The Indian Retail Story

- Hype or Hyper ?

Sunil K Kajaria
 INTRODUCTION

Perhaps no Indian business sector attracts as much buzz today as Organized Retail.
Financial newspapers, business magazines, & international consultants incessantly throw
up rosy numbers aimed at show-casing the tremendous opportunity ahead. Consider the
following:

o The Indian retail industry is valued today at about U.S. $333 billion and is expected
to grow to U.S. $427 billion in 2010 and U.S. $637 billion in 2015. It is India’s
largest industry, accounting for over 10 percent of the country’s GDP and around 8%
of employment.

o In terms of stores, only three percent of Indian retail is organized. Of the 12 million
retail outlets in the country, nearly 5 million sell food and related products.

o The Indian population is witnessing a significant demographic change. The rise of a

large young working population, and the increasing number of women in the
workforce, are expected to be key growth drivers for the organized retail sector.

o Along with demographics, the whole concept of shopping has altered in terms of
format and consumer buying behavior. Modern retail has entered the mainstream as
seen in sprawling, multi-storied malls and huge complexes offering shopping, food,
and entertainment under one roof.

o It is estimated that 70 million Indians in a population of about 1 billion now earn a

salary of $18,000 a year, a figure that is set to rise to 140 million by 2011.

ORGANIZED RETAIL – FACTS & FIGURES

Currently, the Indian retail market is at US $332.8 billion and growing at the rate of 10.8
% p.a. The share of organized retail is estimated at only 5.9% (US $19.6 billion).
However, this segment grew at the rate of 42.4%, p.a. and at this pace, organized retail is
projected to constitute roughly 13 % of the total retail market by 2010.

Growth in retail space, too, is keeping track. Mall space, from a meager 1 million sq. ft.
in 2002, is expected to touch an estimated 60 million sq. ft by end-2008. A report by
Images Retail estimates the number of operational malls to more than double to over 412
by 2010 on the back of major retail developments in tier II and tier III cities in India.

In the organized retail segment, clothing and fashion accessories formed the largest
product category in 2007 with sales of US $7.5 billion, followed by food and grocery
accounting for US $2.3 billion, footwear with US $1.9 billion, consumer durables in the
fourth place at US $ 1.8 billion, and out-of-home food (catering) services and furniture,
furnishings and kitchenware in the others category with US $ 6.07 billion.
Growth Rates was a slightly different story, with the fastest growth being recorded in the
tiny health and beauty care services category (65%). The second fastest growing
organized retail category was that of entertainment (53.8%), followed by mobile phones
and accessories and the food & groceries category.

Product-Wise Sales - Organized Retail

31%
38%
Clothing
Food/Groceries
footwear
Consumer durables
Others

9%
10% 12%

SOME OF THE PIT-FALLS FACING ORGANIZED RETAIL

Despite all the above-mentioned positives, financial success has remained elusive for
most of the entrants in Organized Retail. The heavy initial investments required have
made break- even hard to achieve and most players continue to report low or negative
I.R.Rs on their investment.

Some of the reasons for this under-performance include:

a) Real Estate – This is a huge concern as quality real estate has become too
expensive for many retailers to run a successful operation. This is especially true
for mass merchandise/discount retailers who operate on razor-thin margins.
b) Talent – This has already become a bottleneck for several Indian retailers.
Experienced corporate professionals as well as fresh talent at the store level are
hard to come by and even harder to retain.
 c) Policy – Although most people agree that FDI in Retail is just a matter of time,
the government (at local, state, and national levels) has been highly unpredictable
and inconsistent in setting policy on Organized Retail.
d) Supply Chain –Effectively getting products to the right place at the right time is a
lot tougher than it sounds when there are thousands of items and hundreds of
stores involved. The supply chain infrastructure in India remains rudimentary at
best and needs to be built from the ground up for retailers looking at a pan-India
presence.

