the multinational company sets up an Indian subsidiary to undertake manufacturing of their goods locally in India. Benetton and Bata have this strategy for India, and of these, Bata also has the right to retail in India.
Distribution
Companies like Swarovski and Hugo Boss have setup their distribution offices in India and these distribution offices in turn supply their products to the local Indian retailers.
Wholesale Trading
Metro Cash and Carry has been allowed to carry on wholesale trading in Bangalore on a cash and carry basis. The company has two stores up and running already. Shoprite Checkers of South Africa has also obtained the necessary clearances to setup a wholesale cash and carry business in Mumbai.
Globally, international retailers tend to prefer Joint Ventures and Acquisitions rather than green-field ventures, the exception in case being Carrefour, which seems to have used a mix of both, depending on individual country requirements.
8. FDI in Retailing: The debate
"As foreign retailers enter India buoyancy in the economy will definitely be seen as new products/services and better reach will increase the consumer spend thereby leading to healthier GDP levels. This will in turn attract more capital. However, it will be a case of survival of the fittest as far as Indian grocers and traders are concerned"
Kishore Biyani, MD, Pantaloon Retails (India) Ltd.
With a population of one billion, India has become a magnet for all international industries that have found their growth stagnate due to a saturated domestic market their countries. With a billion strong population and an economy that is growing at a faster pace than most developed economies India is proving to be an irrestible temptation to companies looking to expand their scope of operations globally. Permitting FDI in the Indian retail sector is a widely debated issue. The issue is of a sensitive nature and has severe political implications. This section tries to analyze the positive and negative effects of permitting FDI in the Indian retail sector.
7.1 FDI In Indian Retailing: Why Not?
There are some strong arguments against the opening of the Indian retail sector. There are several lobbies, associations and political parties that oppose such a move. The following are some of the specific arguments that are against the permitting of FDI in the Indian Retail sector:
Foreign Players Will Kill Indian Retailers:
The most popular argument against FDI in retailing has been the same argument that has been offered against FDI in every other field. FDI will hurt the domestic industry. Cliched though it may sound, this argument is quite valid. Given the state of inefficiency in the Indian retailing market, it is quite likely that a section of the domestic retailing industry will be severely hurt.
Indian Retailers Need more time to mature:
The argument for more time is also a typical response given by a host coutry's domesic industry when the threat of FDI is looming over their heads. There are two viewpoints of looking at this issue. One could be a pessimistic viewpoint, considering the fact that in the 57-odd years since we have had independence, retailing has been one of the least developed industries. The industry has done little to modernize itself and provide benefits to the consumer. So, we can really not hope much from this industry in the next few years, and hence there's no point in giving time for our industry to "grow".
On a positive note, Indian retailing has done a decebt job. We have emerged clean and clear from the decades of scarcity we faced. We currenty have in place, a retail network that manages to make good available even in the remote parts of the country. The only proble is that the network is inefficient. There is really no desperate need for FDI into this sector.
The truth, as usual, lies somewhere in between. While it may not be advisable to immediately introduce 100% FDI in retailing, a phased approach is recommended.
Foreign Capital is Not Entering The Market:
One major benefit cited by most supporters of FDI is that permitting FDI would permit foreign capital to flow into India and would help in improving efficiency and cost-effectiveness. But this is strongly countered by the fact that most global retailers who have set up base in oneway or the other in India, have borrowed locally to fund their operations rather than bringing in fresh capital from aboad. The MNCs do not normally bring funding from outside sources since they can access funds in our domestic market by showing comfort letters from their parent companies. There are many local financial institutions, both government and private, which would lend them below prime rate since they are globally recognized.
Cost of Capital for Indian Retailers is Much Higher:
This is definitely a major issue. The cost of capital incurred by an Indian retailer, especially the smalle players, is significantly higher than the CoC for foreign players. In case of the mom and pop stores in India, availability of capital from the formal lending sources is pretty difficult. As a consequence these players often end up borrowing fornm the informal financial markets, where lending rates could be as high as 3% per month. Compare this to the forign players who may be able to access funds at as low as 5-6% per year. The effect of the higher interest rates paid by the small retailers is seen in their prices and profit margins. Such a situation would lead to a huge price disparity between the foreign owned retail chains and local Indian retailers. Before letting foreign players in India, it would be advisable to devise alternate credit delivery mechanisms that can provide access to loans to smaller retailers at lower rates.
