Business.outlookindia.com _ Retail Redux

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    Every retail

    consultant painted

    a rosy picture of

    the industry, but no

    one realised that

    you need to be

    cautious in

    expansion plans.

    Feature /Cover Stories MAGAZINE | APR 02, 2011

    RETAIL

    Retail ReduxBig Retail has bigger troublesoperating inefficiencies, rising wages and huge debts. Its time to set thingsright.

    AJITHA SHASHIDHAR

    Its the commute from Hell . Linking Road in Bandra is one of the main arterial roads connecting south Mumbai withthe western suburbs. Its also a hugely popular shopping des tination, with upmarket, international brands rubbingshoulders wi th hawkers, export-surplus garments and cheap, Chinese knockoffs. It isnt jus t rush hour: negotiatingthis stretch is actually worse on weekends, as shoppers s pill out into the already overcrowded street, and its justawful during the festival season.

    But Diwali 2008 was d ifferentcars had manoeuvring room, the road was relatively empty and anxious s toreownerswaited at shopfronts, persuading passers-by to drop in and browse (and hopefully, buy)

    . You didnt need to be an economist to conclude that consumption wasdown and the economy was in the grip of a downturn.

    Luckily (for storeowners, that is), the nightmare drive returned the next year. Theeconomy was on the upswing, discretionary spending was up and the usualcacophony of shoppers weighed down with overflowing bags , cursing drivers,blaring horns and hawkers calling out bargains was back on Linking Road. It wasbusiness as usual.

    Or was i t? The numbers are certainly rosy enough. According to retail consultancyTechnopak, organised retail, which had been growing at over 30% in 2007 andslowed down to 16% in 2008-09, had picked up again last year: it grew 21% in

    2009-10. The balance sheets of large-format retail companies looked good, too.The K Raheja Groups retail chain (including Shoppers Stop, Hypercity and Crossword) bounced back in Q3 FY10with profits of O19.21 crore (from a loss of Rs 65 crore in FY09)

    . Future Group, which booked losses of Rs 1,835 crore in FY10,recorded its highest-ever sales of Rs 1,150 crore in January 2011, and

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    Margins in

    consignment

    merchandise are

    lower, but at least

    the company isnt

    left holding idle

    inventory.

    Retail is all about

    getting your

    assortment and

    your margins right.

    Private labels give

    us higher margins

    and quality control.

    Most retailers are

    not well-funded or

    dont have the

    managementbandwidth and

    financial prudence

    to bring them out of

    the red.

    Disproportionately

    higher scale-up of

    front-ends ahead of

    back-ends led to

    capital inefficiency.

    Leveraged growth

    became a norm.

    grew by close to 31% in Q3 FY10. The futures bright, believe analysts.Technopak forecasts $50 billion investments in the next decade inorganised retail, taking the industry to $200 billion by 2020 (it currentlyvalues organised retail at 5%$21 billionof the $435 billion overallretail sector.).

    Take a closer look, though, and the cracks in Big Retail become visible. The Rs12,000-crore Future Group has been created on the back of borrowings to the tuneof Rs 3,400 crore. Vishal Retail has accumulated debts of Rs 700 crore; Shoppers

    Stop owes Rs 220 crore and Trent, Rs 260 crore. The debts of the unlis ted biggies (Reliance Retail, Aditya BirlaGroups More, Spencer Retail, etc.) arent known, but they arent likely to be reassuring, either. Until those borrowingsare cleared from their books, and the interest burden eased, profits wi ll continue to be a distant dream

    . In fact, many of them are EBITDA negative, which means operatinginefficiencies are also a major hurdle.

    Reliance Retail had sales of Rs 291 crore in FY10, which was Rs 50 crore lowerthan the previous year, and posted a loss of Rs 190 crore. And while Spencer Retailhas stated that it expects to earn Rs 1,150 crore in FY11 (up from Rs 900 crore lastyear) and will invest Rs 80-90 crore to open another 15-20 hypermarkets in FY12,the company is still at least two years away from breaking even.

    The biggest problem today is that most retailers are either not well-funded or donthave the management bandwidth and financial prudence to bring them out of thered, points out Harminder Sahni, MD of retail consultancy Wazir Advisors.

    Too Much, Too Soon

    Whats behind Big Retails debt-ridden books? The growth of the industry, really

    . As big business groups entered the organised retail space, competitionand ambition skyrocketed. Everyone was in a hurry to scale up and noone spoke of opening less than 500-1,000 stores. Between 2006 and2009, around $15 billion worth investments and 50 million sq ft of retailspace were added across India. Future Group, for instance, acquired 2

    million sq ft of additional space every year to touch 11 million sq ft oftotal retail space, while Vishal Retail scaled up to 2.8 million sq ft in threeyears. Most retailers, including Future Group and Reliance Retail, werenot sure about their various formats. They were not even sure whether acompany-owned or a franchisee model would work for them. WhenReliance entered the scene, Future felt threatened and startedcornering real estate, most of which it didnt require, points out Rajiv

    Karwal, CEO of retail consultancy Milagrow. Reliance Retail and the Future Group declined toparticipate in this story.

