An Overview of Indias Consumer and Retail Sectors

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A Recap of Events of the Past

Impact of Slowdown on Consumer Confidence, Private Consumption & Organised Retail
India was relatively insulated from the events in the global economy over the last two years. Indias GDP grew by 6.1 per cent in 2008-09, as compared to 9 per cent plus growth in the previous few years. This growth was primarily led by government spending and growth in the rural areas. While the impact of the slowdown on overall GDP was limited, private consumption was impacted substantially. Private consumption growth, which was largely tracking GDP growth till before the slowdown, took a significant dip on account of poor consumer confidence. In the first few quarters of 2008-09, growth in GDP came down from 9.1 per cent to 6.1 per cent and growth in private consumption went down from 8.5 per cent to 2.9 per cent. This dip significantly impacted the consumer products and retail sectors. Organised retail, which was growing at over 30 per cent year on year in 2005-06 and 2006-07, slowed down to around 16 per cent in 2008-09. With the revival of economic growth from the second quarter of 2009-10 (GDP grew by 7.9 per cent), private consumption growth has returned (grew by 5.6 per cent), on the back on stronger consumer confidence. As a result, growth in organised retail has returned and we estimate the sector to have grown by 21 per cent in 2009-10. On the basis of various projections that Indias GDP will grow at over 8 per cent in the coming years, return in consumer confidence and growth in private consumption tracking GDP growth, we expect organised retail to see 30 per cent plus growth in the coming years. This trend is already visible and is substantiated by data in exhibit 1.
Exhibit 1:

Impact of Slowdown on Consumer Confidence, Private Consumption & Organised Retail

33% 31% 27% 16% 9.30% 7.10% FY 2006 9.7% 6.3% 2007 9.1% 8.5% 2008 7.9% 5.6% 2010 Q2 21% 31% 29%

27%

25%

25%

6.1% 2.9% 2009

6.1% 1.6% 2010 Q1

7.2% 5.2% 2010

8.1% 7.0% 2011P

8.5% 7.0% 2012P

8.5% 7.5% 2013P

9.0% 7.5% 2014P

9.0% 7.5% 2015P

Organised Retail

GDP

Private Consumption

Source: Ministry of Finance, Technopak Analysis and Estimates Real Growth Rates

Changes in Private Consumption and Retail Growth

Private consumption in India currently adds up to about Rs 34 lakh crore and accounts for ~60 per cent of GDP With growth in GDP expected at over 8 per cent, inflation expected at 6-7 per cent, and private . consumption expected to stay at 60 per cent of GDP nominal growth in private consumption is expected , to be 14-15 per cent. This means a doubling in private consumption in five years time, to reach about Rs 67 trillion by 2015. This provides a very significant opportunity for Indian and international companies to develop and create large business in the consumer products and retail sectors in India.

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The total retail (organised and unorganised) industry in India is currently estimated to be Rs 20 lakh crore. We project this to reach Rs 27 lakh crore by 2015. Organised retail, which is currently estimated to be Rs 1.0 lakh crore (5 per cent share), is projected to reach Rs 3.0 lakh crore (11 per cent share) by 2015. This means a tripling of the current size and scale of organised retail in the next five years. While organised retail will grow at a fast pace, it is important to note that a larger part of the Rs 7.0 lakh crore growth in total retail will come from unorganised retail. We project this segment (unorganised retail) to grow by over Rs 4.5 lakh crore in the next five years. Some key reasons for this trend are as below: Growth in private consumption in India is so sizable that even with 30 per cent plus growth rates, organised retail will be unable to garner a larger share in absolute terms in the next 5 years. In certain consumer categories like apparel, footwear, and consumer durables and electronics, organised retail has established a strong value proposition with the Indian consumer. However, in some very large categories like food & grocery, furniture and home, and pharma it is not same. So the same shopper visits organised retail for the former categories and traditional retail for the latter.
Exhibit 2:

Projections for Private Consumption and Retail

93 62

29 12 0.3 Organised Retail

20 0.9 GDP

27 3 Private Consumption

All values in Rs lakh crore Source: Technopak Analysis and Estimates Real Growth Rates & Values, Inflation assumed at average 7%

Inherent strengths of traditional retail (entrepreneurial drive, relationship management with catchment, real estate and labor costs not fully accounted for in P&Ls, flexibility to deliver very small quantities home, and the MRP regime) coupled with the fact that many mom & pop stores have geared up for competition from new age stores (through improved store ambience, better product mix and support from brands / manufacturers in training, retail operations, etc.) puts them on a strong footing. Given the large share that traditional retail will continue to occupy, especially in categories such as food & grocery, furniture and home, and pharma, it will continue to be an important channel for consumer goods companies, and for organised wholesalers (cash & carry).

Growth of Organised Retail: Real or Hyped?