Foreign retailers would dump cheap goods into India, killing local industry:
Though not entirely accurate, there's some substance to this argument. Certain industries that are currently operating ineffectively in India may face the threat of extinction. There is always a possibility that foreign retailers may source their products from other countries such as China, and dump these cheap items in the Indian markets, and hence the killing the Indian industry. But this would happen only in a select few industries where the cost difference would be significantly higher than the overhead charges involved in importing. On a more positive note, this may in fact force the Indian industry to improve its standards.
Globalization is not a one-way street:
All petroleum services and products, rice, tobacco, salt alcoholic beverages and fresh food traded at public markets are excluded in Japan from any "distributional aspect" by other country companies. Australia, Japan, South Korea do not allow whole trade services in petroleum, its products, rice, tobacco, salt, milk, fertilizers etc by foreign companies.
The French, using their Loi Royer, simply restrict any development of hypermarkets to protect what they call the "centers of French towns and villages and the living of small shopkeepers." Germany has legislative constraints on outlets above 1200 sq meter in size, not dissimilar to France's Loi Royer. This is inspite of the fact that trade constitutes relatively smaller portion of their economy both in terms of employment and value addition compared to India.
In such a scenario, where a huge majority of the foreign players continue to protect their local industries, it is unfair to open up the Indian retailing industry alone. Globalization should be multilateral and not a unilateral process.
7.2 FDI In Indian Retailing: Why?
There definitely is a strong case for permitting FDI in retailing in India. We'll just try and analyze why FDI should be permitted in the Indian retailing industry.
Change in Competitive Landscape:
A study by ATKearney on Global Retailing trends reports that India is the least competitive and least saturated of all major global markets. One definite advantage of FDI inflow in retailing would be an increase in competition. The current non-competitive nature of the Indian retailing industry has led to a state of organizational complacency in most Indian companies. This has resulted in steeper prices for consumers and tremendous margins for retailers. A quickshot comparison of prices of some popular FMCG products in modern and traditional format stores showed that the difference in process is negligible, though organized eratilers have much lower supply chain costs. Even a major retailer like Food World sells its products at MRP. The only noticeable discount store operator has been the Tamil Nadu based Subhiksha chain of retail stores.
FDI can be a powerful catalyst to spur competition in this industry, due to the current scenario of low competition and poor productivity. Competition is key to diffusing FDI-introduced innovation across Indian retailing. Competition is also critical for ensuring that the economic benefits from improved productivity are passed on to consumers through lower prices. For example, a typical Wal-Mart store offers discounts of upto 25% as compared to conventional players. The existence of even one Wal-Mart center in a city would lead to an automatic fall in prices through the city due to the pressue brought on the local players by the market foces of demand and supply.
Supply Chain Improvement:
Retailing is a front-end industry. It is just one chunk of the complex supply chain that starts right from the manufacturing center/farm and covers the last mile delivery to the end consumer. Therefore, FDI investment would drive the growth in the entire supply chain. For example, McDonalds and Metro set up their own supplky chains when they entered India. They have adopted the same international standards for their Indian supply chain as they have elsewhere over the world.
Investment in Technology:
Technology in Indian Retailing is still at nascent levels. The only development seems to have been the widespread use of barcode readers and computers at point of sale billing systems. Foreign retailers currently own most cold-chains in the retailing industry. The allowing of FDI in the retail would help in introducing state-of-the-art retail technologies such as RFID and advanced inventory management systems into the market.
Manpower and Skill development:
Currently, retail is a "non-glamorous" industry in India. Also, there is no specific curriculum available for training people in retailing skills. It is only recently that Pantaloons Retail India has tied up with Welingkars' Management Institute to offer a program on retailing skills. Allowing foreign investment would ensure a grater flow of retailing talent into the reatiling industry in India. Also, the preliminary qualification required for retailing is muych less than that required for other sunrise industries like IT and Biotech, implying that a greater section of the population can benefit.
