Retail Practice

The Great Indian Bazaar

Organised Retail Comes of Age in India
August 2008

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 1

The Great Indian Bazaar

Organised Retail Comes of Age in India
Contents 3

Preface 5

Introduction 7

1. The Indian Retail Market: Emerging, Accessible but Surprisingly

Competitive 11

2. Indian Shoppers: Evolving in Step with the World, in Their Own Time 25

3. Retail Economics: Innovation at Every Step 43

4. A Call to Action: Emerging Priorities for Retailers and the Industry 71

4
 Header
Preface 55
The Indian retail market has attracted much interest in recent times. The market
is large and growing, and traditional mom and pop stores are modernising
themselves even as almost every Indian business house is exploring the retail
opportunity.

Yet, questions about the profitability of the sector remain unanswered. We feel
this is the right time to discuss what it takes to grow and to make money in
India’s retail market.

This report is the product of a year-long research project to gain a perspective

on this market by McKinsey & Company’s Consumer and Retail practice in India
with support from colleagues in other emerging markets.

Kartik Sheth, an Engagement Manager based in our Mumbai office, led the
work. The knowledge effort was initially managed by Pooja Haldea and Archana
Jagannathan, both from our Mumbai office, supported by Amrita Dhar, Arpana
Shahi, Suhail Sameer, Sarayu Natarajan (alumni) and Vikram Vaidyanathan, all
consultants in our India office.

Finally, this report would not have been possible without the support of our
partners from India and other offices across the world. We thank Pierre Avanzo,
Laxman Narasimhan and Subbu Narayanswamy, who refined our insights. Many
other colleagues across the firm also contributed their knowledge: Manuela
Artigas and Nicola Caliccio (Brazil), Wai-Chan Chan and Anne Tse, (alumni,
China); Sandrine DeVillard (France); Brian Salsberg (Japan); Arend Van Wamelan
(South Africa); Peter Child and Khiloni Westphely (the UK). We thank them all.

Peter Haden Ireena Vittal

Introduction 7
These are exciting times for Indian retail.

With continued economic expansion and retail growth, India is set to become
a US$ 4501 billion retail market by 2015, comparable in size to Italy (US$ 462
billion) and much larger than Brazil (US$ 258 billion) today. What’s more, India
is perhaps the last ‘virgin’ BRIC2 market for organised retailers. The game here
has just begun, with organised retail3 accounting for less than 5 per cent of
today’s market and likely to expand to anywhere between 14 to 18 per cent by
2015. By that year, we expect that around 65 million households will patronise
organised retail, amounting to over 300 million shoppers, almost equivalent to
the population of the US today.

This retail revolution could do wonders for the Indian economy: creating over 1.6
million much needed new jobs in the next five years, raising overall economic
productivity and, perhaps most importantly, lowering prices for shoppers as has
been the case in most economies across the world (Exhibit).

Exhibit
THE GROWTH OF ORGANISED RETAIL WILL HAVE MANY BENEFITS
FOR INDIA
• Would raise factor productivity and growth by 30-40%
Higher sector • Would add US$ 3-5 billion in GDP growth over five years
productivity

• Could lower consumer prices by 3-5%

Lower prices for • Could absorb 0.3-0.5% of total inflation
consumers

• Should reduce waste through supply chain pipes

Efficiency
• Could increase farmer income by 20-30%

• Could improve tax contribution by up to 1% of retail sales or

Increased tax
Rs. 3,000 crore
contribution of
retail

• Would create 1.6 million formal jobs in retailing alone

More formal • Would add 2-3 times as many new jobs in supporting systems
employment

1 All figures in this report are at 2007 prices and exchange rates.
2 Brazil, Russia, India, China.
3 Organised retail has been defined as a network of similarly branded stores with an element of self-service.
8

But how much of this Indian retail story is for real? What are Indian shoppers really
looking for? What model should retailers adopt to make money in a market where
talent and real estate are currently in short supply?

McKinsey & Company’s Retail practice in India has spent the last two years studying
these questions, working with its clients and comparing India’s retail market
evolution with that of other emerging markets. This report summarises our latest
perspective. Its insights are based on three distinct sources (Exhibits 1 and 2):

1. How Half the World Shops, the first-ever quantitative global research on
shoppers across the BRIC markets, contrasted with shoppers in the US and
France to understand the differences. This is a proprietary survey of 10,000
shoppers across Brazil, Russia, India, China, and South Africa conducted over
the last two years. As part of this survey, we conducted home audits, joined
shoppers on trips to stores, pored over shopper diaries and led qualitative
and quantitative surveys across six emerging markets. In each of these
markets, we covered all the relevant income segments in tier I, II and III towns
and included both shoppers and influencers. In each, we assessed broad
attitudes to shopping and conducted in-depth analyses of shopping for food,
apparel and electronics.

2. The ‘Bird of Gold’: The Rise of India’s Consumer Market. We also built on insights
on income evolution and category consumption from proprietary research by
the McKinsey Global Institute in India and China. This report is a combination

Exhibit 2
THREE SOURCES OF INSIGHT

• First ever quantitative global research on shopper behaviour and

attitudes
• 6,000 BRIC shoppers; 2,800 South African shoppers; 1,700
US/French shoppers
• Focus group/home audits/shopper diaries

• The Bird of Gold : The Rise of India’s Consumer Market – First-ever

comprehensive research segmenting consumer demand in India
• Data from NCAER*, UN, the Reserve Bank of India, Oxford
Economics

• Insights from in-depth client studies across countries

– China
– Thailand
– Brazil
– US

* National Council of Applied Economic Research, India

 9

of two disciplines: economics and management. By integrating these two

perspectives, MGI gained insights into the microeconomic underpinnings
of the broad trends shaping the global economy. As a result, the report
provides business leaders and policy makers with a fact base and insights
into one of the most important trends in the world economy over the next two
decades—the integration of well over a billion new consumers from emerging
economies into the global marketplace.

3. Finally, we created detailed case studies of the evolution of organised retail in

several developing countries such as Brazil, Russia, India, China, South Africa,
Mexico, and mature ones in North America and Europe. We also reviewed
industry structure and conduct in these markets, paying special attention to
the performance of winning and struggling retailers.

This report is organised into four sections.

Chapter 1: The Indian Retail Market: Emerging, Accessible but Surprisingly

Competitive

Chapter 2: Indian Shoppers: Evolving in Step with the World, in Their Own Time

Chapter 3: Retail Economics: Innovation at Every Step

Chapter 4: A Call to Action: Emerging Priorities for Retailers and the Industry

A final word: Our perspectives on retailing in India extend from luxury to lifestyle
to value retailing across urban and rural markets. This report, however, refers
primarily to customers with the largest potential—in the large urban middle-class
or what we call the “belly” of the market, including nuances of their purchases in
key categories including grocery and food, apparel and electronics.
10
1. The Indian Retail Market:
Emerging, Accessible but
Surprisingly Competitive 11
It is early days in the evolution of organised retail in India, but things are changing
fast. The market is growing exponentially, as economic growth lifts more of
India’s people into the consuming classes and organised retail lures more and
more existing shoppers into its open doors.

As stated earlier, by 2015, India is likely to be a US$ 450 billion retail market.
Over 300 million shoppers are likely to patronise organised retail, a five-fold
growth up to 2015, accounting for anywhere between 14 and 18 per cent of total
retail (Exhibit 1.1). The “share of organised” estimate is always a source of

Exhibit 1.1
BY 2015, ORGANISED RETAIL WILL HAVE A 14-18% SHARE
OF TOTAL RETAIL
Size of organised retail in India
US$ billion
65-80

CAGR
30-35%

2007 2015
Share of
organised retail 4-5 14-18
Per cent

huge debate. Our assessment of market potential assumes organised retail will
emerge where a critical mass of shoppers exist, purchasing the three largest
categories today—food, apparel and electronics. We do not factor in any major
constraints such as diminishing real estate supply or discontinuous growth
through franchising of existing mom and pop stores.
12

But what will characterise this fast growing market? As is often the case with
India, every assertion and its opposite is true. The market is large but basket
sizes are small. Shoppers will embrace foreign and westernised brands but are
unlikely to let go of traditional categories any time soon. Organised retail will
expand rapidly but mom and pop stores will also hold their sway.

Dealing with these seeming contradictions won’t be easy; many of the existing
players as well as new entrants will struggle to survive. A useful point of departure
is: who will be the “relevant” shoppers, those likely to be the customers of
organised retail?

POTENTIAL SEGMENTS FOR ORGANISED RETAIL WILL GROW FIVE-FOLD BY

2015

India has about 200 million households today. In an emerging market such
as this, income remains the most critical driver of consumption. In an earlier
McKinsey & Company report, The ‘Bird of Gold’: The Rise of the India’s Consumer
Market, we identified five distinct consumer segments1 (Exhibit 1.2), ranging
from around 1 million ‘global’ households earning over US$ 22,000 a year in
2006 to about 100 million ‘deprived’ households barely surviving on an annual
income of less than US$ 2,000 (the box ‘Indian consumers fall into five groups’

Exhibit 1.2
Market for
INDIA HAS FIVE MAIN CONSUMER SEGMENTS modern retail

Household income* Total households HH retail spend

Million, 2005 US$/HH
100% = 206

Globals
>US$ 22,000 1 12, 800

Strivers
US$ 11,000-22,000 2 5, 200

Seekers
US$ 4,000-11,000 11 2, 300

Aspirers
US$ 2,000-4,000 91 1, 350

Deprived
<US$ 2,000 101 700

* Real per annum

Source: The Great Indian Middle class; NCAER; MGI India Consumer Demand Model

1 Chapter 2 of this report describes shopping behaviour in the various segments.

 13

INDIAN CONSUMERS FALL INTO FIVE GROUPS

Indian households can be classified into five economic groups based on real
annual disposable income:

Globals: Enjoying an annual disposable income of over Rs. 1 million per

annum, households in this group comprise the richest people in the country
and can afford a global lifestyle. The group has traditionally consisted of senior
corporate executives, large business owners, politicians, big agricultural-land
owners and top-tier professionals. It now also includes a younger, upwardly
mobile section—mid-level executives and graduates from India’s best colleges
who are offered the highest salaries in the country.

Strivers: With an annual disposable income of Rs. 500,000 to Rs. 1 million

per household, this group consists of highly successful people in cities,
towns, and villages who have established sources of income and substantial
savings. It includes businesspeople, professionals, government officials, and
medium-scale industrialists.

Seekers: Households in this group have an annual disposable income of Rs.

200,000 to Rs. 500,000 per household. By far the most varied economic
group in terms of employment, attitude, age, and other variables, this
group includes those fresh out of college as well as traditional white-collar
employees, mid-level government officials, and medium-scale traders and
businesspeople.

Aspirers: With an annual disposable income of Rs. 90,000 to Rs. 200,000

per household, this group includes small shopkeepers and farmers, and low-
skilled workers in industries and services. People in this group spend about
half of their income on basic necessities.

Deprived: This group consists of the poorest households in the country with
an annual disposable income of less than Rs. 90,000 per household, making
ends meet through unskilled or low-skilled activities. People falling in this
economic group often find it hard to find work throughout the year and have to
rely on seasonal or part-time employment.

Source: The ‘Bird of Gold’: The Rise of India’s Consumer Market, McKinsey Global
Institute, May 2007
14

provides a brief description of each segment). The top three segments—globals,

strivers and seekers, comprising 14 million households in 2006, are existing
and potential shoppers for organised retail.