SCOPE OF ANALYSIS

The primary objective of this report is to examine the industry dynamics of one of the
fastest growing segments of the Organized Retail Sector – the LIFESTYLE segment
(consisting of Clothing & accessories, footwear, home furnishings etc).

The report looks at the attractiveness of the Lifestyle Segment based on issues such as
pricing power, substitutes, financial parameters, short-term & long-term advantages,
growth prospects & drivers, IPR, entry barriers, and risk factors.

It also analyzes various operating and environmental issues relating to technology,

exchange rates, govt. regulations, and duty / tax structures.

Finally, the report will try and identify some of the the strengths & strategies that
would help new entrants in making a successful entry into this sector.
PART I: THE PRODUCT - ORGANIZED LIFESTYLE RETAIL (OLR)

A) Do the OLR companies dominate their Market Segment? Do they have any particular
pricing power relative to other (unorganized) players?

OLR companies have traditionally started their retail operations in cities like Mumbai and
Delhi and then expanded geographically into Tier II & Tier III cities. Later entrants have
turned this trend on its head by first entering the smaller cities rather than focusing on the
metros. In fact, cities in South India have taken to the supermarket style of shopping very
eagerly and so far the maximum number of organized grocery and department stores are
in Chennai, Bangalore and Hyderabad.

In cities where OLR companies have managed to establish a meaningful presence, sales
growth has out-paced that of the unorganized sector.

ANALYSIS: Over a period of time, OLR companies are likely to establish a dominant
position in the Lifestyle segment.

It remains unclear whether OLR companies have any particular pricing power relative to
the unorganized players. Consumers in India are strongly focused on the value for money
factor, but given similar quality and prices, would prefer to shop at organized outlets.

Hence, OLR companies will probably have to earn their profits through scale &
operational efficiency rather than superior pricing power. Consumers are likely to remain
loyal only if prices are similar or lower as compared to unorganized retail.

ANALYSIS: Pricing power is likely to remain neutral / marginally positive for the OLR
companies.

SCORE: 4.0 / 5.0

B) Are there any easy substitutes for the OLR segment? Are Imports a concern (either of
similar or substitute products)?

OLR companies aim to provide customers with superior choice and better customer
service. As retailers exist primarily as the interface between manufacturers and
customers, there are no real alternatives or substitutes for this industry. At best, the
consumer has a choice between organized and unorganized players but the retail industry
as an intermediary cannot be substituted. Unlike the West, where a number of
manufacturers are relying extensively on web-based selling, no such competition exists
for Indian retailers and there is in the medium time-frame little chance of
disintermediation.
Imports are not a major issue of concern for retailers in the current scenario.

ANALYSIS: The Retail industry as an intermediary will continue to perform a vital role
between Manufacturers & Consumers. There are no real substitutes for OLR nor are
there any threats of imports.

SCORE: 4.0 / 5.0

C) How do the Company’s financial ratios compare with its peers? Important ratios:
EVA, ROCE, EBITDA margins, Sales growth, Wage cost / Sales Unit etc.

Despite all the hype about growth & opportunities, financial performance of most OLR
companies has been a real disappointment. Operating & Net margins have declined
(primarily due to higher real estate rentals & staff costs) despite stellar growth over the
last few years. Many of the publicly owned OLR companies have recently announced
fund raising plans, clearly indicating that levels of investment will be higher than initially
anticipated and payback periods much longer.

A look at the financial performance over the last two years (Sales Growth, Operating
Margins, & Net Margins for three listed OLR Players – Shopper’s Stop, Pantaloons, and
Trent) indicates that the industry has a long way to go towards improving its score on
financial parameters.