Tourism Development:
One lesson that has been observed from the growth of Dubai and Singapore has been that a strong retailing sector can prove to be major boost to the tourism industry. The consumer electronics retailing in Singapore and Gold retailing in Dubaui are extremely popular in the international shopping community and have acted as major drivers of tourism growth in these cities.
Greater Sourcing From India:
Once foreign players setup base in India, they would also start increase the levels of their sourcing from India. As a point in case, the Wal-Mart's sourcing from China grew by almost 5 times after FDI was allowed in China and Wal-Mart was permitted to setup base. A similar trend can happen in India. In fact, Metro has already started sourcing operations from India at a substantial scale.
Upgradation in Agriculture:
A long-term benefit of FDI in food retailing would be the transfer of global best practices to the Indian farmer. McDonalds and Metro already have agronomists in their team who work with the farmers and educate them on modern practices. In India too, ITC has been working on a similar initiative.
Efficient Small and Medium Scale Industries:
A huge part of the retailing products come through from small and medium scale industries, especially in the food processing industry. Permitting FDI in retail would create a drive towards efficiency in the related backend small and medium scale industries.
Growth in market size:
Introduction of foreign investment is likely to be accompanied by a huge explosion in the whole sector due to the greater spending power and better shopping experience. This effect has been observed in the Chinese market. What this growth would imply is that there would be space for both the current players as well as the foreign retailers in the new market place.
Greater Productivity:
A combination of competition, industry status, better skills, greater scale, modern technology and better upstream processes, would result in ahuge productivity growth in this sector.
Benefits to government:
There are several benefits to the government. They can be broadly classified into three broad categories:
Greater GDP: Retailing currently contributes to almost 10% of the Indian GDP and is India's largest private industry. Therefore, growth in retailing is vital if the Indian government wants to achieve the 8-10% GDP growth that has long been a dream.
Greater Tax Income: Allowing FDI in retail implies a growth in modern formats. Tax collection from modern format stores is much easier from organized retail sector. Also, the implementation of VAT would be much easier. Modern retailing formats would also create a new set of income tax paying population, in the form of the skilled labour force that would be employed in the modern format stores. This would help in increasing the total tax revenues to the Indian government.
Huge Employment Generation:
Retailing generates almost 8% of the total employment in this country. But this is still less than the 12% figure seen in the US and other countries where retail is suffciciently modernized. Also the kind of employment generated would have a positive impact on a section of population that hasn't benefited from the IT revolution. Retailing requires minimal skills, and a high school graduation would be more than sufficient for entry-level positions. This implies that the jobs being created would be for a section of population whose employment prospects have not been good till date.
7.3 Incentives for FDI in Retail
Governments around the world woo foreign direct investment by offering costly tax breaks, import duty exemptions, land and power subsidies, and other enticements. Yet our evidence suggests that they are largely ineffective.
In many cases, governments give away substantial sums for investments that would have been made anyway. India, for instance, waived its 35 percent tax on corporate profits for companies that moved back-office processing and IT jobs there-a concession worth roughly $6,000 annually for every full-time IT employee and $2,000 for every processing one. These measures, following similar concessions by the Philippines, might have been needed to offset perceived risk when the industry was in its infancy. But they are almost certainly irrelevant today when India commands more than a quarter of the global market. A survey of executives at companies that have moved jobs to India revealed that financial incentives were the least important factor in the decision. Most executives believe that they would rather see the government spend its money upgrading the local infrastructure.
To make matters worse for state and municipal governments, they get into bidding wars to win particular investments-a competition every bit as common in rich countries, where such authorities vie for new auto plants and professional sports teams. Yet even in the case of these bidding wars, financial incentives often don't stand high on a company's list of considerations. Ford executives, for instance, say that the top three factors in their decision to build a plant in the Indian state of Tamil Nadu were the availability of a supplier base and skilled labor as well as the quality of the infrastructure. The generous financial incentives Ford received were only as important as proximity to a port. Land subsidies were even less significant.