    New formats opened up (hypermarkets, convenience stores, department s tores, etc.) and employee costs also shotup: at Shoppers Stop, for instance, it increased from Rs 385 per sq ft to Rs 525 sq ft between FY05 and FY09

    . Nobody really had the resources to expand on such scale and externalborrowings to fund capex and working capital requirements becamecommonplace. Retail was expected to be a negative cash-flow businessin the initial years, but top-geared expansion and inefficient capitaldeployment only increased dependence on external capital, says NikhilVora, Managing Director of IDFC Securities, in a report on Indianorganised retail.

    Disproportionately higher scale-up of front-ends ahead of back-ends led to capitalinefficiency. Leveraged growth became more a norm than an exception, adds Vora.Significantly, retailers themselves now agree with that analysis . Says Thomas

    Varghese, CEO, Aditya Birla Retail (ABRL), Every retail consultant painted a rosy picture of the retail industry, but noone realised that it is a low-margin business and you need to be cautious in expansion plans . If I have 100 s toresand only 11 make money, there is no way my business will be profitable. BS Nagesh, Vice-chairman, ShoppersStop, agrees. The biggest mis take all of us have made is that we assumed that opportunity was equal to reality. Wemay have successfully opened 20 s tores, but that didnt mean we could open 20 more and expect them to do as wellas the previous 20 did.

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    The New Imperative

    For the pas t year or so, large-format retailers have been restructuring their bus inesses, reworking their businessmodels, keeping in m ind these newfound realities. For starters, theyre closing down unviable stores and attemptingto rightsize themselves. We have done rol l-outs without understanding the catchment areas well, admits Varghese,adding that ABRL has clos ed 160 of its 582 s tores. Others did the same. South India-based value retailer Subhikshahad accumulated debt of Rs 900 crore, and closed all 1,600 stores in its chain after 2008. Reliance Retail, whichopened around 1,000 stores in 86 cities across 3.5 mil lion sq ft space, shut down and re-sized around 400 stores in2008. It is also known to have cancelled realty agreements in several cities. Similarly, Spencer Retail has shut 150 ofits 400 s tores, and Vishal Retail closed about 22 of its 172 outlets.

    On its part, the K Raheja Group exercised caution in the expansion of its hypermarket format, HyperCity. While the firststore opened in suburban Mumbai in 2006, the second s tore came up only two years la ter. Last year, the companyopened eight stores, but these were sm aller70,000 sq ft, compared to the earlier 100,000 sq ft boxes. There wasno point investing in excess realty, if we could manage with a li ttle less , points out Mark Ashman, CEO, HyperCity.

    Companies are also becoming ruthless in weeding out non-performers in their portfolios. Future Group has gottenout of its n iche format stores like aLL, BlueSky and Fashion Station, while Shoppers Stop closed its catalogueretailing and personal products bus inesses , Argos and Arcelia, respectively. It also shut down its coffee-shop chainBrios and has instead leased out that space to Caf Coffee Day. By giving up Brios, we saved close to 33% spaceand our sales increased by 50%, points out Govind Shrikhande, CEO, Shoppers Stop.

    Even flush-with-funds Reliance Retail has been particularly hardnosed in i ts approach to unviable formats. It hasshut down most of its supermarket format stores, Reliance Fresh, and is focusing on only smaller, niche formatssuch as neighbourhood s tores, consumer goods and clothing. Reliance was the most audacious venture. It enteredall kinds of formats just because it was cash-rich. It couldnt handle these and made losses , declares Karwal.

    The emphas is now is on improving operational efficiencieseverywhere. Shoppers Stop, for instance, switchedelectricity suppl iers (from Reliance to Tata Power) and has shaved 25% off its power bill. ABRL has been working onconsolidating its back-end infrastructure. Its earlier structure of regional dis tribution and process ing centres, fromwhere dry goods, s taples and farm produce would be sent to zonal offices and then to stores, has been scrapped.Now, zonal offices have been merged with the regional offices, saving the company a few hundred crores,according to Varghese.

    Pantaloon Retail, too, has been working on creating supply-chain efficiencies: from nearly 20 delivery centres, its

    apparel and fashion inventory is now routed through just four. Similarly, theres a centralised warehouse in Nagpurfor slow-moving products in the grocery business. If you reduce the num ber of stock points, inventory holdingautomatically comes down, points out Ashish Nanda, Partner (Retail and Consumer Service), Ernst & Young.Theres a flip s ide, however: it takes longer to fulfil increases in demand. Its all about balancing service needs andthe cost it takes to transfer stock, Nanda adds.