SHOPPERS STOP Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08
(in Rs. Crs)
Sales 193.12 225.9 268.18 241.09 242.07 306.33 342.91 328.22
EBITDA 14.50 19.25 28.51 16.28 14.33 15.22 14.88 14.25
PAT 5.40 8.02 14.13 -3.39 1.97 0.23 0.84 -0.39

PANTALOON Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08

(in Rs. Crs)
Sales 627.75 658.70 795.48 904.29 1191.88 1176.27 1346.06 1474.92
EBITDA 40.25 42.51 57.28 61.21 74.54 96.35 110.93 115.79
PAT 15.83 15.00 14.37 18.72 18.67 29.69 31.65 32.10

* Effect of Profit on Sale of Investments in Sep-06 & Dec-06 have been adjusted

TRENT Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08

(in Rs. Crs)
Sales 105.09 120.29 121.83 108.58 121.60 119.49 144.17 125.00
EBITDA 11.17 14.12 15.15 9.86 12.15 13.64 13.08 10.63
PAT 6.57 8.03 10.44 6.80 7.70 9.11 9.90 7.50

* Figures for Mar-08 are estimated

 Chart 1: Trend in Sales Growth (Q.E. June 2006 =100)
250.00

200.00

150.00

Shoppers Stop
Pantaloon
Trent

100.00

50.00

0.00
Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08

Chart 2: Quarter-wise Operating Profit Margins (%)

14.00%

12.00%

10.00%

8.00%
Shoppers Stop
Pantaloon
Trent
6.00%

4.00%

2.00%

0.00%
Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08
 Chart 3: Quarter-wise Net Profit Margins(%)
10.00%

8.00%

6.00%

Shoppers Stop
4.00% Pantaloon
Trent

2.00%

0.00%
Ju Se De Ma Ju Se De Ma
n- p- c- r- n- p- c- r-
06 06 06 07 07 07 07 08

-2.00%

ANALYSIS: Operational efficiencies and scale benefits are yet to kick in for most OLR
companies. Long payback periods and excessive reliance on equity capital seem
guaranteed to continue.

SCORE: 1.5 / 5.0

D) Do the OLR Companies have any unique attribute which may be of significance to its
short term /long term advantages?

Indian consumers have shown preference for organized retail over unorganized outlets,
given similar quality and prices. OLR companies have a real opportunity to utilize this
preference and convert large number of consumers to its format. This would be best
achieved through rapid expansion in Tier II and Tier III cities where the “newness factor”
is still at work.

Another employable advantage for OLR companies is the fantastic valuations assigned to
them by the Indian Bourses. Equity investors seem to be strongly convinced of the Great
Indian Retail story and are rewarding companies in the OLR space with 40x- 60x P.E.
multiples. It would be sensible for such companies to raise as much equity capital as
possible and use the proceeds to expand rapidly across geographies.
A third source of advantage could be from leveraging I.T as well as supply chain skills
into providing better prices as well as better customer service. However, similar to
operational efficiency and “scale” gains, these seem to be theoretical at present and have
not yet manifest themselves in the numbers.

ANALYSIS: Both Customers & Investors are currently impressed by Indian Organized
Retail. OLR companies would do well to convert this preference (which may or may not
last) into a sustainable competitive advantage by creating scale and deliver the
theoretical “operational efficiencies” promised by this scale.

SCORE: 3.0 / 5.0

E) Do the OLR Companies have any unique attribute which may be of significance to its
short term /long term disadvantages?

All the hype about Indian Retail has created a mad scramble amongst Indian Business
Houses to enter this sector. Much like the dot-com bubble of 1999-2000 where capturing
“eyeballs” was the name of the game, this time around retail seems to be the new “Gold
Rush” and everybody seems desperate to run in with a pick & shovel.

The key concern is that most of these entrants have similar business models and are
simply going to bid up prices of real estate and staff in the short term. Profitability, which
is already a problem, will get reduced even further.

ANALYSIS: Until the Gold Rush into Retail ends (possibly due to the continued stock-
market meltdown), OLR players will face heightened competition for resources like real
estate and staff.

SCORE: 3.0 / 5.0

F) Are there any serious IPR based entry barriers for OLR companies? Does this
segment lead its industry in R&D and IPR Development?