When incentives do attract foreign investment, unintended consequences often follow. Fiscal costs can escalate as incentives are extended to local companies. Furthermore, generous incentives can encourage too much investment, as they did in Brazil's automotive industry. Responding to subsidies worth more than $100,000 for each job created, foreign carmakers added 40 percent more capacity, we estimate, than would otherwise have been built during the late 1990s. By 2002, the industry was saddled with 80 percent overcapacity. Low utilization rates have eroded the productivity of domestic and foreign players by at least 20 percent and tied up capital that could have been used more efficiently elsewhere in the economy.
Sometimes, incentives subsidize inefficient production that wouldn't exist without them. Brazil's government, for example, tried to get consumer electronics companies, foreign and domestic, to locate in Manaus by offering tax incentives that cost it $576 million in 2001 alone. Manaus is in the middle of the Amazon, 2,500 miles from São Paulo and 500 miles upriver from the port of Belém. More than two months are needed to ship components from Asia and 10 to 20 days to move assembled products to São Paulo. Freight charges add 5 percent to production costs, and extra inventory adds at least 2 percent more. Skilled labor is often imported, negating any labor cost advantage. Only with breaks from the hefty taxes and tariffs imposed on production in Brazil could Manaus have attracted plants to produce goods in such an expensive, inconvenient location.
So, one clear lesson for the Indian government here is that there should be no incentives to attract FDI into retailing. The most important incentive for retailers is the market potential and the competitive scenario rather than external factors like incentives. The government can make better use of these funds in the development and modernization of infrastructure.
7.4 Regulating FDI in Retail
Even as governments in emerging markets dole out such lucrative incentives, many of these governments restrict the way foreign companies operate in order to protect local industry and to maximize spillovers to the domestic economy. The most popular restrictions are local-content requirements, which force foreign companies to purchase a certain percentage of inputs locally, and joint-venture requirements. Although local-content requirements are now illegal under World Trade Organization rules, developing countries find barriers-generally tariffs on components-to restrict the way companies operate. In most cases, these restrictions aren't needed to develop a supplier industry or to help local companies learn from foreign ones. In the few cases when they appear to work, they come at a high cost to the economy.
Local-content requirements existed in some industries specifically: automotive in India and China and consumer electronics in Brazil. Their overall economic impact was marginal at best. Several executives of foreign carmakers in India, for instance, show that they would have sourced many components locally without local-content requirements. Why? Because of the cost and time required to import parts, the rapid escalation of import prices after the rupee lost value in 1991, and the large supply of relatively low-wage, technically trained workers in the local component industry. The same reasons likely apply to China's auto industry.
It is also pretty clearl now that local-content requirements aren't needed to develop a strong supplier industry. China doesn't have local-content requirements for consumer electronics, but its companies are rapidly moving from assembling final goods to producing the full value chain of components, all the way to semiconductors. This evolution has created a virtuous cycle of "crowding in" even more global players. Similarly, Mexico began phasing out local-content requirements for automakers in 1994 but still has seven times more jobs in companies that make components (which are also exported) than in final-assembly plants.
Local-content requirements may at times have increased the proportion of local components in finished goods, but only by shielding inefficient and subscale suppliers, lowering productivity, and raising prices for manufacturers and consumers. Consider the local-content requirements for consumer electronics made in Manaus. When they began to be phased out, in 1991, the proportion of foreign-made components went from less than 20 percent of the total (by value) in 1990 to more than 50 percent by 1995.
We estimate that half of the local component makers in Manaus closed shop when faced with competition from imports. Consumers paid the price for all that inefficiency. Although China is known for its low-cost manufacturing, local-content regulations for auto parts have not only increased their price but also made cars produced there 20 to 30 percent more expensive than cars produced in the United States. In India, as an estimate, such regulations add 20 percent to the cost of cars.
There no compelling evidence to support the case for joint-venture requirements. When joint ventures make economic and strategic sense, foreign players pursue them. Neither Brazil nor Mexico has joint-venture requirements in retailing, but joint ventures were the most common way for foreign companies to enter those markets. Local-market knowledge, after all, is crucial to success in service industries. In a low-margin business such as retailing, understanding the nuances of consumer preferences and building reliable local supply and distribution networks make the difference between success and failure, and foreign players operate at a disadvantage in these respects. In China and India, local partnerships often give foreign players the government contacts they need to cut through red tape.