Our extensive study of consumption segments in India shows that only the top
three have the income, attitude and confidence to patronise organised retail
today, as described below:

n Only the top 14 million households have the income to spend on categories
beyond the basic (food, housing, education, utilities and transport).
Members of these income groups are increasingly experimenting with new
categories (even in food) and consumption occasions as they become
richer and more comfortable with new shopping formats. The top 1 million
households, the ‘globals’, could be shoppers in any city in the world: they are
demanding, they know what they want, and they spend on many categories
including vacations abroad, branded apparel and new food service offers.
The next 13 million ‘seeker’ and ‘striver’ households are still experimenting
with new formats and categories but are eager consumers nevertheless.
Already, they spend only 15 to 20 per cent of their incomes on food (much
lower than the all-India average of 42 per cent). And today, over 50 per cent
of their retail spending is on categories other than food. Since penetration of
these segments is still low in most categories, they clearly have many years
of consumption growth ahead of them.

n The 91 million ‘aspirer’ households are just starting to buy more than the
basics but are still not comfortable with organised retail. The aspirer segment
is the market of tomorrow. Currently, its members do spend on categories
beyond the basics, primarily on special occasions, and increasingly sample
all the categories that better-off households do. Doing so is their signal
that they have “arrived”. However our work in India reveals that organised
retail—with its air conditioned stores, security guards at the entrance, and
uniformed staff—intimidates them. As increasing incomes allow them to
browse and shop, and they get more familiar with these formats, they will
enter and buy. For now, they will walk around malls but not enter the stores.

n The bottom 101 million households are focused on necessities. Indians in

this category are still spending a disproportionate amount on the basics of
life. Many of them are living under the country’s official definition of poverty
(consuming 2,400 calories per capita a day in rural areas, 2,100 in urban
areas). They spend as much as 60 per cent of their incomes on food. Other
 15

basics such as housing, health, education, utilities and transport take away
another 18 per cent. This leaves them very little for other categories. They are
unlikely to be users of organised retail at least in the next 5 to 10 years.

If living costs increase and GDP growth slows, the ‘threshold of income’ of
households entering modern retail will change. But the impact at worst will be to
slow the pace of growth by a matter of months.

For India, these times could be called magical. Over the next 10 years, the relative
sizes of consumption segments will change substantially (Exhibit 1.3). Sustained
income growth with inflation under control will lift consumption among a massive
number of households over the next decade (Exhibit 1.4), as it did in China
between 2001 and 2004. The largest part of the growth will be among seekers,
with the number of households in this segment growing from 11 million in 2006
to 55 million in 2015. This group will lead the move towards organised retail. In
addition, the richest shopper segment, the globals, will also grow, from 1 million
to 3 million households, creating a market for lifestyle products—as is happening
in China today. The boom in luxury products though, is yet to happen.2

For retailers, the thing to note is that the shoppers they are attracting today are
going to be outnumbered by the new shoppers of tomorrow. They need to find
ways to retain the early shoppers, who will be the bigger spenders tomorrow

Exhibit 1.3
THREE SEGMENTS HAVE THE HIGHEST POTENTIAL Potential target
consumer
FOR ORGANISED RETAIL segments

Household income
bracket Total households
2005E, million 2015F, million
100% = 206 100% = 244

Globals
>US$ 22,000 1 3 14 million
growing to
64 million
Strivers
US$ 11,000-22,000 2 6

Seekers
11 55
US$ 4,000-11,000

Aspirers
US$ 2,000-4,000 91 106
Market
for next
Deprived wave of
<US$ 2,000 101 74 growth

Source: The Great Indian Middle Class; NCAER; MGI India Consumer Demand Model

2 The rest of this report focuses on value and lifestyle retail, not luxury retail.
16

Exhibit 1.4
CHANGE IN THE UNDERLYING INCOME CURVE WILL DRIVE GROWTH

Number of consuming HH growing at fastest rate . . . . . . similar to the Chinese evolution

1985
1995
Distribution of household income 2005 Annual urban household income distribution
% of households 2015 RMB
2025

2001 2006
35 mean mean

30
Threshold
25 middle
class
20 39 million
households
15
in 2004
10

0
0 100 200 300 400 500 600 700 800 900 1000 22,000 28,000 33,000
-5
17 million
Annual household disposable income
households
thousand, Indian rupees, 2000
in 2001

Source: MGI; IGD Global Retailing conference

and core to a format’s success. But they also need to manage how they are
perceived by the relatively less well-off shoppers of tomorrow. Retailers who
welcome them early and hook them through a better understanding of their
needs will enjoy the riches to come.

So what do these shoppers look for? What is the shopping basket currently and
how will it change?

BASKET SIZE IS SMALL AND LIKELY TO REMAIN SO, UNLESS CONSUMPTION

IS SHAPED ACTIVELY

As organised retail grows in India, the country will remain a market of millions of
small transactions. Today, the shopping basket of those frequenting hypermarkets
in India amounts to US$ 7 to US$ 10 a trip, very small compared to US$ 40 to
US$ 45 in the US and about half of the Chinese bill size (estimated at between
US$ 10 to US$ 18). While basket size will increase, it is likely to remain small for
some time to come since organised retail is still in the early stages of growth.

There are vast implications of the small basket size. At the very least, the small
basket size suggests that it will take twice as many customers as in China and
four times as many customers as in the US to achieve the same sales density
in India. That most stores in India are currently a fourth to a sixth the size
of those in developed markets, (with similar demand peaks on the weekend)
indicates the extent of the retail operations challenge. The result is visible in
 17

stores today. The best stores look packed, with long check-out lines. Clearly
operational efficiency, e.g., at check out, and sound asset utilisation are critical
from day one.

But that is not all. Our work also suggests that shaping consumption will be
critical to driving growth in this market. For example, it is evident that some of
the more successful stores today are the victims of their own success, becoming
saturated at 8,000 to 12,000 customers per day. Without expanding their sizes,
to ensure healthy store growth these retailers will find it essential to shape their
customers’ consumption. This can be done in two ways: creating new peaks
apart from the weekend and offering more categories to increase basket size.
They will also need to consider what kind of customers they would like to convert
into their core franchise.

Building a sustainable model will therefore require that retailers think carefully
about who their target shoppers are, what these shoppers want and how to
service them efficiently. Just as importantly, retailers must know how to reach
this soon-to-be massive number of Indian shoppers.

THE MARKET IS GEOGRAPHICALLY CONCENTRATED

Perhaps it will be good news for retailers that the Indian market is surprisingly
concentrated and is likely to remain so. But they must also note the corollary:
while this concentration makes it easier to reach shoppers, it also creates
intense competition in specific parts of the country.

The first question to consider is where do the targeted Indian shoppers live?
Urban India accounts for 30 per cent of the country’s total population but
currently accounts for 64 per cent of its consumption. The number of urban
dwellers will remain high even in 2015, when consuming households are likely
to have grown five-fold, as stated before. Rural India has lots of individually rich
shoppers, but they are widely dispersed and hence difficult to reach.

What’s more, the market within urban India is further concentrated: 39 per cent
of India’s buying power is in the eight large tier I cities (Exhibit 1.5 and 1.6).
The concentration is even greater in luxury retailing. Recent McKinsey research
shows that just five neighbourhoods in Mumbai and Delhi and one in a town in
Punjab account for 65 per cent of potential luxury customers in India.3 But as

3 It’s important to note here that this degree of concentration by no means suggests that
organised retail in India makes sense only in these 34 cities. There could be equally valid retail
strategies aimed at tier III and IV towns or even rural India. This report however is restricted
to large-scale strategies to build presence first where the major consuming segments are
located. We believe that unconventional or niche strategies might create significant value but
will clearly require a very different business model.
18

Exhibit 1.5
CLASSIFICATION OF CITIES AND TOWNS

Mumbai Tier I: Major cities

Kolkata, Delhi,
Chennai 8 cities
Bangalore Population > 4 million
Hyderabad Total income >100 billion Indian rupees
Ahmedabad, Pune
Surat, Kanpur, Nagpur, Lucknow,
Tier II: Mainstream cities
Jaipur, Kochi, Vadodara, Indore,
Ludhiana, Madurai, Bhopal, Patna,
Nasik, Agra, Varanasi, Rajkot, Meerut, 26 cities
Jabalpur, Dhanbad, Kozhikode . . . Population >1 million

Tiruchirapalli, Amritsar, Faridabad, Aurangabad,

Allahabad Gwalior, Jodhpur, Raipur, Bhubaneshwar, Tier III: Climbers
Goa, Pondicherry Aligarh, Moradabad, Mangalore,
Gorakhpur, Bhavnagar… 33 cities
Population >500,000

Rohtak, Rourkela, Udaipur, Anand, Faizabad, Hassan, Tier IV: Small towns
Shimla, Roorkee, Gurgaon, Shillong…
5,094 towns

Note: Population for each city estimated using the average urban household size (from MGI model) and the estimated number of households
in each city from NCAER (in the year 2001).
Source: The Great Indian Middle Class, NCAER; McKinsey Global Institute

Exhibit 1.6

BUYING POWER IS CONCENTRATED IN 8 TIER-I CITIES TODAY

ESTIMATES

Number of cities* Share of urban income

Per cent; 2001

Tier I 8 39

Tier II 26 14

Tier III 33 9

Tier IV 5,094 towns 39

* Classification based on population. Tier I >4 million, Tier II – 1-4 million, Tier III 0.5-1 million, Tier IV – rest of urban centres
Source: Census of India 2001; NCAER “The Great Indian Middle Class”; MGI

incomes increase over the next five to 10 years, buying power will spread to an
additional 26 tier II cities.

One model of retailing suggests that perhaps organised retail is likely to focus
on these 34 cities, which account for over half of today’s spending and most of
 19

Exhibit 1.7

EXPECTED GEOGRAPHIC SPREAD OF RETAIL IN INDIA IS SIMILAR

TO CHINA’S

WAVE 1 – First phase of

retail action (in the mid-90s)
• Key cities: Beijing,
Shanghai and Guangzhou

WAVE 2 – Second phase

(2000-2007)
• Tier II: 29 capital and
prefecture cities

WAVE 3 – From 2007

• Tier III: 251 urban areas

India’s economic growth. In this respect, India will be similar to China, where the
key economic centres of Beijing, Shanghai and Guangzhou produced the first
shoppers for organised retail, followed by the next 29 tier II cities, which enjoyed
a second wave of economic growth to emerge as major retail centres between
2000 and 2007 (Exhibit 1.7). Today over 1,000 cities in China can support a
hypermarket compared to under 200 cities in India today.

Knowing where the high-potential shoppers are located is only the first step in
the game. Just as importantly, retailers need to think about how their priorities
will change over the coming years as Indian shoppers and competition in the
industry evolve.

HETEROGENEOUS EVOLUTION IS LIKELY

The early focus of organised retailers in India has been on acquiring sites to
open doors and attract customers, both critical factors in building a business
from scratch. Differentiation has been less crucial at this nascent stage, as
supply creates demand and an attractive price proposition and convenient
location have been sufficient to attract shoppers. Indeed, every day, more new
players announce their entry.

But we believe several of these entrants will struggle in the next phase of retail
evolution, as the rules for winning change dramatically and suddenly. We would
20

not be surprised if many of these initial adventurers do not survive the next
stage of evolution in India. This has been the case in several other sectors that
developed in the last 15 years in India (whether airlines or telecommunication)
and also in the retail sector in China, which is about 10 years ahead of India in
its evolution (Exhibit 1.8).

Our work with retailers in China confirms that the country has reached the
‘exploratory’ stage, especially in the top urban centres. In these markets,

Exhibit 1.8

EARLY DAYS FOR ORGANISED RETAIL Phase 4

Phase 3
Phase 2 Mature
Phase 1 Consolidated
Exploratory
Fragmented

India China Brazil Singapore

Time from fragmented stage

– 5-15 years 10-25 years > 25 years

• Dominance of • Large-scale • Global • 3-4 winning

mom and pop innovation in retailers start local retailers
stores formats and acquiring survive and
• First few value flourish
organised local propositions by
• Multiple global
retailers appear local retailers
retailers in the
• First few global
top 10
Organised retailers enter
retail’s
share of
3-5% 5-30% 30-80% >80%
total
market

winners are those who can retain customers (not just acquire them), offer a
differentiated proposition vs. other players (not just open a store) and increase
operational efficiency as scale becomes material. Shoppers are now used to
basic benefits (such as attractive prices and convenient location) and are looking
for more. Winners will reinvent themselves and deliver clear benefits. Others are
as likely to consolidate as have players in other sectors.

