Monday, December 26, 2011

FDI in Retail: Will it help the economy?

If one has read my last article, it would be clear that the UPA Govt has not passed a single legislation this year that can help the economy nor has it shown any interest. All of a sudden when rupee began to reach 53 against dollar the fear began in the government. Depletion of dollars and no major reform eroded the growth projection to less than 7% and decreased the confidence of India in the eyes of the world. It was a desperate attempt to inject dollars and hence in between the Winter Session the Govt decided to clear FDI in single brand to 100%. It had to finally backtrack after the entire opposition including its own allies protested against this.

FDI in retail is a huge legislation as its impact can be felt across farmers and traders which are the biggest vote banks for Congress and BJP respectively. But does FDI in retail help the economy? Does it help the farmer? Does it help to control inflation?

The answers for this can be understood if the existing scenario with facts are presented. Let's look at it.
  • 60% of what farmers produce gets consumed in villages (over 6 lakh villages).
  • 40% makes it to the market for everyone else to consume.
  • The current Agriculture Produce Marketing Act (APMC) prohibits farmers to sell to anybody who doesn't have APMC license. There are exceptions to this in several states notably Punjab and Gujarat.
  • 40% of this 40% that reaches the market gets wasted as there is no storage facility at the APMC yard nor does the govt has ever bothered to set up cold storage facilities in proportion to what is produced. It has set up in some places, but not adequate for all fruits and vegetables.
  • 40 million people get employment because of the existing unorganized retail or mom-pop stores. 200 million people lives depend on this 40 million. (Source)
The amount of wastage in 2011:

So, how does this 40% reach the consumer?

There are anywhere 6-7 layers between a farmer and a consumer(follow the chart below). The farmers go to village Haats, Shandies etc that are setup on a regular basis (daily, weekly or bi-weekly) and are either held at the village or 6-20 km from the village. So, the farmer travels. The farmer also goes to APMC yards where there are government agents and middlemen (commission agents) who purchase from the farmers and pass on to wholesale dealers, retailers and thereby consumers. Each layer adds a price and hence the consumer ends up paying a huge price and the farmer gets only a portion of it as profit. The rest is eaten up by the middlemen.

Hence, farmer sells say potato at Rs.2 per kg while consumer buys at Rs.12 per kg which means Rs.10 is eaten up by middle men. Neither there is regulation nor control on the prices or the profits the middlemen make. This is one of the major reasons of high inflation in India. I had explained this in my earlier article - Why onion prices have skyrocketed? .

Further, farmers don't get the correct price and the weights are not accurate as well.

EXCESS WASTAGE, INFLATION CAUSED DUE TO MULTIPLE LAYERS and NO PROFIT FOR FARMERS - clearly 3 major problems in the existing model.

The current organized retail stores in India (prominent ones):

Big Bazaar, Spencers, etc constitute only 5% of organized retail while the unorganized retail is still 95%. Each of these stores may look like they are making profits, but their losses run into thousands of crores. (Source:

Will the entry of foreign players help the current scene? If yes, how?

Again, looking at the chart which showed 6-7 layers in the existing model between a farmer and a consumer, the entry of foreign players will reduce it to 3-4 layers, a cut down of 3 layers in most cases.

The foreign players like Walmart, Carefour, Tesco have huge presence across the world. They have the expertise to manage such huge distribution issues and have applied technology to the fullest extent. When such players come in they will directly deal with farmers and get the produce from them. They would ensure that farmers are given better price, weights are checked properly and storage facilities set up for excess quantity to prevent wastage. Basically transparency sets in.

To maintain any cold storage facility is not a rocket science. However, for 60 years no Govt or any law has accelerated this process. Yes, these storage facilities require electricity, water but that's precisely what Govt has spelled out that 50% of investment that such companies would make must be in this sort of back end infrastructure. In other words what Government could not do these companies are expected to do!!

As an example, look at how Walmart has opened stores in Punjab and how it is helping them get better prices and ensure transparency in the system. This is not to say Walmart is sincere in what it does and our middle men and small stores are not. It's just there are many practices which such stores have which others do not. Such an expertise is needed to propel competition in this sector ultimately benefiting the customer. In Punjab today Walmart has tied up with farmers on contract farming basis and such stores not only regularly take the harvest/produce from farmers, but ensure a clean mechanism of making payments. They don't have to travel much as Walmart has set up a network of centers to do this collection.  The farmers are also trained on how to increase the yield and productivity that helps them and Walmart. Here's more to read on this.

These are the pictures of Walmart store in India. As of today 100% FDI in single brand is not allowed and hence Walmart has tied up with Bharti and called it - "Best Price Modern Wholesale".