More important, joint ventures, required or not, are hardly necessary for local companies to benefit from the presence of foreign ones. The fast-growing Indian vendors that provide back-office services to foreign companies got a start only after multinationals pioneered this approach-and trained a critical mass of local employees. (The CEO of Wipro Spectramind, for instance, started out at GE Capital, and the CEO of Daksh came from Motorola.) In Mexico, foreign carmakers introduced dealer financing decades ago-the beginnings of consumer financing there. (It has since spread to many industries.) Chinese consumer electronics and IT companies, such as Haier and Legend, are honing their skills by competing with foreign companies in China. Some, including Legend, have learned marketing and distribution techniques by serving as local distributors for global brands.
7.5 What should the government do?
To get the most from foreign direct investment, developing nations should abandon their incentives and regulations and concentrate instead on strengthening their economic foundations-in particular, stabilizing the economy and promoting competitive markets. Macroeconomic instability discourages long-term investment by making demand, prices, and interest rates difficult to forecast. Most foreign investment entered Brazil, for instance, only after the government stabilized its economy through the 1994 Real Plan.
Competition is essential to diffuse the impact of foreign investment, for without competitive markets, the entry of foreign players has little effect on inefficient domestic incumbents and their productivity. Our only case study in which foreign direct investment failed to have a clearly positive impact dealt with banking in Brazil. A key reason was the industry's low competitive intensity: thanks to the high cost of switching banks and to entry barriers for new competitors, banking in any country is less competitive than other businesses. In Brazil this problem is exacerbated by high interest rates that make it more profitable to lend to the government than to consumers and by the lack of competition from nonbank players such as mutual funds.5
Foreign direct investment had the most dramatic positive impact when domestic incumbents-such as companies in Mexico's food-retailing industry, China's consumer electronics industry, and India's business-process-outsourcing industry-weren't shielded from foreign rivals. To promote competitive markets, developing nations must reduce restrictions on foreign investment, lower import tariffs, streamline the requirements for starting new businesses, and encourage new market entrants.
Another important way of promoting fair competition is to crack down on companies in the informal economy (or "gray" market), which don't pay taxes or obey regulatory requirements. These dodges give such companies an unearned cost advantage, allowing them to stay in business despite their small scale and inefficiency. In the Brazilian food-retailing sector, for example, up to half of all companies are profitable because they underpay their value-added and payroll taxes. Similarly, small-scale (and often home-based) personal-computer-assembly companies in Brazil and India compete with leading global PC manufacturers by avoiding taxes that in some cases account for close to 50 percent of the consumer's final price. This lack of compliance not only robs government coffers but also allows informal players to maintain subscale and inefficient operations and thus impedes the transition to a more productive economy and a higher standard of living.
Finally, developing countries must continue to build a strong infrastructure, including roads, power supplies, and ports-particularly if they want to attract export-oriented foreign investment. In India, for instance, the continuing liberalization of the power and telecom sectors, a process that began in 1991, sparked an investment boom, which led to the upgrading of the infrastructure. That, in turn, became an important prerequisite for the development of the IT- and business-process-outsourcing industry.
7.6 FDI in Retail: An implementation framework
This section tries to propose an implementation framework for introducing in FDI in Indian Retailing. The following table captures the essence of the issue.
FDI Policy
Timeline
Highlights
FDI Cap of 26%
2004-2005
* Entry of smaller American, European Retailers
* Would see several "financially innovative" ventures with dummy investors and the like.
FDI Cap of 49%
2005-2007
* Entry of major retailers
* Partnership with existing major Indian players
00% FDI Permitted
Beyond 2007
* Real testing ground for Indian retailers
9. The Chinese Example
"Opening up FDI in Retail will not open the flood gates overnight. In china, for instance, it took 15 years to reach 20% penetration - time enough for industry to adapt. That small cannot coexist with the large is only a myth."
Vivek Mehra, Executive Director, PwC, India.
This section is a case study of the Chinese Retailing industry. Here we track the changes in the Chinese landscape after it allowed FDI in the Retailing sector. The Chinese experience is extremely educative because of the various similarities that the two countries share.