Importantly, moving from phase 1 to 2 is a matter of competitive intensity and

not time or the buying power of the city. Hence in cities such as Bangalore and
Hyderabad, early signs of phase 2 are evident as real estate availability has
allowed new formats to develop. On the other hand, cities like Delhi and Mumbai
are still in phase 1 despite the high buying power of their residents. In Bangalore
 21

and Hyderabad, organised retail already has a concentrated presence with an

estimated share of 18 to 24 per cent or four to five times the all-India share.
The impact is visible in the performance of many stores and the search for
differentiation has already started.

Phases 3 and 4 of the retail evolution are still some distance away. With a
25-year history of organised retail, Brazil resembles the consolidated market
of phase 3. Well-established retailers hold 60 to 80 per cent4 of the total retail
market. Mergers and acquisitions have been frequent, and shopper segments
are increasingly thinly sliced, with distinct formats catering to each. The basis
of competition has moved from mere presence and efficiency to innovation and
then increased customer lock-in.

What does all this mean for retail in India? First, it is likely to have a small
share and face intense competition. Second, organised retail will grow alongside
traditional retail, not usurp it.

Small but growing share for organised retail, with pockets of intense
competition
As more players try to build initial positions in India, the competitive landscape
will become crowded, especially in some catchments and cities. With few
entry barriers, there will be many more entrants—local and, depending on how
regulations evolve, global. It is quite likely that, even with a 14 to 18 per cent
overall share nationally, organised retail will feature catchments with intense
competition quite early in the game. In Hyderabad, for instance, one catchment
already has over 10 hypermarkets, six convenience stores and hundreds of
traditional mom and pop stores fighting for a share of the wallets of its newly
affluent shoppers. This is also true for some areas in Bangalore.

Second, price and location will soon lose their power and winners will need to
swiftly differentiate themselves—be ‘famous for’ something (Exhibit 1.9). Till
now just opening stores was enough to generate footfalls and retailers were
catering to all consumer segments—they were everything to everyone. Now
retailers will be forced to make choices about the segment to target and then
tailor their delivery to cater to this segment. However, it will be important for
them to differentiate themselves only to the extent that they remain attractive
to a large enough customer segment and hence viable.

4 Organised retail in Brazil includes a large informal sector that qualifies as ‘organised’.
22

Exhibit 1.9
ORGANISED RETAILERS WILL NEED TO BE “FAMOUS FOR”
SOMETHING
• Price promotions and
discounts
• Lowest prices everyday
• Mix of private label and high-
• Convenient location in high end brands across categories
street/mall Price and price points
• Convenient in-store layout • Distinctive fashion to drive
footfall

Convenience Authority/Range

Experience Service

• Fun family experience • Attentive and knowledgeable staff

• Comfortable and safe environment • Products available when required

Finally, this evolution will happen sooner than expected. As we’ve said above, in
the more developed markets, differentiation is already a prerequisite.

Mom and pop stores will survive

Diverging from popular belief, we see that mom and pop stores will retain their
hold in India even as organised retail evolves.

Both will grow alongside, as has happened in China (Exhibit 1.10). Shopper
attitudes, existing regulations and a cost advantage over organised retail will
preserve the popularity and viability of traditional retail. The street vendor
and neighbourhood store (kirana store) benefit not just from Indians’ habit of
buying fresh food often, making convenient location a must. They also gain from
their sagacity in offering credit and home delivery. These stores have for long
maintained accounts for households, waiving payment till the end of the month
and sending goods to the door, at just a phoned-in request. Kirana stores also
enjoy lower operating costs and higher asset turns. Further, organised packaged
goods players have recognised them as a sweet spot and are working closely
with them to improve in-store experience and service.

True, this cost advantage could diminish as organised retailers start to leverage
their scale to negotiate better with their suppliers. However, the biggest
challenges to traditional stores’ sustainability will not be competition but the
opportunity cost of the real estate they are occupying and the willingness of the
next generation to continue in this business.
 23

Exhibit 1.10
Exhibit 1.10

EMPHASIS ON CONVENIENCE FAVOURS CONTINUED GROWTH

IN MOM & POP STORES, AS SEEN IN CHINA
Total retail sales revenue; US$ billion

CAGR
Per cent Per cent
500
23

58 21% growth in
300 traditional
42%
retail over 4
42 years
Organised

42 5
Mom & Pop 58

2001 2005

Source: MGI; Euromonitor; Planet Retail; trade interviews; McKinsey analysis

Despite these two challenges, we are already seeing the Indian entrepreneurial
spirit at work at several kirana stores, ensuring their survival even if in a new
form. Adaptations include:

1. Becoming specialist stores: we see more chemist, food and lifestyle/beauty

stores.

2. Switching to exclusive brand outlets (from multi-brand ones): many are

evolving their relationships with brand owners.

3. Providing new services suited to their location and size advantage. For
instance, some convenience stores are following their counterparts elsewhere
in the world; internationally, some convenience stores make 50 per cent of
their profits by selling mobile telecom, travelling and ticketing services. In
India, the largest telecom player sells about 70 per cent of its pre-paid airtime
through a large network of over 750,000 mom and pop stores.

This holds a clue for organised retailers: find out what fast-evolving Indians are
buying and how and discover how best to adapt to or shape this behaviour. The
next chapter describes the evolving attitudes of Indian shoppers, what shopping
baskets hold today and how their composition is likely to change in the coming
years.
24
2. Indian Shoppers: Evolving in Step
with the World, in Their Own Time 25
Organised retail will grow in India as retailers establish positions and start
shaping this market. But how well they do so will depend on their understanding
of Indian shoppers and what will make them shift their buying behaviour. So
far the hustle and bustle of bazaars, the home delivery and ‘cottage industry’
credit of the local grocer and the bargaining pleasure of mom and pop stores
have been attractive enough. What will attract shoppers in large numbers to
organised retail? And what will they buy when they get there?

To answer this question, we studied Indian shoppers in two ways: one, obtaining
a category view of their spending and how it is changing as they get richer; two,
getting a holistic view of their attitudes and behaviour as shoppers compared
with their peers in other markets (see box ‘Decoding the Indian shopper’). Our
extensive study showed that:

n Indian shoppers have some similarities to their peers in other markets, but
have also been shaped by a unique context and history and therefore differ
in ways that are important for retailers to understand.

n Indians are experimenting with several categories as incomes rise. Non-food

categories, particularly apparel and electronics, are leading the shift to
organised retail.
26

DECODING THE INDIAN SHOPPER

We used two different approaches to understand Indian shoppers. One,

to obtain a category view of spending and how it is changing as incomes
rise, we used insights from our study of consumption in India, as reported
in The ‘Bird of Gold’: The Rise of the India’s Consumer Market, and from
the extensive work we have done in specific retail categories, both for
retailers and branded manufacturers.

Two, we built a more holistic view of the attitudes and behaviours of Indian
shoppers by comparing them with shoppers in other emerging markets,
including China, India, South Africa, Russia and Brazil. We called this effort
‘How Half the World Shops’.1 Our hypothesis was that these shoppers
differ from those in mature retail markets and, as their incomes rise, they
will continue to show different shopping habits and preferences. Using
multiple techniques, from kitchen and wardrobe audits to shopping trips
with individuals, from qualitative and quantitative analysis to online survey,
we compared behaviour across emerging markets. Next, we compared
our findings with similar research among US and French shoppers. This
led us to a powerful set of insights on their overall shopping habits and
a detailed understanding of food, apparel and electronics, as presented
in this chapter.

INDIAN SHOPPERS DIFFER IN KEY WAYS FROM THOSE IN OTHER MARKETS

BUT ARE NOT DIFFICULT TO UNDERSTAND

Indian shoppers seem bewildering in their diversity and unique preferences. A

global luxury retailer is delighted that its first store in a luxury hotel in India broke
even in an incredibly short time. But a local lifestyle retailer bemoans the fact
that its store economics do not work on a high street like Connaught Place in
Delhi. Similarly, Indian shoppers will wait for the seasonal sales to buy branded
shirts, but are also buying more top-end mobile phones than shoppers in the
UK are today.

Do these paradoxes indicate that the Indian shopper is intrinsically difficult to

understand? We believe not. As we conducted our research, we were conscious
of two lessons from our work with some of the most successful early entrants into
organised retail. One, it is not wise to think in terms of averages when catering to
Indian shoppers. Segments are as far apart from each other as can be imagined,

1 The first-ever quantitative global research on shopper behaviour and attitudes by

McKinsey & Company, covering 6,000 BRIC shoppers and 2,000 US and French shoppers
using focus groups, home audits and shopper diaries.
 27

in income, spending across categories and adoption of categories. The ‘global’

Indians are as different in their outlook and behaviour from the aspirers they live
close to as they are from shoppers in Singapore and Moscow.

Two, it’s better to shape not predict the behaviour of Indian shoppers. The bulk
are new to organised retail and their attitudes and preferences are evolving so
fast that what is a buying factor today is taken for granted tomorrow. A recent
attitudinal survey we conducted revealed that almost half of Indian shoppers do
not have clear preferences as they are either frustrated with what is available to
them or are not served by modern retail and don’t care. As a result many of the
attitudinal segments we see in other markets are yet to be seen in India. The
segments are clearly to be seen in Brazil, the US and France, and are starting to
emerge in China. But in India shoppers are still quite undifferentiated, whether
it’s the rich, the young or shoppers in metros. Again, this is a sign that it is early
days for organised retail in India.

We have assessed Indians’ shopping attitudes as a ‘snapshot’ restricted to 13

million ‘seeker’ and ‘striver’ households, falling in the middle of the consumption
classes described in chapter 1. To avoid the trap of ‘averaging’, we have left
out the 1 million ’global’ households (who shop differently) and the shopping
behaviour of the 91 million ‘aspirer’ households (whom we view as the shoppers
of tomorrow). We studied these shoppers across six cities in India and compared
them with 8,000 of their counterparts in Brazil, Russia, China, South Africa, the
US and France.

The resulting ‘photograph’ is revealing, although we recognise that it captures

an Indian shopper who is evolving very fast. It shows that some Indian shopping
habits are universal, i.e., they are more or less the same as those in the rest of
the world, some are similar to those of other BRIC shoppers but different from
those in more mature retail markets, and some are unique.

Some shopping habits are universal

Indian shoppers are very much the same as their global counterparts in four
critical attitudes. First, they will not travel for more than 15 minutes for regular
shopping (for food and other standard purchases). Second, they like to see the
best brands, even if they are not yet ready to buy them. Third, they want to be
able to choose from a range of products. Fourth, they need to check prices
within and across stores. Let us look at two of these attitudes more closely:
28

Shoppers follow a 15-minute rule. Shoppers do not travel long distances for
regular shopping. All those covered in our study, including Indian shoppers,
follow the 15-minute rule (Exhibit 2.1). In our survey, 64 per cent of respondents
said shopping locations should be within 15 minutes of travel from home, as did
fairly similar numbers in China (69 per cent) and France (70 per cent). In India,
this travel distance was defined as the journey time by ‘autorickshaw’2, in China
as a journey by bus or bicycle and in the US as a journey by car.