    Inventory management is top priority for Shoppers Stop, too. The company is reducing its bought-out merchandise(from 60% to 47% of stock) and instead moving to consignm ent mode (where the manufacturer is respons ible for thesale of products and the s tore gets a share of the revenue). Now, 40% of its merchandise is acquired onconsignment basis. Margins in cons ignment merchandise are lower (25%, against 40% for bought-out stock),agrees Shrikhande, but at least the company isn t left holding idle inventory.

    On its part, the Future Group needs to do a lot more to climb over its mountain of debt. In a recent conference call with

    analysts, CEO Kishore Biyani stated that the group would be undertaking a series of corrective s teps to reduce itsdebt. Each of its retail chainsFuture Value Retail, Pantaloon, Central and Brand Factory, Planet Sports and HomeTownare to be converted into fully-owned subsidiaries with independent balance s heets and P&L accounts, whichwill help them raise capitalequity and debton their own. Creation of these subsidiaries will not only de-leverage

    the parent companys balance sheet and unlock value in these bus inesses , but also bring in more efficiency andfaster decision-making, Biyani said. Consumer durables business E-Zone will be converted into a digital commercebusiness and Future plans to sell its stake in non-retail businesses such as consumer finance and insurance.

    Big Retails salvation may well lie in private labels (about 40% of Walmarts sales are from store brands). The mostcritical reason is , obvious ly, margin play: gross margins on private labels are, on average, 25-30% higher than thoseoffered by manufacturer brands. In consumer products, especially, retailer margins can be as high as 40%,compared to 12-17% offered by brands. Equally, though, store labels allow retailers greater freedom in long-termcategory planning, pricing and promotion and, therefore, the ability to ride out business cycles betterwhich has

    assumed even greater importance after the past two years.

    Large-format retailers are now nursing big ambitions for their private-label businesses . While Biyani wants al l 300SKUs (stock-keeping units) in his value s tores to be private labels, Varghese is aiming for 80% of the merchandisein ABRLs More stores to be retailer brands. At HyperCity, private labels account for 22% of sales . Retail is all aboutgetting your assortment and your margins right. Private labels not only give us higher margins, they also enable us to

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    closely control the quality of our products, points out Ashman. It isnt a strategy written in stone, though: TrentsWestside had only store brands (much like British retailer Marks and Spencer), but has now started carrying otherbrands as well; a large part of Vishal Retails problems sprang from its manufacturing-to-retail approach.

    Where Now?

    Will al l these measures bring in investors with the desperately-needed funds for expansion? Retail is still a big no-nofor most private investors in India. There have been less than a handful of s ignificant private equity deals in retail.Private equity companies TPG Inc and Bain Capital invested $80 million in kidswear brand Lil liput in August last year;

    and in September, the debt-ridden Vishal Retail found a buyer in Shriram Group and TPG. But the deal is still to take

    off.

    With the government not allowing FDI to come and interest rates going up, the pain of the debt-ridden Indian retailcompanies is likely to only increase further. Some months ago, the Future Group filed a prospectus for a Rs 750crore IPO for its company Future Ventures, but no dates been set yet, understandably, perhaps. As Wazirs Sahnisays, Today, online retail businesses have a better chance of getting funding. Nobody wants to touch brick-and-mortar stores.

    Future Group

    Turnover: Rs 12,500 croreNumber of stores: Over 16 million sq ft of retail space.Entered the market in: 1997Business in 2008-09: Massive expansion spree, adding close to 4 million sq ft of spaceacross its various formats. Post slowdown, it posted a loss of Rs 1,835 crore (FY10) andaccumulated debts of Rs 3,400 crore.Lessons learnt: Expand cautiously and reduce dependence on external borrowings.Corrections made: Closed down formats like aLL, BlueSky and Fashion Station. Stores thatcurrently average 14,000-15,000 sq ft will be cut down to around 2,000 sq ft. The group is alsolooking to divest its non-retail businesses.

    Shoppers Stop

    Turnover: Rs 1,570 croreNumber of stores: 2.7 million sq ft of retail space.Entered the market in: 2000Business in 2008-09: Made losses of Rs 63.8 crore in FY09.Lessons learnt: To stay focused and not be over-ambitious.Corrections made: Exited the catalogue retail and food businesses. Restricted private labelto 10% and moved up the aspiration ladder with a bridge to luxury positioning.

    More

    Turnover: Rs 1,700 croreNumber of stores: 570 supermarkets and 12 hypermarkets.

    Entered the market in: 2007Business in 2008-09: Over 650 stores. Struggling to make money due to an aggressiveexpansion strategy.Lessons learnt: Not to be over-ambitious.Corrections made: Closed 160 stores. Consolidated back-end operations and reduced headcount. Merged zonal distribution centres and brought down costs by more than Rs 100 crore.

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