A single store hires 35,000 and has changed the way the whole supply chain system works there. Think of this - If one store can employ 35,000 and if Walmart can open 10 such stores they would employ a mammoth 3,50,000 people and train them with better customer friendly practices and update them with technology. How many small stores can create such a huge employment at the same time? In today's world the next generation doesn't want to join their parents' business of mom and pop stores. Think of what opportunities such stores can have if they could tie up with such multi giants to supply their products as is happening in Punjab?


Can FDI in retail help control inflation? Will prices come down?

This is definitely a grey area. It has mixed shades. Take a look at this video here. According to this, the 5% organized retail which exists in India haven't helped much in bringing prices down. In many cases prices at such stores are more than the ordinary retail store (Source). So, will inflation be able to come down? 

The fact we have to consider here is that 5% doesn't bring competition but 20-30% will surely do. Presence of multiple stores will propel competition. If Hyundai and Maruti alone were the cars in India there would not have been lower prices. If Airtel and Spice were the only cellular service providers prices of calls would not have come down. Presence of different companies spurs competition. One could not think of buying any other car for the range Rs 4-5 lakh a few years ago other than Maruti. Now, there are several cars to choose from for that range. Similarly, a handful of stores being a part of organized retail doesn't help.

On the other hand a logical thought that comes to one's mind is how could these stores sell at a lower price when their operating costs are so high - rent, electricity, water, labor charges etc. Many stores actually got closed like Subiksha as they did not have the expertise of the back end. Big Bazaar, Spencers are all incurring operating losses. So, will multiple stores help? We cannot definitely say. That is why this area is a shady area with no clear visible impact in India. Hence this must be done on an experimental basis.

The government has this condition that such stores must be set up in cities with population more than 1 million and currently there are 51 cities in India that satisfy this condition. This has to be experimented. Only then can it be determined if inflation can truly be controlled. Contrary to the claims of both who oppose this legislation and those who want it to be enacted have no proof of all that they claim regarding inflation is indeed true.

Can foreign companies dump goods from different parts of the world? If so, what about - Made In India - products?

As it is many customers today get to see products from different countries. So, this is not new. However, Walmart for example gets 80-90% of its goods from China. China is the biggest beneficiary. If these stores are allowed to operate in India they will surely dump them into our markets. No doubt the consumer benefits, but goods and products made in India will not reach the consumer. Hence, the government has put the condition that 30% of products such stores would sell in India must be from Indian suppliers. This is good, but must be increased to 40%. By doing so, such stores can also get an opportunity to sell goods made here to other countries and make additional profits. Who knows tomorrow Indian mangoes may be available in America in Walmart and become dominant there? 

This is a very important clause and must be carefully implemented. There might be a need for a regulator to monitor if the stores are indeed sourcing 30% from Indian counterparts. If the stores do not take this seriously it will cause losses to a lot of small stores who would have dreams of tying up with them. This is definitely a genuine concern for retailers.

Will the small stores eventually shut? No, this is an exaggerated fear

How many stores have closed because of Big Bazaar and Pantaloon? Hardly any. In fact the unorganized retail continues to show 15% growth while organized retail has come down from 25% to 15% in the last few years. Why is this so? This is because a consumer would prefer to go to stores at a walking distance even if the cost is Rs.1 more than a store for which he has to travel a small distance. Most housewives cannot depend on their husbands or use transportation to get small items. They would prefer to go to near by stores. It is this particular attribute of Indian retail mindset that still keeps the small stores going. There are other personalized services these stores may offer. In many places they offer door-to-door delivery, deferred payments, cash payments accepted and many more which the big stores may not offer. Simply because it doesn't work out to them. Since Big Bazaar cannot come up in every street it cannot displace the small retailers. It may hit their profits but cannot shut them down. If it had to then it would have been visible by now.

The real estate prices are too high for such giant stores to be set up everywhere. Hence, they must be allowed to change the whole supply chain and bring in clean and efficient mechanisms.

This chart explains how FDI in different countries has helped them and why the govt's idea of India specific model is actually good.

Images courtesy: Source

In conclusion I feel FDI must be allowed in cities to start with and depending on how it would control inflation and farmers should be applied across the country. For whatever reasons BJP is opposing looks wholly opportunistic. Congress at one point too opposed this. It is not too late when this would become a reality. For sure FDI in retail will come about.

1 comment:

pravms said...

Nice writeup (as always), Anjan!!! I think that the farmers and the end customers will receive maximum benefits. Due to the marketing strategies and competition among the numerous supermarket chains here in the UK, the cost of food items are too less (as compared to the average income earned) and are of the best quality... Also, these corporates take social and environmental responsibilities (wherever possible), which is what is required for the future generations in India....