Exhibit 2.1
Exhibit 2.1

MOST SHOPPERS SURVEYED FOLLOW THE 15-MINUTE RULE

Convenience is a must globally…
% of people travelling less than 15 minutes

78 74 70 69 69 64

Key
Implications
• Measure and
Brazil US France China Russia India forecast
catchment’
density
• Watch for
…although mode of 15-min travel differs
transport/
infrastructure
evolution

• Auto rickshaw • Bicycling • Driving

• Walking

Source: How Half the World Shops (2006)

Exceptions are made only for high-value categories such as apparel, electronics
or jewellery and festive or wedding purchases. On these occasions, Indian
shoppers are willing to go across town or even to other cities (e.g., Kanchipuram
to buy saris for a South Indian bride).

Clearly, one implication of this is that traditional formats in convenient locations

are here to stay. Second, locations within neighbourhoods will be coveted and
real estate pricing for these locations will continue to remain strong. Finally, for
locations outside neighbourhoods and eventually in suburbs, which are likely to
see massive real estate investment, retailers will need to innovate to meet the
15-minute rule. One example of such innovation is by retailers in China, who
organise buses to take shoppers to stores outside their neighbourhood and who
are now developing tailored “suburb formats” especially those within townships
being built from new.

2 Motorised three-wheeled vehicle.

 29

Shoppers are highly value and price conscious. Shoppers choose stores they
perceive as offering value. This is especially critical in emerging markets, where
shoppers often believe that retailers increase prices to recover store rentals
and overhead costs such as air conditioning and security. To find out which
stores price “right” and which at a “premium”, shoppers regularly compare
prices. Our research showed that price checking is common across markets.
An equivalent number of Indian and US shoppers (39 per cent) reported this
behaviour, exceeded only by French shoppers (43 per cent).

How it is done is fairly simple. Indian shoppers use Key Value Items (KVIs)
to quickly check if the store is pricing at a premium or otherwise, but their
list of items is small—3.4 in India versus 6.4 in Brazil (Exhibit 2.2). For daily
purchases, they usually check a few unbranded items including (local) rice,
pulses and wheat flour and a few branded products that vary across regions in
India3 and include a malted beverage, a tea or coffee brand and a soap brand.
Prices are checked for other categories as well. For jewellery, the price of a
plain gold chain helps assess price, while for electronics the price of a colour
television or a 165-litre refrigerator meets the same purpose. Interestingly, this
behaviour is of a milder degree than in other countries. As can be expected, this
complexity is increasing as more competitors enter and organised retail begins
to play a bigger role in shoppers’ lives.

Exhibit 2.2
INDIAN SHOPPERS CHECK FOR PRICES, BUT IN LESS STORES AND
FOR FEWER PRODUCTS
“I often check prices between stores”
Per cent agree/strongly agree
Typical reference products differ by
income
• Strivers, seekers: Rice, pulses, flour
• Aspirers: Wheat, sugar, oil

43 39 39 37 33
20

France India US Brazil Russia China

Average
number of
stores
checked 2.7 2.4 1.9 2.4 2.6 2.7

Average number of products checked in a visit: 3.4 in India vs. 6.4 in Brazil

Source: How Half the World Shops (2006)

3 It is notable that the list was equally small but slightly different for the ‘aspirers’ segment of
Indian shoppers. They checked prices for cooking oil, sugar and wheat.
30

A clear implication for retailers is that they need to pay careful attention to the
pricing of these KVIs. We also observe the critical importance of range in setting
price perceptions. While these are early days for private label in India, several
retailers are experimenting with larger ranges that include exclusive and private
label brands which are proving popular with cash-constrained consumers.
Cheaper alternatives to mainstream brands (in the form of B brands or private
label products) are likely to grow within organised retail as they have in both
BRIC and developed markets.

Notably, our research also showed that not all retailers are getting value for their
pricing. For example, retailers pricing low across the whole range but not getting
KVIs and their entry price points right can be perceived as higher priced. We will
discuss this further in the next chapter.

Some Indian shopping attitudes are like those of other BRIC shoppers (although
different from shoppers in developed retail markets)

As with their counterparts in Brazil, Russia and China, the Indian shoppers
covered in our survey enjoy shopping, distrust retailers, want to see top brands,
treat quality and safety as a major decision factor, shop frequently for fresh food
and are highly open to credit. The most notable of these tendencies are their
attitude to shopping as an activity, to fresh products and to credit.

Love for shopping. About two-thirds of shoppers surveyed in India and about 40
per cent of those surveyed in China said that shopping is a favourite leisure activity
for the family (Exhibit 2.3). This is in marked contrast to the mature shopping
markets such as the US and France, where it is considered a chore. Indians
(and Chinese) see shopping as family entertainment, spending hours together in
a mall or a store. For many of them it is a “window to the world”, filled with the
excitement and pleasure of discovering new things and a new way of living.

This has important implications for retailers. First, this is an opportunity to

create exciting retail formats that help retain this attitude to shopping. Clearly,
as the Indian market and retail networks grow, retailers need to ensure that
the “magic” of the front-end does not diminish as they look for efficiency at the
back-end.

Second, retailers need to be able to design their layout and operations to

cope with many shoppers who are essentially browsing or window shopping
for pleasure. It is critical not to drive these shoppers away as they will shortly
become bigger spenders when their incomes rise. But managing the implication
for basket size and store footfall is an intriguing challenge.
 31

Exhibit 2.3
SHOPPING IS THE “WINDOW TO THE WORLD”

“Shopping is one of my favourite leisure activities”

Per cent agree/strongly agree
63

41
33
23 22
14

India China Brazil US Russia France

“We go for “If it’s a

Shopper pleasure - large
Quotes it’s an supermarket
excuse to we will stay
go out” at least 3
hours.”

Source: How Half the World Shops (2006)

Preference for fresh. Indian and other BRIC shoppers place a high premium on
freshness. Over 70 per cent of shoppers surveyed in all BRIC countries prefer
fresh products. Equally importantly, over 40 per cent shop for fresh food every
day, with the Chinese shopping even more frequently. The Brazilians and Russians
surveyed shop for fresh food every day of the week while Indians do so six days a
week; the Chinese reported 11 shopping trips a week for fresh food (Exhibit 2.4).
Fresh categories bought include fruits and vegetables as well as meat.

Exhibit 2.4
SHOPPING FREQUENCY
DESIRE FOR FRESH PRODUCTS DRIVES SHOPPING FREQUENCY
ILLUSTRATIVE

Mom & pop store visit Modern retail visit

Shopping
trips/week

Brazil

Russia

India

11

China

Source: How Half the World Shops (2006)

32

This preference for fresh products has a lot to do with cooking styles, availability
and trust in retailers. Brazilian, Indian and Chinese shoppers usually cook fresh
food at home every day, most of the time from scratch, using fresh ingredients.
This makes freshness very important. Second, they are used to having fresh
produce at hand throughout the year (It is only in Russia that winter brings a
lack of fresh products.) In India, in addition to the habits of ‘hot’ cooked food,
low refrigerator penetration and poor power stability have further contributed to
this attitude.

But what connotes fresh in India is different from other markets. In India, fresh
implies unpacked fruits and vegetables and meat freshly cut from a butcher. In
China, fresh connotes live seafood while in South Africa, it has to be packed or
frozen to be considered fresh! This makes it critical to understand the preference
for fresh food and how it will evolve.

What does this mean for retailers? For one thing, Indian shoppers will buy only a
small share of fresh food from organised retail. This is so in China where, even
after a decade of organised retail, less than 10 per cent of fresh produce and
an even smaller per cent of meat are sold by organised retailers. According to a
recent study by Neilsen, shoppers in Wuhan (a tier I town in China), make about
21 shopping trips a month to wet markets, about 10 a month to traditional
retail stores, and less than 20 to all other organised retail formats including
supermarkets, hypermarkets and department stores (Exhibit 2.5). This has
prompted some notable innovations. Even global retailers have added a live
market feel for these categories in their stores, with live snake and fish displays
and a ‘wet’ floor that makes fresh produce shoppers feel at ease.

Distrust of retailers. In general, BRIC shoppers do not trust retailers much. Over
60 per cent of shoppers in Brazil and Russia and 25 per cent in China said they
do not trust their retailers. But the highest distrust is found in India, where 67
per cent reported lack of trust in retailers. Indian shoppers expect the retailers
they use most frequently to try to cheat them on prices in a small way (in fact,
some shoppers told us that they prefer shopping at a store where they know the
storeholder personally, because he is likely to “cheat them the least”).

Building trust quickly with modern shoppers is therefore critical for organised
retailers, particularly in the prices they charge. Our research suggests that
exposure to modern formats such as hypermarkets will help. However, given the
strong suspicion among most shoppers today, how retailers gain trust will be a
key differentiator in the retail market of tomorrow. The good news is that this
 33

Exhibit 2.5

IN CHINA TOO, FRESH PRODUCTS ARE BOUGHT MAINLY

IN WET MARKETS
Trade sector, average number of visits per month: Wuhan example
21.72

10.84

7.50

5.33

1.50 1.39 1.12 0.93 0.66 0.60

Wet Traditional Super- Hyper- Super- Depart- Wholesale Confect- Personal Online
markets grocery market market market in mental market ionery care shopping
depart- stores shops
ment
stores
Source: Nielsen Shopper trends 2004
Ref: Q6

can be done through simple mechanisms, e.g., price and quality guarantees that
can build trust among Indian shoppers. We have seen some emerging market
retailers use this as a way to win the loyalty of core customers.

Openness to credit. Shoppers in BRIC countries are very open to credit but not
all find it easily available. While a third of shoppers surveyed in India agreed
that they would like to have credit for shopping, only 7 per cent said they use it
regularly (Exhibit 2.6). The young in India seem even more open to credit than
older shoppers: 45 per cent of surveyed shoppers aged 25 years and below said
they would like to have credit, compared to 30 per cent aged 25 to 34 and 28
per cent aged 35 and above. In Brazil, close to two-thirds of surveyed shoppers
said they were open to credit and over two-thirds reported using it. This is easy
to believe as retailers have led the retail financing revolution in Brazil. Indeed,
retailers in apparel, electronics and furniture have innovated to lock in shoppers
through credit. In India, a similar revolution is imminent as most financing till
now has been geared to serve the salaried employee. This is surprising in a
country where, of the 400 million working citizens, only 13 million are salaried
employees with unorganised labour and the self-employed (117 million) and
farmers (270 million) making up the rest. A consumer finance company aiming
to finance consumption for non-salaried households has met with remarkable
success, entering over 100 cities in India in under two years.
34

Exhibit 2.6

SURVEYED SHOPPERS ARE EXTREMELY OPEN TO CREDIT BUT FIND

IT HARD TO COME BY
Highly open to credit but constrained by availability Openness
Usage
Openness to credit versus usage
Per cent agree/strongly agree The young are even more open to credit
Per cent agree/strongly agree
31
7 Age groups
18
9 Less than 25 45

58
65 25-34 30

30
35 and above 28
25

18
60

20
40

Source: How Half the World Shops (2006)

Uniquely Indian shopping habits

In at least six respects, Indian shopping behaviour is quite different from that of
shoppers elsewhere in the world. Our survey revealed that Indians are currently
the most promiscuous in their shopping between stores, dislike pre-packaged
goods, are willing to pay for service and convenience, favour ethnicity in women’s
apparel and jewellery, are very occasion-oriented in their purchases and use
brands as proxies.

Least loyal to stores. While Indian shoppers clearly enjoy shopping, they are also
much less loyal to a single retailer. Indeed, over 60 per cent of Indian shoppers
covered in our survey say they buy at more than one retailer compared to 10 per
cent of Brazilian and 24 per cent of Chinese shoppers. This is likely to change as
stores get bigger and offer more range, shopping baskets grow and Indians get
more used to shopping for many items at once. But for now, retailers will need
to find a way to create loyal shoppers among the current flirters.