Some recent high profile failures in organised retail have led to a belief that growth in organised retail is not as promising as it was believed to be. In order to take an objective view of the organised retail market in India, Technopak traced the growth trajectory of some of the other large sectors in India. The growth in organised retail is very similar to some of the other large sectors however, the only difference being that it not as consolidated as in sectors like Telecom (where 4-5 players command majority of market share).Hence, despite a few setbacks Technopak expects that the organised retail would emerge much more stronger than ever before and would also see significant players emerging in the next few years.
Exhibit 3:

Evolution Curve of Various Industries

Industry Size
TO T1

T2

T3 T4

T5

T6 T7

T8

T9 T10 T11 T12 T13 T14

IT

Organised Retail

BPO

Telecom

Source: Technopak Analysis

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Exhibit 4:

Consumer Sector in India Effect of Recession and Recovery

Description Heavy goods intended to last 3 or more years Impact of Recession Highest impact Product examples Refrigerators, Washing Machines, Automobiles

Categories Durables

Semi-durables

Goods that are neither perishable nor lasting Goods that do not last for long, so need be continually replaced Services that are becoming essential

High impact (dependent on discretionary spends)

Clothing, Furnishing, Home Textiles, etc.

Non-durables

Limited impact (due to basic nature of products)

FMCG, Food Products

Services

Limited impact (necessity based services)

Healthcare, Education, Telecom, etc.

FMCG, CDIT and Apparel categories have experienced very different growth trajectories over the last few years. While CDIT has shown tremendous growth (primarily led by high growth in mobile handsets market), FMCG which has been a well penetrated market has been growing a stable rate. Given the fact that the discretionary income of the Indian population is rising at about 15 per cent every year, one would expect the apparel sector to witness a higher growth. However, the actual growth rate has been fairly low. We believe that, on a price performance value proposition to the consumer, players in apparel have not offered the same value as the players in telecom or CDIT or automobiles etc. have. The cost of laptops (which are in the CDIT category) decreased by about 25 per cent, while the volume increased by about 76 per cent on a yearly basis. LCDs showed a similar trend too. In the apparel and home textiles categories, a smaller volume growth and a higher price growth translating to a low price performance value to the consumer was observed.
Exhibit 5:

Sector Growth Rates

25% 20% 15% 10% 5% 0% 2005 2006 2007 2008 FMCG
Source: Technopak Analysis

Growth Rates

2009 CDIT

2010 (P) Apparel

2011 (P)

2012 (P)

2013 (P)

2014 (P)

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Thus, the share of wallet appears to have shifted from categories like apparel, home furnishings etc. to CDIT, automobiles and travel as shown in exhibit 6.
Exhibit 6:

Apparent Shift in the Share of Wallet

Categories Talk time Volume CAGR (Last 4-5 years) 80% Per Unit Price Change -24%

Laptops

76%

-20%

LCDs

40%

-20%

Premium Shirts (Apparel)

6%

15%

Home Textiles

12%

25%

This hypothesis is further strengthened by the fact that post recession, categories like consumer durables, automobiles recovered the fastest whereas categories like apparel, home furnishings etc. are still to recover completely.

Exhibit 7:

Financial Comparison of FMCG Companies and Retailers (FY09)

Vishal Retaii Westside Koutons Shoppers Stop Pantaloon Retail Britannia ITC GSK Marico Dabur P&G HUL 0 15% 30 EBITDA/Sales Source: Technopak Analysis 60 ROCE 90 1% -4% 8% 3% 22% 20% 12% 10% 11% 8% 25% 23% 19% 12% 19% 32% 35% 38% 39% 48% 35% 121% 120 FMCG Companies 28% Retailers

Financial Performance
The financial performance of retail sector vis--vis FMCG sector is different. The EBITDA and ROC for the retail sector is about 10-12 per cent, while for the FMCG sector, the numbers are higher. Thus ,there is an opportunity for the retail sector to get these financial metric right. The low level of returns in retail is primarily due to the high level of inefficiencies at the back end. Inventory management which is an integral part of any successful retail operation is currently lacking. A significant amount of capital of an Indian retailer is blocked in inventory leading to a strain on the balance sheet. A comparison of Indian apparel retailers with international retailers highlights this point. While gross margins of apparel retailers in India are almost similar to any other international retailer, high inventory levels have led to significantly lower returns.