8.1 Chinese Policy in Retailing
FDI in Retailing was permitted in China for the first time in 1992. Foreign retailers were initially granted permission to trade only in six provinces and SEZs (including Beijing, Shanghai and Guangzhou). Foreign ownership was initially restricted to 49%, but that has been gradually relaxed now. The table provides a summary of the FDI policy in place in China.
Deng Xiaoping's tour of southern China in 1992 provided the impetus for foreign investment, which peaked from 1994 to 1997, when for 4 concurrent years, China was the world's second largest recipient of foreign direct investment (FDI) after the US. FDI in China in 2002 amounted to USD52.7 billion, a 20% increase from 2001. Up to September 2002, 41% of FDI was attributed to investments from Hong Kong and Taiwan, while investments from the US, Japan and Korea amounted to 22%. A major part of the total FDI was channeled into manufacturing with a focus on labor intensive, low-tech export manufacturing projects. Only about 2% went to wholesale, retail trade and catering.
8.2 Retail FDI Impact in China
FDI in retailing has had a significant impact on the Chinese economy. The effect of FDI on China can be classified in terms of the significant statistical changes that have occurred in the past few years.
FDI in Retailing has helped in growing the retail market
The graph shows the retail sales trends observed in China over the last decade and a half. As can be seen, the incoming of FDI has helped in achieving a significant growth in the total retail sales. The implication is that, allowing FDI would expand the market, thus creating more room for the newly joined players in the market. This should put to rest the fear that bringing FDI will kill all Indian retailers.
New Employment Opportunities:
The growth in the retail market would be accompanied by a significant improvement in the level of new jobs created within the industry. As we can see from the graph, ever since the introduction of FDI, the total employment in the retail sector has gone up significantly. And this is not due to any economy wide phenomenon, because during the same period, the percentage contributionf of retailing to the overall employment in China has also witnessed a significant surge.
The takeaway here is that FDI is likely to bring in a whole new set of jobs into the economy and this would go a great way in achieving the government's employment and GDP growth targets.
FDI wont kill local players:
The Chinese experience has been that even after the advent of foreign players, local players can manage to standup against the global onslaught. A quick study of the statistics involved shows that, in china, after FDI, the number of traditional format based stores has actually increased over time, and so has the number of modern format stores, though at a much faster rate.
And till date of the top 10 retailers in china, only 4 are global companies, the rest being Chinese owned chains. But the four foreign firms also are amongst the most profitable of all retail companies in china. The lesson here is that if Indian retailers get their strategy right then there's still lot of hope in the market for them. But that would need a committed effort.
No. of Stores in 1996
No. of stores in 2001
Traditional
,920,604
2,565,028
Supermarkets
3,079
52,194
Convenience Stores
8091
Hypermarkets
593
S.No
TOP 10 RETAILERS
Turnover $ m
No. Stores
Lianhua
,698
,225
2
Hualian
,027
818
3
Beijing Hualian
966
42
4
Shanghai Nong Gong Shang
903
325
5
Carrefour
823
28
6
Suguo
638
663
7
Trustmart
607
43
8
Metro
598
6
9
China Resources Vanguard
561
343
0
Wal mart
422
22
The major lesson for India from the Chinese experience is that allowing FDI is beneficial to the economy as a whole and would benefit a very vast section of the population.
0. Recommendations
This section discusses the policy changes that are needed to ensure that Indian retail significantly improves its productivity. While doing this, we try to identify the stakeholders in the process of retail change, understand their viewpoint and their relevance as potential bottlenecks, and finally define how best to address their issues.
Permit FDI in retail
FDI has played a key role in the rapid development of high quality retail in several other developing countries. Allowing global retailers to invest in this sector would attract best practice players into India. Several retailers (such as Tesco, Marks & Spencer and Toys 'R' Us) have already evinced an interest in building businesses here.
The counter stores are likely to be most threatened by the introduction of FDI. The small trader lobby has been vocal on the issue of not permitting FDI into retail, and has successfully ensured that policy on this front is unchanged. The lobby is based on the premise that modern retail will impact the livelihood of millions of small family-run retail businesses. However as we have seen broad based reforms in the retail sector, in the long run, is extremely beneficial for the entire economy. This would increase employment in retail and would also improve retail spending.