Dislike for pre-packaged fresh. As mentioned earlier, pre-packaged implies a

lack of freshness for Indians. What is startling is the extent of this attitude.
As many as 65 per cent of Indians surveyed said they would never buy pre-
packaged fruits or vegetables. In contrast, just 24 per cent of Chinese and 6
per cent of Americans surveyed have this preference. The attitude is common
in India across income categories, age groups and types of cities. Notably, it is
 35

less entrenched for meat, poultry and seafood: 41 per cent of Indians surveyed
dislike pre-packaged products in these categories.

Convenience and service matter. Travel is difficult and expensive in India.

We have seen shoppers “costing” a store visit with the approximate savings
expected from additional travel. As a result, as many as 64 per cent of Indians
covered in our survey say they are willing to pay a little more for conveniently
located stores compared to just 31 per cent of Chinese and 19 per cent of US
shoppers surveyed. Services such as home delivery are common, with even
hypermarkets providing home delivery. Additionally, in electronics, 65 per cent of
Indian shoppers surveyed said that they were willing to pay for good after-sales
service and for product warranties.

Ethnic apparel and accessories. Ethnicity remains the dominant preference in

women’s apparel and jewellery in India. Today, more than 75 per cent of women’s
apparel sold in India is ethnic in style and the majority of jewellery sold (85 per
cent) is traditional in design. This is driven by a strong local culture and heritage
in apparel and accessories, combined with a social ethos rooted in arranged
marriages. This social context is reflected in the fact that apparel purchases
for occasions such as weddings or festivals account for nearly 37 per cent of
shopping trips in these categories.

But this does not imply this behaviour will last forever. With over 350 million
Indian citizens below the age of 18 and another 350 million between 18 to
40 years of age, how long will ethnicity rule? We believe that two contradictory
forces are at work. One, the traditional importance of ethnic styles might get
stronger as pride in being Indian increases—leading perhaps to hybrid fashion
trends, currently termed as ‘fusion-wear’. Two, the Indian wardrobe will get more
varied as Indian shoppers get richer and start buying different clothes for party,
formal and sports wear. These categories might be less ethnic in nature, even
though the ethnic styling will not disappear.

Occasion-oriented shopping. Indian shopping especially in categories such as

apparel is heavily oriented towards special occasions such as weddings and
festivals. Thirty-eight per cent of Indians claim that special occasions drive
most apparel purchases, compared to 6 per cent of Chinese and 3 percent of
Russians. This attitude again cuts across income groups and cities.

Brands as proxies. In the absence of adequate information, quality control and

trust in retailers, Indians use brands as a proxy for all these. In apparel, brands
36

serve as a proxy for the latest fashion as well as the right quality. In food and
grocery, Indians seem to be willing to live with a little less. For example, in
shampoos, 57 per cent of shoppers surveyed said that buying a well-known
brand is important while as many as 49 per cent were willing to buy lesser
known brands. The only exception to this is electronics, where as many as 85
per cent of shoppers stated that they always want a well known brand. The
risk of a high-cost purchase is mitigated through the trust offered by a reputed
brand.

Clearly, not thinking in terms of averages provides a more accurate assessment

of how Indian shoppers think and how they are likely to evolve. The key is to keep
refreshing these insights as these shoppers are evolving very rapidly.

In view of these shopping habits and preferences, what products are Indians
buying now and which are they likely to favour in the future?

INDIANS ARE STILL SPENDING MAINLY ON BASIC GOODS AND SERVICES

BUT THIS IS CHANGING RAPIDLY

For retailers in India there are two big questions: What will Indian shoppers buy?
How much of this will they buy from organised retail? The answer to both will be
determined by income increases as the economy grows and the actions of retailers
(and brand manufacturers) in shaping consumption. Our study shows that:

n The consumption basket in India is changing and will be very different across
income segments

n Popular categories will reflect current preferences unique to India

n Non-food products will lead the shift to organised retail, especially in apparel
and electronics. However, organised food will be the largest category in
absolute terms, although with a much smaller share of total food spend.

Consumption in India is changing significantly and will differ across income

segments
Today, household income primarily determines the retail categories Indian
shoppers buy. With incomes still relatively low for the vast majority, food forms
the bulk of purchases, although apparel and electronics have also become
popular categories. But as incomes rise, people will have more money to spend
on things other than food, even while the absolute spend on food is likely to
double at a per capita level (Exhibit 2.7).
 37

Exhibit 2.7
SHARE OF WALLET IN INDIA IS SHIFTING FROM FOOD TO MORE
DISCRETIONARY SPENDING
Share of average household consumption Food spend
%, thousand, Indian rupees, 2000 Non-food spending

60 82 140 248
100% 4
3 7 9
1 13 Health care
5
11 2 6
3 9 Education and recreation
4 17
2 6 Communications
19
14 8
3 20 Transportation
5 9
12 3
11 Personal products and services
6 12
3 Household products
5 10 Housing and utilities
56 5 Apparel
42
34
25 Food, beverages, and tobacco

1995 2005E 2015F 2025F

Note: Figures are rounded to the nearest integer and may not add up to 100%.
Source: McKinsey Global Institute

Exhibit 2.8
EVEN WITHIN THE TOP INCOME SEGMENTS, THERE IS A FIVE-FOLD
DIFFERENCE IN PER CAPITA SPENDING ON APPAREL

Rs per capita per year, apparel spend

2008 2013

Globals 22,250 24,750

Strivers 9,200 10,500 Market for

modern retail

Seekers 4,400 5X 5,000

Aspirers 780 950

Deprived 300 350

Source: McKinsey Global Institute 2007; How Half the World Shops 2006

Today, the amount of discretionary spending by consumers varies widely by

income segment, driven both by affordability and openness to new categories.
The differences can be extreme. Our research identified a five-fold difference in
the per capita spend on apparel between different categories even within the
top income segments (Exhibit 2.8). Clearly, not all shoppers are equally valuable
to retailers.
38

While income is a primary driver of consumer choices, a key insight from our
research is that the average household does sample most categories and the
width and depth of category consumption is increasing as Indian households
get richer.

For the (near) future, retailers should remember that Indian shoppers are now
sampling different categories very early in their shopping histories. Shopping for
a new category or a premium brand can celebrate the ability to indulge or signal
increased status. This is true of shoppers in Brazil, India and China. So a shopper
in a ‘favela’ or a slum in Rio De Janiero buys only limited types of processed
foods but buys the best brands within them as these are her little indulgences
in life. A shopper in a Mumbai slum buys ‘foreign’ brands as a way of signalling
that she can afford these things. For weddings, many shoppers in India will buy
branded “His and Her” watches for the bride and groom, ensuring that over 40
per cent of that brand’s sales are now linked to the wedding season.

Retailers need to catch these customers early, and shape their buying behaviour
as the leaders in the telecom and financial services industries in India have
done over the past three years.

Popular categories will reflect current preferences unique to India

Our detailed study of total category spending by Indian shoppers reveals a
market structure that is uniquely Indian, with fresh food, apparel and electronics
emerging as key categories for organised retail (Exhibit 2.9). This is based on a
category (and sub-category) assessment of the market in India as well as drivers
of growth in the future. Our current estimates suggest the following:

Food: Given the preference for fresh products and the relative lack of concern
about top brands among Indians, fresh, staples and basics will remain the
largest segment in total food consumption.

Apparel: India is the only market in the world where men’s apparel—around
40 per cent of spending—is a much larger category than women’s—around 30
per cent (Exhibit 2.10). This of course does not include the huge spending on
jewellery in India. Also, in women’s wear, ethnic apparel (salwar kameez and the
saree) constitute around 90 per cent of total spending.

Men’s apparel will likely continue to account for 40 to 50 per cent of the apparel
market in 2015. At current rates of adoption, non-ethnic apparel for women is
likely to comprise less than 10 per cent of the market in 2015.
 39

Exhibit 2.9

FRESH FOOD, ETHNIC APPAREL AND MOBILE ELECTRONICS WILL BE

KEY CATEGORIES FOR ORGANISED RETAIL
Food, 2015 Apparel, 2015 Electronics, 2015
Per cent share of consumption Per cent share of consumption Per cent share of consumption
100% = US$ 252 bn 100% = US$ 40 bn 100% = US$ 20-25 bn
Fruits, Children Personal
FMCG vegetables & and Men’s electronics Tele-
& foods perishables infants wear Consumer com
3
20 durables 15
25
38 40
Women’s 45
non-ethnic 9

26 38
38
Women’s Home
Staples ethnic electronics

• ~30% share of fresh — • One of the only markets • Disproportionate share of

fruits, vegetables and where men’s apparel is telecom/mobile phones
perishables much larger than women’s
• Women’s ethnic is 3x non-
ethnic
Source: McKinsey analysis

Exhibit 2.10
INDIA’S APPAREL MARKET IS DOMINATED BY MEN’S WEAR

Apparel market size and growth rate by demographic and occasion-based categories Revenue
US$ billions, per cent, 2005 00-05
CAGR

100%= 7.2 6.3 1.5 4.6

0.4
Other* 1.4 1.3
0.4
Casuals 0.7 0.4
2.5

0.5
Formals
(including 5.8 4.6
ethnic)
1.7
0.6

9% 12% 8% 10%

Men’s wear Women’s wear Unisex** Kid’s wear

* Includes innerwear, nightwear, jackets, socks etc.

** Unisex formals: wollens, unisex casuals: jeans, unisex other: scarves, ties etc.
Source: Images Fashion report 2006

Electronics: Mobile phones are likely to have a disproportionate share of the

market, accounting for 40 per cent of sales in 2015. Indeed, more homes will
have mobile phones than television sets in India. Home electronics will come
a close second, with a 38 per cent share. This is partly driven by demographic
40

trends. The vast majority of young Indians live with their parents and so already
have access to many consumer electronic products such as TVs and DVD players,
whereas a phone remains an individual purchase and a statement of ‘arrival’. It
also reflects the tougher choices consumers make when their spending power
is limited.

Non-food categories will lead the shift to organised retail

Our study also shows that a smaller share of spending on food will switch to organised
retail while that on non-food categories will switch a lot faster (Exhibit 2.11).

Exhibit 2.11
NON-FOOD CATEGORIES WILL LEAD THE SHIFT TO ORGANISED RETAIL
Per cent
Organised Organised
Share of retail size in 2005 retail size in 2015
organised retail
55
Watches
50

45

40 Electronics Apparel
Watches
35

30
Footwear
25 Jewellery
Footwear
20 2015
GM* average
15 Food and grocery
Electronics Apparel
10
Jewellery
5 GM*
GM Food and grocery 2005
0 average
Low High
* General merchandise: includes home utility categories such as cutlery, cleaning products and buckets
Share of wallet (overall)
Source: McKinsey analysis

Food: In food retail, we believe that price and convenience will be key factors of
success. We expect that organised food retail will amount to only 5 to 15 per cent
of total food retail by 2015, limited by its inability to match kirana (convenience)
stores in providing fresh goods on a daily basis, offer home delivery and be
located close to home. Packaged food will do much better, with organised retail
accounting for as much as 20 to 30 per cent of total retail in the sector by
2015. The category’s advantage will be an ability to offer prices lower than the
maximum retail price and to create private labels. In some of the top 10 cities
where real estate is available, share of organised retail in food could be as high
as 20 to 30 per cent as seen already in Bangalore, Hyderabad and Chennai.
 41

Apparel: Price and authority/range will be crucial in apparel retail, where organised
retail is likely to account for 20 to 30 per cent of total garment retail in 2015.
Since shopping is occasion-oriented, convenience is not as important. Retailers
will need to create their own occasions to drive consumption and build core
franchises. Knowledge about fashion cycles and quality must be built. Offering
markdowns in a controlled way will likely be a key driver of price perception, as
will broadening the range through expanded use of private labels.