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A Look into the Future

The last decade (2000-2009) has given India the confidence to dream big, and the next one is poised to bring those to reality. As India enters a new decade of growth there would be significant changes at both consumption and retail level. Some key themes expected to emerge in next few years which can have a direct impact on retailers and consumer goods companies include:

Dramatic Changes in the Indian Consumption Basket

Around 4-5 years back, the categories with highest consumption included food, clothing and housing. Recently, doctor and having healthcare services have become important and have overtaken clothing in the consumption basket. The new order being roti doctor kapda makan. Categories like education, personal transport, travel and leisure have been witnessing rapid growth. Categories of apparel, home textiles and housing are expected to move below education as there are significant changes that are expected in the education sector. As the size of these categories is dependent upon the consumers wallet, it puts pressure on the categories that are not offering competitive price performance value to the consumer. For example, our spending on self learning and coaching amounts to about Rs 45,000 crore. The size of the education market, containing the spending on self learning and coaching as well as tuitions is equivalent to the size of the organised retail market in India. Thus, the spending on this category is coming from the same share of wallet. Going ahead it is expected that emergence of new categories would put significant pressure on some of the categories which lag on price performance matrix.

Commoditisation Trap: Bigger Threat than Before for Brands

Given the changing consumption habits of the Indian consumer and share of categories, we expect that there would be a new way of classifying the consumption of Indian consumers. On one hand there would be a need based consumption categories like food and groceries, footwear, textile and apparel and there would be aspiration based categories like personal transport, health and beauty services, jewellery and watches. Categories which are mainly need based would see low consumer involvement resulting in commoditisation of these categories. Low-involvement, in turn, will imply: Consumers zeroing on just one or two attributes for taking the consumption decision e.g. just the size of the LCD panel for the TV, just the capacity of the refrigerator, just the fiber composition of the garment and the confidence in the retailer / brand etc. Consumers will optimize their purchases largely on simple attributes of price and convenience (time efficiency) in order to release more resources (money, time, mental involvement) for the aspiration / lifestyle based consumption categories. Diminishing power of manufacturers brands operating in such categories.
Exhibit 8:

Commoditisation in the Mobile Phone Market

Market Share of Local Players 20% NOKIA 63% 16% 12% 8% 4% 0% 1% 2007 No. of Players 5 15 3% 2008 2009 Nokia Market Share 56% 54% Spice Lava Micromax Karbonn Nokia Market Share 64% 28 18% 60% 56% 52% 48%

Market Share of Local Players Source: Technopak Analysis

Emergence of private labels and increasing retailer presence across the country would see a rapid commoditisation across various categories. We are already witnessing a certain degree of commoditisation in the mobile phone market with the emergence of large number of smaller brands challenging the market leader. Consumers are also taking their decision based on one or two main factors like price, battery life etc.

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Emergence of New Hot Spots of Consumption

Currently the top 8-10 cities contribute to disproportionate share of the markets in most of the consumer goods categories. However, going ahead growth in India would be far more exclusive as the new hot spots of consumption (primarily driven by investments in these regions) appear on the map. In the near future, investments in mega projects and development of infrastructure is expected to create new hot spots in India. These new centers of consumption would present an opportunity for both retail and consumer product companies to focus on and derive growth from the consumption potential of these new hot spots.

Focus on Financial Returns

Last year has been a steep learning curve for the organised retail. Going forward we expect an increased focus on the financial returns by retailer rather than just the top line. This would imply focusing on performance improvement through better inventory management, gross margins, improvement through better sourcing and private label programme. We expect that profitable growth would be the way forward for organised retail than top line growth.

Revival of Investor Interest

Globally, retail and consumer product industry Performance Metric Correlation to Value attracts a large quantum of investments through ROCE 0.65 private equity. Pre 2008 we saw a number of private 0.40 equity deals in the retail space. The industry is again Same store sales growth emerging as a strong contender for private equity New growth 0.20 investments. The recent deals in Caf Coffee Day, Lilliput and successful listing of Jubilant Foodworks (Dominos) on the stock exchanges have revived investor interest in the sector. As retailers look to raise fresh capital, understanding what the markets reward will be the key. Generally, retailers tend to look at new growth as the key area that they want to take back to investors for valuation of business. In the international market, ROCE has the highest correlation with the performance of retail business and other parameters. The same store sales and the new stores growth comes second. Hence, it would be very important for retailers to focus on generating returns through better performance and working capital management.

Conclusion
The events of the last 15-18 months have provided a steep learning for the retail and consumer product industry. While the last decade (2000-2009) has seen significant addition to consumption and retail market, it is expected that consumption is likely to double in India over the next 5 years, (nominal growth of Rs 33.75 lakh crore). There is going to be significant changes in the overall consumption basket hence brands in low involvement categories would be under the increasing threat of commoditisation. Profitable growth would be the emphasis for retailers and investors in the time to come. We expect that in the next 5-10 years, the scale of business opportunity and pace of change would be fundamentally different from what it has been in the past. This calls for almost every company to go back to the strategy drawing board and develop a vision for the next decade in order to emerge as a successful player in the consumer and retail sector.

Authors Raghav Gupta, President | raghav.gupta@technopak.com Rohit Bhatiani, Principal Consultant| rohit.bhatiani@technopak.com Pranay Gupta, Consultant | pranay.gupta@technopak.com
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