OLR Companies are at the forefront of developing IPR based applications and solutions,
and can be expected to try and convert this into a source of competitive advantage over
the unorganized segment.

However, it is unclear which OLR companies will actually be successful in create path-
breaking IPR applications and which will try and obtain such knowledge from foreign
collaborators. It is also unclear as to what extent IPR & R&D will make a difference in
altering the competitive landscape.
ANALYSIS: In the current scenario, it would be difficult to ascertain the long-term impact
of developments taking place on the IPR front, both industry-wide and for OLR
companies individually.

SCORE: 3.0 / 5.0

PART II: GROWTH PROSPECTS

G) Where is the segment placed in its Lifecycle? What strategic steps are OLR
companies taking to indicate that they have a clear vision of managing the product
lifecycle?

Indian Retail is at a nascent stage. While organized retail has grown substantially in
previous years, there remains huge scope for further gains. Going forward, OLR
companies will benefit from the combination of increased market-size and increased
market-share.

Established players like Shopper’s stop, Pantaloons etc. are expanding across geographies
at a furious pace as they try to covert their first mover advantage into long-term gains.
They are investing heavily in I.T. and supply-chain solutions. Branding is another
corporate activity which is receiving its due credit.

Many of the OLR Companies are also readying themselves for a rural thrust as the bulk
of India’s population still live in rural areas and to be able to cater specifically to them
will mean generating tremendous amounts of business in the future.

In the past decade, international companies entering India (Levi’s, Tommy

Hilfiger, Marks & Spencer, Mango etc) have generally aimed for the upper-middle and
rich classes of Indian society. Now, these companies, too, are focusing on the lower and
lower-middle classes of India.

Companies like ITC are taking the additional step of creating links with its suppliers.
It has set up its "e-Choupal" scheme to try and improve the productivity of farmers that
supply its food processing operations. It has built internet kiosks in rural villages to help
give farmers access to the latest information on things like the weather, current market
prices and what foods are in demand. It is committed to take the benefit of organized
retailing to the doorstep of the farmer.

ANALYSIS: The Retail market is at a nascent stage of growth and Organized Retail players
are working on multiple strategies to increase not only market-share but market-size.
Organized retail will definitely be able to hugely impact the industry in the coming years
and they are well positioned to ride the development of the retail industry as it matures
over the next decade or so.

SCORE: 4.0 / 5.0

H) What factors could turn out to be a source of risk for the growth prospects of OLR
Companies?

Due to delay in property deliveries by mall developers, Pantaloon is running 12-18

months behind its target of achieving 30 million sq. ft of retail space by 2011. Other
companies like Shopper’s Stop are also reporting delays in new store roll-outs.

High real estate prices have had a dampening effect on the industry and the signing of
new leases has slowed down significantly over the last 12 months.

Existing players have been overly aggressive in projecting sales and are now facing
execution risks on this front. Their inability to curb staffing, branding and real estate
costs have put pressure on the bottom-line. The inflationary environment currently
persisting in the country is further adding to woes as an industry-wide slowdown is
possible in the near term.

The Equity markets have been extremely favorable to OLR companies. Many of these
companies have significant fund-raising plans going forward and a sharp downturn in the
equity markets might lead to funding issues as they are currently free cash flow negative.

ANALYSIS: Risks to growth seem to be mostly from delays in raising capital, execution
risks, as well as a general economic slowdown. These can be considered to be temporary
in nature and seem unlikely to upset growth projections going forward for the industry as
a whole.

SCORE: 4.0 / 5.0

PART III: OPERATING & REGULATORY ENVIRONMENT

I) How is the global environment for OLR companies? Points of view to be considered
are technological transfers, Exports Possibilities, sensitivity to exchange rates, Free
Trade Agreements etc.

OLR companies are slightly impacted by changes taking place globally. Rising
commodity prices and interest rates will both have a negative impact but this is expected
to be temporary at worst.