Electronics: Already fairly organised in India, the electronics market is likely to

see 40 to 50 per cent of sales through organised retail in 2015. Large format
retailers will use electronics as a ‘loss leader’ and to increase basket size.
Price will be even more important than other categories given the high levels
of involvement. Shoppers surveyed exhibited a desire for better shopping
ambience—from good lighting and cleanliness in stores to range and brand
availability as well as credit and after-sales service. All of this will offer organised
retailers a chance to win by providing a premium look and feel in their stores.
Shoppers do trust in sales people’s advice but, overall, trust in local stores
is low. Half the surveyed shoppers said they find it difficult to find the right
products. Organised retail should be able to fill these gaps.

Some product categories such as furniture are largely sold through carpenter
orders and are as yet an insignificant part of retail. These categories could move
directly to organised retail. In fact, players will attract more and more shoppers
towards organised retail as they address the current deficiencies of Indian retail.
But their job will not be done until they know how to turn these volumes into
profits, the subject of the next chapter.
42
3. Retail Economics: Innovation at
Every Step 43
As we have seen, India is an exciting high-growth market with millions of new
consumers whose behaviour is being shaped every day. But retailers cannot only
grow volumes; they must also make money. The graveyards of several emerging
markets (and even markets such as Korea and Japan) are filled with retailers
who could not build a profitable business.

Talk to anyone about retail in India and, after the enthusiasm about the retail
opportunity, the discussion quickly moves to how making money is difficult
in Indian retail. Several factors are responsible: sky-high rentals, increasing
talent retention costs, stretched supplier financing, rising operating costs and
pressure on prices (except for food). Many existing players are suffering from
poor profitability and we expect to see some changing ownership, especially
once regulation allows foreign players to enter.

This is before real competition has emerged. As competitive intensity increases,

retailers will have to live with an annual 1 to 2 per cent price squeeze each year.

So can retailers make money in India? We believe they can. We do see successful
retailers in India, who have built winning formats for this country. But successful
formats from developed countries may not suffice here. Profitable retailers will
innovate both on ‘earn’ and ‘turns’ of the retail ROCE tree.1 We believe winning
retailers will offer a compelling format to shoppers. This might require that they
“evolve” their formats more quickly than they have done in other markets. Early
evidence suggests that the life of a format in India is much shorter than the
usual five to seven years in developed markets, and that winners will have to
redesign formats frequently to keep pace with the fast-evolving shopper. This is
not new. We have seen similar innovations and tailoring in other sectors in India.

We believe the winners in India will be those who recognise that making profits
will require a different approach since this is a market of millions of small
transactions and rapidly evolving customers, whose spending across categories

1 Return on Capital Employed; the ROCE tree framework disaggregates retail performance on
various indicators of profitability.
44

is different from that of shoppers elsewhere and whose shopping habits vary
across clusters. Also, cost drivers in India may differ since it is early days of retail
evolution here. Models imported as is from other countries will not work in India.

Why is this level of tailoring required in India? The answer lies in the evolution
of various drivers of profitability here. The rest of this chapter discusses five
of these drivers and the likely imperatives for retailers in India. Assuming such
mechanisms are in place, we suggest five ways that will help retailers create a
profitable operating model:

n Integrating real estate into the business model

n Creating an effective and scalable supply chain

n Increasing basket size by shaping consumption

n Developing and retaining talent

n Influencing regulation to ensure healthy development of the sector.

INTEGRATING REAL ESTATE INTO THE BUSINESS MODEL

As in retail anywhere in the world, rentals are one of the highest costs. That
they are much higher than expected is no surprise in a country where the real
estate sector has just started to become organised. Today rentals as a share of
costs are twice as high as elsewhere. This situation will ease but high rentals
will remain a reality in highly desirable locations.

Retailers face two separate real estate challenges in India. The first is securing
retail space in India’s top-10 cities, where competition is high and focused
on a limited number of sites; rents here have already reached international
benchmarks. The second is in finding a viable business model for the remaining
200 cities (of the total 5,400 cities or towns), where land is available at low
rents but sales density is even lower.

Real estate players in turn face two retail challenges. The first is stabilising
rentals which tend to be riskier than in commercial development, depending
on location in the mall and success with shoppers. Secondly, successful malls
add a lot of value to surrounding real estate whether retail, commercial or
residential, creating the need to find successful “anchor” tenants that can help
drive footfalls and monetise the remaining real estate. While this effect is not
unique to India, the quantum of it is.
 45

Integrating real estate into the retail business model therefore creates huge
value in either business.

Securing space in the top 10 cities

Demand for retail space is high in India’s top-10 cities, which are currently the
focus of retail development. Unfortunately, restrictive land-use regulation, a lack
of effective city planning, and high demand for other forms of real estate (such
as commercial office space) have led to limited supply of retail space in many
of these cities. This combination of high demand and low supply has raised
rents both in absolute terms and as a percentage of costs and they are now
comparable to the world’s highest (Exhibit 3.1).

Exhibit 3.1
RENTALS ARE VERY HIGH – IN ABSOLUTE TERMS AND AS A
PERCENTAGE OF SALES
High street locations
in top cities Absolute retail lease rentals Rent as per cent of sales (for top cities)
Rs per sq.ft. per month; 2007 Per cent Indian retailer
International retailer
Tokyo (Ginza) 2,344
Hong Kong
(Causeway Bay) 2,188
5-10
New York** 1,500
Hypermarkets
Singapore
945
(Orchard Road)
1-5
Taipei
748
(Zhongxiao Road)
Shanghai
(Nanjing Road West) 739

Beijing
626
(Wangfujing) 15-30
Jakarta
277
(CBD) Specialty retailer
Bangkok
(Pratumwan) 244 10-12
Manila
63
(Makati CBD) Delhi*
1,200
* Khan Market, Delhi
** SOHO-Upper Westside

Source:Real estate expert interviews, Cushman & Wakefield; LoopNet, CB Richard Ellis Asian Retail Property Review (2006)

From the point of view of the developer, real estate parcels are small in these
dense cities, leaving little room for monetisation through a strong retail offering.
The ability to charge rentals varies drastically by floor and store location. Lastly,
malls take time to mature and even then risk being upstaged by the newest
mall on the block. Hence mall development is seen as riskier as compared
to commercial office and residential space, which translates into higher
expectations of retail rentals than of commercial and residential development.
Retailers hence end up paying high rentals which may not be sustainable as
46

Exhibit 3.2
RETAILERS MAY FIND IT DIFFICULT TO SUSTAIN HIGH RENTALS
Typical hypermarket economics in Mumbai (50,000 sq.ft. store)1 ILLUSTRATIVE
Scenarios
Illustrative metrics 2007 2015 conservative 2015 best-case

Footfalls (customers per day) 5,000 5,6002 8,0003

Basket size (Rs./customer/visit) 700 900 1,200

Sales (Rs. crore) 50 754 1604

Sales density (Rs./sq.ft./year) 10,000 15,000 28,000

Rent (Rs./sq.ft./month) 100 1505 1505

Rent as per cent of sales (per cent) 12 12 6

1 All figures are rounded

2 In line with population growth @1.5% per year High values will
3 In line with increase in addressable market be difficult to
4 Assuming group sizes of 2-5
5 Annual rental increase of 5% per year as in typical contracts sustain
Source: Real estate and retail expert interviews; McKinsey analysis

illustrated in our projections for a Mumbai-based hypermarket (Exhibit 3.2).

Actual cases could differ from this illustration of store economics.

Compounding this problem is the uneven quality of mall space available. Malls
in India have suffered from a lack of clear positioning, and from unplanned
tenant-mix and adjacencies. Variable design and low-quality construction have
further reduced their attractiveness. Since builders, not real estate developers,
have constructed most malls, mall management has often been haphazard, with
builders selling parts of the mall early or handing over its management to a third
party. These problems should ease over time as Indian developers learn from
their mistakes and as malls are managed better.

Retailers in India suffer from very high real estate costs, ranging from 5 to 12
per cent of sales compared with 1 to 5 per cent for an international hypermarket
retailer. For a specialist retailer, real estate costs range from an estimated 15
to 30 per cent of sales compared with 10 to 12 per cent for a similar retailer in
other markets. In Delhi’s prime Khan Market area, for example, rentals in 2007
were Rs. 1,200 per square foot per month—not much less than those in New
York’s Soho or Upper West Side areas (Rs. 1,500 per square foot per month).
Rentals in prime locations in these cities will be high in the foreseeable future,
and will prove to be the biggest cost for retailers in the top cities.

Do such high prices pose a structural problem or are they merely a short-term
demand-supply gap? A bit of both, we believe. While India did start off with
a rather peculiar situation of very limited supply, retail space will increase as
 47

the real estate sector becomes more organised and finds resources to drive
growth. There is clear evidence of this in the stock market listings and its
positive impact on real estate players. As a result, a huge build-out is currently
underway, which will rise significantly in the next two to three years. Indeed, the
hectic retail development in the top-10 cities suggests that adequate amounts
of mall space are likely to be available in two to three years. Retailers might face
a new challenge soon: plenty of mall space but uncertainty regarding which mall
to bet on. A large part of this new real estate is in large constructions above
1 million square feet and often concentrated in some parts of the city (e.g., in
the eastern suburbs of Mumbai or the south-west corner of Delhi). While rentals
might ease, clearly not all these planned malls will survive. Nevertheless, real
estate players have shown an ability to modify end-use based on demand and
a glut may not develop.

That said, supply gaps will persist in parts of the top-10 cities, where land
availability remains restricted for reasons mentioned above. Rentals are likely
to remain high and unless real estate is integrated into the business model by
retailers or vice versa, new supply is unlikely to meet the underlying demand,
maintaining the high premiums in these locations.

Finally, in supply-rich suburbs and tier II towns, developing the right format will
be a bigger challenge to making money than finding the space.

Finding a viable rental model outside the top-10 cities

In the remaining 5,400 urban centres (outside the top-10 cities), the challenge
will be making adequate returns given low sales densities. Retail space is
available at competitive rents. But sales density varies from that of a tier I
town. For example, for a hypermarket, retail sales density in a tier II town ranges
between Rs. 6,000 and Rs. 8,000 per square foot compared to Rs. 10,000 and
Rs. 15,000 per square foot in a tier I city such as Mumbai. With other operating
costs only marginally lower, it becomes difficult to make an adequate return
even with lower rents (Exhibit 3.3).

It is a similar situation in China: approaches to real estate (and economics)

vary significantly between the denser and more expensive tier I cities and the
emerging tier II and III cities. In the smaller cities, land is cheaper (and so is
labour usually), and so fixed operating costs are typically 30 per cent lower than
those in tier I cities. However, lower density and sometimes lower incomes also
mean that average sales productivity is lower by 45 per cent. There are other
differences in frequency of purchase and width of consumption baskets, all
of which have implications for the width and depth of range needed. In short,
format economics differ vastly between big cities and smaller towns in China.
48

Exhibit 3.3
IN TIER II CITIES AND BEYOND, RETURNS ARE LIMITED
BY LOWER SALES DENSITY
ESTIMATES
Retail rentals for hypermarkets* Sales density for hypermarkets*
Rs per sq.ft. p.m. Rs per sq.ft. p.a.
80-150 10,000-15,000

-61% -48% • Lower rentals

• Lower sales
30-60 density
6,000-8,000 • New format
needed to make
money

Mumbai Tier II Mumbai Tier II

* For prime locations as anchor tenants

Source: Real estate expert interviews; literature search

The same will be true for retailers in India. We believe retailers will need to think
of a portfolio of formats early on, as different clusters of catchments emerge.
And they will need to innovate to make profits. An example is a retailer that
uses air-coolers instead of air-conditioners in one of its tier III city stores to
keep costs down. Stores in smaller cities may need to offer more categories to
sustain profits while they wait for the customer base to grow. Further, real estate
will be one of the key factors defining clusters, leading to different format sizes,
tailored product ranges and varying merchandise density.