Remove Bottlenecks in the supply chain
To adequately develop the upstream, the government should take adequate steps to do away with constraints on processing, manufacturing, and distribution.
Relax SSI Reservation
The reservation of large sub-segments for the small-scale renders the processing sector, particularly in food and apparel, inefficient. Therefore, the first step should be to continue to relax restrictions and permit larger, more efficient players to enter these sectors. While the incumbent small-scale retailers may oppose such a move, it should be emphasized that this will allow small-scale firms to increase scale and become far more productive and competitive.
Remove distribution constraints
Allow retailers to source directly from the farmers and remove restrictions on food grain movement across states. Encouraging additional investment in storage infrastructure (such as cold chains and silos) will help remove constraints.
Organize market for real estate
Here the objective is to ensure a regular supply of real estate for retail and to ensure transparency in dealings. There are four major areas of action that retailers should focus on:
Ensure proper rent laws: Linking rents to market value will ease out businesses surviving on uneconomic rental rates (e.g. shops in Connaught Place in Delhi). Currently, rental laws in India as well as their implementation are extremely pro-tenant. Strict enforcement of rental laws will make landowners more confident getting their property back.
Make zoning laws more flexible: The government needs to be more flexible with zoning laws and ensure that usage norms take into account both demand and supply without upsetting the balance, both in urban and suburban areas.
Restructure finances of municipal bodies: The responsibility for providing adequate local infrastructure rests with the local governments. To improve their finances, these local governments need to enforce property tax collection to raise funds for infrastructure development.
Increase land supply: City administrators need to bring government owned land into the market more regularly. This will encourage and aid large-scale developments both in the suburbs and within the cities.
Simplify the tax structure
The government should ensure the adoption of a uniform sales tax rate across states, and with time, introduce Value Added Taxation (VAT). It should also eliminate octroi wherever it is levied. These policies are already being considered, and most states have agreed to uniform taxation, at least in principle.
Ensure flexibility of labor laws
Permitting flexibility in the use of labor, without doing away with the benefits accruing to them will permit retailers to better organize operations and improve capacity utilization. This will include permitting retail businesses to stay open all days of the week, encouraging use of part time labor, etc. Some southern states have already agreed to these on the face of requests from some well-established retailers.
Better enforcement of tax collection from small retailers
Small retailers in India derive several benefits from non-enforcement of labor and taxation laws. While it will be difficult for the enforcement mechanism to regularly monitor labor usage and electricity consumption by the millions of small retailers, it should definitely improve the tax collection mechanism.
Ensure single window clearance for retail chains: State governments should make all licenses and permits available through a single agency at least at the city level. Providing one-time licenses for multiple stores in a chain will ease the bureaucratic hurdle experienced by modern retailers.
Eliminating bureaucratic hurdles
The state/local government is a critical stakeholder in retail. Several important changes in retail environment imply a loss of power for government officials. These comprise better enforcement of laws among small counter stores, simplification of legislation and loss of tax revenue from sales and octroi levies. While the legislative change may be easier to initiate, the behavioral change process will definitely take more time.
1.
References
Papers, reports and books:
. McKinsey & Co and CII. 2000. "Retailing in India: The Emerging Revolution".
2. ET Intelligence Group. 2003. "Changing Gears: Retailing in India".
3. B. Bhattacharya & Satinder Palaha. 1996. "Policy Impediments to Trade and FDI in India".
4. Planning Commission, N.K.Singh Committee. 2002. "Report of the Steering Committee on Foreign Direct Investment".
5. Pricewaterhouse Coopers. 2004. "Retail & Consumer: From New Delhi to New Zealand".
6. ICICI Property Services Group. 2004. "Organized Retail Formats Development in India: An analysis and estimation of future trends"
Websites:
. www.mckinseyquarterly.com
2. www.pwc.com
3. www.worldbank.org
4. www.planningcommission.nic.in
5. www.euromonitor.com
6. www.stats.gov.cn
7. www.china.org.cn
8. www.cia.gov
The Indian retail sector
A Government Policy Perspective of Indian Retail
Design Customization
7 A Government Policy Perspective of Indian Retail