Of greater importance is the fact that foreign manufacturers of all kinds of products and
from all geographies are eager to enter the Indian market and will be pursuing the same
either independently or through tie-ups with organized retail companies.

Hence, issues like technology transfers, exchange rates, free trade agreements etc do not
have any negative implications for the organized retail sector. Greater foreign
involvement in the future is an eventuality and a positive for OLR companies
ANALYSIS: Despite the gloomy conditions existing in global markets today, manufacturers
across the world are scrambling to set up shop in India, and this should translate into
higher growth for OLR companies.

SCORE: 4.0 / 5.0

J) How effected is the Company by Govt. Regulations and Duty /Tax Structures –
Examine with respect to Pricing, markets accessibility, ongoing regulation,
Profitability, Entry Barriers, Competition from Govt. Owned Companies etc.

There has been decent controversy over the proposed entry of large Foreign Retail
Players like Wal-Mart & Carrefour into India. Also, domestic players like Reliance Fresh
have faced resistance in places like West Bengal & Uttar Pradesh. It would be fair to say
that Govt. regulation has been very arbitrary and inconsistent.

A lot of this inconsistency is probably due to the fact that unorganized retailing is a form
of disguised unemployment/underemployment throughout the country. Hence, there is a
lot of scope for “political intervention” and we can expect Govt. regulations to remain
biased against organized retail.

At the same time, the best way for organized retail to counter this issue is to aim for
geographical diversification and large scale of operations.

We can also continue to expect excessive Govt. intervention in pricing (especially for
agricultural goods) as well as markets accessibility. Competition from Govt. owned
companies is not much of an issue.

ANALYSIS: Govt. Regulation is likely to remain inconsistent, discriminatory, and

excessive. Pricing of a good many products will continue to feel the pinch of government
intervention, especially in the current inflationary environment. The way out for
organized retail is to achieve adequate diversification and maintain a long-term outlook.

SCORE: 2.0 / 5.0

SCORING

QUESTION A B C D E F G H I J TOTAL
MAX. PTS 5 5 5 5 5 5 5 5 5 5 50
YOUR 4 4 1.5 3 3 3 4 4 4 2 32.5
SCORE
 CONCLUSION

The purpose of this Business Evaluation Model is to provide a meaningful qualitative

analysis of the Organized Lifestyle Retail Industry’s long term prospects and
opportunities.

Our analysis of the OLR segment shows that the Industry ranks high on the following
factors: a) Ability to dominate the market segment b) Lack of credible substitutes c) Little
threat from imports d) Unique attributes such as positive preference by consumers e)
Willingness by equity investors to tolerate long payback periods f) Nascent stage of
market development g) Relatively low levels of risks to growth.

Significant negatives for the industry include a) Terrible financial performance currently
and for an extended period of time into the future b) Excessive & inconsistent Govt.
regulations c) Excessive enthusiasm leading to rush of new entrants

Keeping the above in perspective, the OLR segment presents itself as an attractive
business opportunity, and this view is validated by the achieved score of 32.5 (A score of
30 or above in this model is usually a robust indicator of the attractiveness of a product or
industry segment).

However, new entrants have to be very careful before they commit themselves to the
possibilities of this sector. Major fear factors include long gestation periods, huge
financial investment, and entrenched competition. New entrants must not only have
extremely deep pockets and a long term outlook, but must, in my opinion, also bring
something extra to the party – Something which distinguishes them from the “Gold
Rush” players.

Possible extras could include: a) Existing presence in Commercial Real Estate / Mall
development leading to a sort of forward integration b) Existing presence in areas
like Branded Apparels leading to future differentiation through private labels etc.
and c) In-house sourcing skills. An ever-increasing proportion of retail products
sold in India is coming from places like China, Thailand, Vietnam etc. and entrants
who already have a foot-hold in the trading business might be successful in
differentiating themselves from the competition.