Integrating real estate into the business model

Having recognised the importance of retail space in India, retailers with big
ambitions are integrating real estate into the business model (Exhibit 3.4).
Clearly, at this phase of retail evolution, real estate is a competitive, strategic
asset and the right “land grab” is critical, especially for the more attractive sites
in the top-10 cities. Our analysis suggests that most consumption in India is
concentrated in the top-200 cities and, within them, in an estimated 500 to 600
catchments (based on city maps, income profiles, competitive intensity, and a
few other factors). Winners will need to build a presence in these catchments
at the right cost.

Real estate having been scarce up to now, several retailers have actively shaped
the supply of real estate by setting up their own real estate funds, participating in
 49

Exhibit 3.4
RETAILERS ARE VERTICALLY INTEGRATING INTO REAL ESTATE
AND VICE VERSA
Top Top
retailers Real estate presence developers Retail presence

• Real estate funds

ü • Tie ups with developers ü • Plans to enter into
retail soon
• Planning US$1 bn real estate
ü fund
• Plans to tie-up with real estate ü • Purchased Piramyd chain of
department stores
players • Announced aggressive plans

ü • Owned by real estate to build Ansal

developer ü • Plans
Highway Plaza and
Budget shopping
ü • Real estate Venture Capital
fund
destinations

• Buying out several

Shoppers
•
hypermarket properties
Partnership with developers
ü • Owns
Stop Limited

û • None Haico Supermarket

ü • Owns
and Loft (footwear shop)
• None
û Both retailers and real estate players are
realising the strategic importance of real
estate in retail
Source: Literature search; Interviews

land auctions and building partnerships with developers. These innovations are
necessitated by the capital requirements of real estate and retail respectively.
Top real estate developers, in their turn, have entered retail or are planning to do
so. If there is a substantial increase in the availability of real estate, the need to
integrate vertically might ease, but it may still prove critical for creating capacity
in the right catchments. Hence, we expect big retailers to continue to play a
significant role in real estate.

With the real estate strategy determined, the next big task will be creating an
effective supply chain, building afresh and filling in the gaps in India’s creaky
system.

CREATING AN EFFECTIVE AND SCALABLE SUPPLY CHAIN

Supply chain and sourcing systems have always been the two big advantages
of organised retail worldwide. They have helped retailers leverage scale, better
understand what shoppers want, and offer tailored ranges and more attractive
prices over time. This is likely to be true in India as well.

Indeed, getting supply and sourcing right might be even more critical in the next
couple of years as we believe retailers will be under significant price pressure.
50

Our recent work in several food categories (including grains, dairy, poultry, and
some categories of packaged goods) suggests that in several food categories
there is likely to be upward pressure on price, due to much faster growing
demand than supply. This will be a secular trend across all types of retailing,
and not just restricted to organised retail. Similarly, in non-food categories (such
as apparel, home and general merchandise), there is likely to be downward
pressure on prices as current prices are perhaps higher than incomes or current
demand for quality can support. With prices likely to be under pressure, a lot of
the focus will be on getting sourcing costs right.

Building an efficient supply eco-system in India where almost none exists today
can be an important source of differentiation for retailers as it goes beyond
managing costs. Given the small and limited vendor base, the real issues retailers
will face are securing supply given limited vendor depth in most categories as
well as creating an eco-system of capabilities and capital to grow this vendor
base.

Hence retailers must prepare for two different tasks:

n Tailor the existing supply chain to ensure the right stock reaches the right
shelf at the right time at a low cost

n Build a supplier base to secure future supply and create a differentiated

range of goods (including private labels in certain categories).

Getting the right stock to the right shelf at the right time at a low cost
An efficient supply chain can significantly boost margins, potentially creating
incremental margins of 8 to 10 per cent in packaged foods, fast-moving
consumer goods and electronics (Exhibit 3.5).

The challenge in India, however, goes far beyond getting the right margin structure.
The traditional Indian supply chain, created largely by packaged goods players,
was different from today’s but was effective in meeting the needs of players then.
It had small suppliers and several intermediaries, there were multiple handoffs,
and logistics required detailed planning and much outsourcing. Yet, stocks were
delivered at reasonable costs across the country. Indeed, we have seen several
companies (especially packaged goods firms) convert this into a competitive
advantage by creating a closed eco-system of suppliers that scaled up with the
company and produced to specifications, with an elaborate but effective supply
chain consisting of third-party distributors and logistics suppliers.
 51

Exhibit 3.5
AN EFFICIENT SUPPLY CHAIN CAN BOOST MARGINS
FOOD EXAMPLE
Base case Incremental
margins margins Some sources of additional value
Per cent Per cent
~20 5-8 • Direct sourcing from wholesale markets
Fresh fruits and • Better demand-supply matching
vegetables • Increasing yields

10-12 6 • Build own distribution centres

Meat and poultry

12-15 6-8 • Build own distribution centres

Milk and dairy
products

10-15 5-8 • Direct sourcing from wholesale markets,

Staples mills processing
• Process in-house

12-15 8-10 • Centralised negotiations

Packaged foods, • Build own distribution centres
FMCG • Contract manufacturing
Source: McKinsey analysis; interviews; Mandi visits

But this supply eco-system does not work for retailers today. It has too many
hand-offs and too little end-to-end information flow to meet the critical metrics
that retailers look for: fill-rates of stock keeping units (SKUs) on store shelves,
automatic re-order of core SKUs, assortments tailored to individual stores and,
most importantly, control of inventory levels at various points in the supply chain.

To build an efficient supply chain, retailers will need to consider differentiated

sourcing strategies, design optimal logistics links for each part of their network,
and strengthen inventory management.

n Consider differentiated sourcing strategies. Retailers with scale need

no longer buy everything from distributors and intermediaries. They have
several alternatives, from (more) direct sourcing to consignment to in-
store cut-ins (demarcated concession area given to a third party). In fresh
foods, for example, retailers in Mumbai can buy staples such as onions
and tomatoes wholesale from markets outside the city, saving losses
from additional handling and transport. This is especially critical for higher
value fresh foods (such as lettuce), where losses can be much higher and
production is more concentrated. Some retailers are even buying directly
from farmers and carrying inventory for the year for more seasonal crops
such as mangoes and apples. Moreover, importing is an emerging option.
52

Exhibit 3.6
Exhibit 3.6

EXTENT OF DIRECT SOURCING IS LINKED TO SCALE TOMATOES

IN A CITY AND CAN YIELD UP TO 8% MORE MARGIN NASHIK TO BOMBAY

Shelf price creates substantial opportunities for removing cost

Per cent, cost build-up of tomatoes at a Mumbai modern retail store
Direct sourcing can
remove up to 8% of price
Stage 1: Sourcing at and maintain margins
Stage 2: Sourcing mandi in destination
at mandi* in source city (Vashi in Mumbai) 100
Stage 3: Direct city (Nashik) can can yield 5-7%
sourcing from yield additional 1- savings
farmers can save 27
2% savings
an additional 1-2% 73

20
53

41 12

Production Packaging**, Nashik Transport, pack- Mumbai mandi Transport, Retail gross
cost transport, mandi price aging, wholesaler price packaging, price
commission, margin, APMC tax wholesaler
APMC tax*** margin

* Mandi is a traditional wholesale market

** Packaging is the amortised cost of plastic crates; 4 uses per crate
*** Tax is levied at the mandi under the Agricultural Produce Market Committee Act
Source: Interviews; field visits; team analysis

In each case, the retailer has to find the right tradeoff between sourcing directly
and the scale of operations. Our work reveals that this is best done in three stages
depending on scale in a city (Exhibit 3.6). A word of caution, however: while
disintermediating saves margins, it requires deep category understanding (in
a market with opaque pricing and shallow supply of quality products). It also
requires investment in active internal teams. Moreover, retailers will need to
take on the risks associated with buying large volumes even when demand
has fallen to ensure continuous support to farmers and/or aggregators.

This is not easy and retailers should think carefully about the timing of
such decisions. There is growing evidence of experiments in this area. A
retailer in south India, for example, sources fresh fruits and vegetables
directly from 400 farmers in Karnataka. Another big retailer procures
apples directly from orchards in Haryana and has invested in a world-class
storage facility there. Yet another retailer has a pilot contract farming
project on 5,000 acres of land in Indore; this retailer plans to supply
seeds and other inputs for crops to be grown in line with its requirements
and will directly source 50 per cent of the fresh produce grown.
This is true in categories beyond food too: whether in fast-moving consumer
goods, electronics or apparel, retailers are exploring ways to reduce total cost
in the system between their stores and their suppliers. Over time, as they
scale up and set up local warehouses and sorting centres, more retailers will
start taking responsibility for stocks a lot earlier in the chain.
 53

Disintermediation: Much ado about nothing

For a long time, there have been debates about whether removing the
three to seven intermediaries in the Indian food chain will solve all of
India’s problems. Clearly it will not. True, some intermediaries make
disproportionate margins. But they also played a critical role in the market
when no one else would invest. The real issue with the Indian food chain
is the information and timing gap between demand and supply. For too
long Indian farmers have grown what they have traditionally done, with few
market signals on what to grow, in what quantity and quality, when and at
what price. In addition, pricing has been opaque and it has remained a
buyers’ market.

Those interested in shaping the Indian food chain need to evolve a more
market-responsive model. This should be one that helps the system
grow what the market pays for, in a manner that it reduces risk for the
farmer. This model is not difficult to craft and will reduce the overall risk
of farming in India by establishing clear links between demand and supply,
quantity, quality, and timing. Then the price to farmers will reflect price to
customers. Indeed, there is evidence that this is possible in India as seen
in sectors such as poultry in south India, dairy in parts of India and certain
vegetables linked to exports.

The key question is who will catalyse it? Retailers will play a role, in pockets
of the country and in certain crops. But we must also recognise that while
they will “complete” the chain for farmers and play a “catalyst” role they
are also in phase 1 of their growth and have a host of other challenges to
manage in parallel.

n Optimise logistics management. Getting stocks into a store in India is a

massive challenge, given poor city roads and complex intra-city transportation
regulations, the high costs of moving goods between states, and inefficient
storage (e.g., small store backrooms owing to expensive real estate). Too
often retailers debate cost of transport. We believe, however, that at this
stage of retail evolution in India, the real value lies in designing an efficient
network and not in optimising the cost of moving goods around.

Our work in India suggests that three things determine network design: the
category sourcing strategy, the type of city/town in which the store is located
and level of inventory needed. This has to reflect the fact that the logistics
54

network varies for different sub-categories. To illustrate, within apparel, men’s

and women’s formals are sourced from around Mumbai and Bangalore while
low-cost kids’ wear can be imported or purchased from near Kolkata and
winter wear from exporters in Ludhiana. Even within a category such as
apparel, there will be several “flow” networks that send “basic” products
directly from the factory to the store while pushing riskier “fashion” items into
high-tech warehouses. Given the speed of growth within this and supporting
sectors, the network design will need to be redrawn each year.

Similarly, the existing infrastructure while labour intensive and low on

technology is also very low on operating costs and operates efficiently at low
volumes even absorbing the inventory carrying cost in many cases. Benefits
to retailers in modernising it depend highly on scale and the characteristics
of product category.

Exhibit 3.7
RETAILER SUPPLY CHAINS WILL BLEND THE TRADITIONAL
WITH THE MODERN
Component of
supply chain Current scenario Selective modernise Adapt to situation

Vendor/ • Fragmented base • Help a few become large • Develop vendor

suppliers management systems to
handle several launched
suppliers and tens of
thousands of SKUs

• Small fleet sizes run • Maintain dedicated • Optimise routes and locals
Transportation by entrepreneur outsourced fleet for last mile but continue using small
drivers • Tie up with emerging large fleets
fleets

• Bare-boned, labour- • Modernise only in select • Operate low cost “godowns”

Warehousing intensive warehouses cases (e.g., apparel central but optimise picking and
• No palletisation warehouse) storage through world class
• Palletise selectively IT

• Stocks “pushed” • “Pull” standard items through • “Push” seasonal and

Flow patterns through network auto replenishment systems promotional merchandise
• Flows through several • Move products direct from • Continue using
intermediaries (CF&A, supplier to store (via cross intermediaries but maintain
wholesales, etc.) docking) for certain complete information
categories ownership

Indeed, our recent work in Indian retail suggests that retailers may have
a blended supply chain across all its elements (Exhibit 3.7). Vendors and
intermediaries hold significant cost advantages due to cheaper labour,
lower expectations of return and even tax advantages. There is obviously
no “perfect” system. What is critical is to evolve the internal mechanisms
to maintain complete control of the flow of goods while ensuring the cost-
 55

advantage of the lowest cost natural operator. The trick might be to keep
it tailored and simple: align all the human linkages end-to-end even as the
“system” gets automated and IT-enabled.

n Strengthen inventory management. Retailers in India also need to manage

inventory better, particularly in view of the relatively high stock-outs faced by
customers. It is also true that planning for logistics in India is comparable
to such planning in pre-EU Europe, given the many regions and many rules
involved. Larger FMCG suppliers are increasingly well placed to do this as
they rationalise their distributor network and move to fewer and/or bigger
distribution centres (in step with sales tax regularisation).

The biggest challenge will be inventory management. Even as a lot of working

capital will be supplier-funded, credit periods for food, grocery and FMCG
stands at just 7 to 10 days as against 45 to 60 days internationally, ensuring
that retailers will invest as much in working capital as they will in their stores.
Fixing this will be slow and painful. Indian retailers will need to build a world-
class IT system all the way from point of sale to supplier ordering that will
coexist with an underdeveloped physical supply chain to deliver the right
products to customers at the right time at the lowest cost.

Once retailers have fixed the fundamentals, i.e., created a differentiated sourcing
strategy and a working logistics system with a “system” view of inventory, they
can think of tomorrow, i.e., how to secure future supply and create a winning
range.

Building a supplier base to offer a differentiated range of goods

Retailers in India need to actively support the development of suppliers to secure

supply as they scale and broaden their assortments/range.

n Secure supply. India has few differentiated or specialised vendors across

most key retail categories. Helping to develop vendors will secure supplies as well
as cut costs, while locking in a good vendor base will be a future differentiator.

This approach has been used successfully in several other industries in India.
An auto player faced with a fragmented supplier base followed a three-pronged
strategy. First, it set up alliances with 12 suppliers, called joint ventures or
associates depending on the auto player’s stake in the outfit. Some were
even located in its own manufacturing facility. Second, it developed supplier
56

capabilities by arranging technical collaborations with them, helped suppliers

implement Japanese production systems to raise productivity and cut costs,
and allowed them to gain business by supplying to others firms. Third, it
helped improve supplier operations by holding them to manufacturing and
quality standards and helping them reduce inventory levels by adopting the
Just-In-Time approach.

Similarly, a global electronics player integrated backwards to secure supply of

critical components. The firm set up a new compressor plant in north India for
captive sales and exports to the Middle East and other European countries.
The plant is part of a global strategy: worldwide, the firm has compressor
plants in only two other countries—China and South Korea.

Significant investment may be required in creating a large supply-chain team

(three to four times the size of those in other markets). Cooperating more
actively with third parties on logistics, transportation, labour, and so forth,
may also be needed. This will help improve margins but also reduce the cash
flow at risk, an important metric for retailers.

Importing from other countries such as China will have its own challenges.
Retailers finding their requirements too large for local vendors will also find
themselves sub-scale for global players. They may choose to collaborate in
sourcing with other retailers. Learning to manage this balance will be a key
skill in creating secure supply.

n Broaden range including private label. Range in India is narrow across

categories compared with developed markets. A leading Indian hypermarket
would have 8,000 to 10,000 food SKUs on offer compared to as many as
25,000 at Tesco in the UK. Consumer companies have traditionally focused
on few SKUs due to lower affordability and fragmented retail. In future,
shoppers will increasingly demand a broader range of products (our research
shows they are already doing so in several categories from watches to
apparel to packaged foods to soaps) and retailers will use this as a source
of differentiation.

Range will enable retailers to distinguish themselves through a unique

product assortment, and to attract and retain customers through private
labels, which acquire their own brand status. Range breadth is one of the key
drivers of modern retail. A broader range can also help create the perception
of low price—a key factor of success as we will show in the next section.
Private labels or store brands can also help reduce entry prices and raise
 57

margins: high-volume private-label manufacturing contracts increase retailers’

bargaining power with vendors and attract more shoppers owing to lower
prices. In a recent case, a branded food manufacturer that tried to drop its
retailer margins found that the retailer dropped the brand but maintained sales
in that category by filling up the gap through a broader private-label offering.

Several retailers in India are focusing on private labels in apparel, home

products, cosmetics, fresh foods and appliances. Contrasting India with other
markets reveals a startling fact: India is a highly unbranded market. In most
categories, branded players hold less than 10 per cent of the total market,
compared to 40 to 60 per cent in other markets. Again, this is just a sign
of the early days of organised retail in India. However, in most categories,
brands and organised retail are likely to grow at the same time with the
possible exception of men’s formal wear, consumer electronics and some
FMCG products.

This is a unique phenomenon, suggesting that the big Indian brands of

tomorrow could well be retailer brands. In Brazil, retailer brands are tough
to build as they have to compete with strong established consumer brands
as well as “B brands” developed in the informal sector. This is also true of
Russia, where shoppers do not trust local brands (including retail brands). But
in India, there is an intriguing combination of factors: shoppers like brands
(as they represent quality and often status); they accept new brands easily;
and they do not seem to differentiate between retailer brands and those from
branded companies. Smart retailers will actively develop strong store brands
in India.

Even while retailers fix the backend, they will need to expand consumption at the
frontend. Indian shoppers have for long been subject to a small range of goods
constrained by income on one side and the limited range provided by traditional
retail on the other. With both constraints relaxing, shoppers are experimenting
with new product categories such as pastas, preserves and ready-to-eat foods.
As the primary source of information and availability of these categories, modern
retail will play a definitive role in shaping them.

INCREASING BASKET SIZE BY SHAPING CONSUMPTION

Average basket sizes in India are a fourth of those in developed markets and half
of those in China. While income growth will increase them, greater increases will
come from shoppers “learning” how to use categories they have never bought
before. Hence, a critical requirement for making money in India is to increase
58

average basket size, both by managing overall price perception to induce the
large number of “window shoppers” to make their first purchases, and by actively
increasing consumption, i.e., persuading existing shoppers to buy more.

Managing price perception

Price is an important consideration for shoppers worldwide. In over 15 countries
where McKinsey has conducted shopper research, price is the second most
important factor (after location) in choosing a store. In India, price is even more
important at this stage of market evolution, where modern retail is not found at
the most convenient locations. Our research reveals that most shoppers believe
organised retail to be more expensive than traditional retail (at least until they
become regular customers). Unless told otherwise, shoppers believe that an
improved shopping experience (e.g., big stores, air conditioning, high quality
interiors, a doorman and security) means higher prices. As a result, retailers
need to especially focus on reassuring consumers about prices.

Offering low prices, however, does not by itself create a low-price perception
among shoppers. Our research showed in one case that, although a hypermarket
was offering prices considerably lower than those of its competitors, shoppers
perceived that all retailers were offering the same prices (Exhibit 3.8). Despite
having become the cheapest player in the market, this retailer was not benefitting
from its investment.

Exhibit 3.8
LOW PRICES ALONE ARE NOT SUFFICIENT TO CREATE
LOW PRICE PERCEPTION DISGUISED
EXAMPLE
Real price position compared to consumer price perception
Hypermarket real price position is . . . but consumers perceive that all
5.5-7% below that of key competitors . . . retailers have similar prices
Price position compared to average Consumer price perception
hypermarket basket* compared to average hypermarket

• Retailer A is
the cheapest
Retailer A -5.0% Retailer A 0.0% player in the
market, but is
not getting
credit for its
Retailer B +1.8% Retailer B 0.0%
Key investment
compe- • Retailer D is
titors cheaper by
Retailer C +0.5% Retailer C 0.0%
2-3% but is
perceived to be
2-3% more
Retailer D -2.3% Retailer D +2-3% expensive

Average
Average
hypermarket
hypermarket
price
price position
perception
* Includes promotions – price position is the effective price that consumers pay
Source: Market research and price checks in Latin America (2004)
 59

So how can retailers build the right price perception? Our work across the globe
suggests that most retailers signal pricing in five ways (Exhibit 3.9):

Exhibit 3.9
FIVE LEVERS INFLUENCE PRICE PERCEPTION
AND INCREASE FOOTFALLS

• Offer Key value items (KVI)

• Offer Every Day Low Prices (EDLP) or high-low prices

1
Reference
price
strategy
5 2

• Introduce customer Loyalty Range • Leverage private

lifecycle programs architecture labels
management • Attract through
opening price points

4 3
• Conduct catchment- Promotion/ Price • Align in-store
specific promotion marketing communi- environment with price
cation offering

Source: McKinsey ‘Getting Credit for Value’ Framework

1. Reference price strategy: Creating the right reference prices on key value
items. Like shoppers elsewhere, Indian shoppers remember prices of key
value items (KVIs). But how can one have KVIs in a largely unbranded,
commoditised market? We found that shoppers have their own ways. For high-
involvement categories such as electronics or jewellery, shoppers benchmark
what they consider “plain vanilla” products. In electronics they note the price
of the no-frills products in the “company” showroom, while for jewellery they
consider the price of gold per gram and the charges for making a simple gold
chain in the most trustworthy store in the city. For packaged foods, usually
under the maximum retail price (MRP) regime, it is a lot easier to compare
prices. Surprisingly, shoppers’ list of packaged goods includes more of the
basic products (on which they spend a lot of money) such as rice, oil and
sugar, and not just the largest brand of soap or coffee.

The lack of reference pricing across a broad range of products coupled

with the lack of trust described earlier may make it difficult for a player to
deliver the lowest price proposition across all categories. It is reasonable to
assume that similar to other BRIC markets, an “Every Day Low Price” (EDLP)
proposition will be difficult to deliver.
60

Hence, in India we find that a few KVIs such as the leading brand of sunflower
oil or butter disproportionately affect store perception. What is critical to
remember though is that, while the number of KVIs per customer is few, KVIs
can vary by age, income, education, geography and state of origin. Retailers
need to understand their catchments to know their customers’ KVIs and
price these locally. For one electronics retailer, getting the KVIs right required
understanding what the most important products were for the biggest
community in that cluster, ensuring daily price benchmarking against each of
the stores nearby, and then changing the way the KVIs and the fixtures were
displayed in the store design.

It is also critical to price KVIs right through store incentives and management.
While the guidelines for store management can be set by the central team,
execution and benchmarking often rest with the store staff. Our recent work
in helping retailers in India develop this capability suggests that it is best
to offer the right incentives to buyers and store staff. Even with well done
analysis, setting incentives is such a detailed and frequent exercise that,
unless the store staff and shoppers are aligned with the approach, prices and
promotions may be driven more by suppliers than by the store.

2. Range architecture: Carefully designing the range available. Range is

a critical element of signalling price perception. While it includes several
measures such as the width and depth of each category, perhaps the most
important one is the Opening Price Point (OPP) often used by shoppers to
assess prices. Not getting the OPP right will hurt retailers. A retailer in India
that discontinued the entry price points in four key segments found it lost
almost 30 per cent of sales by value in those categories, almost thrice the
actual sales at those price points. Shoppers simply assumed the whole range
had become more expensive and walked away.

We have learnt that the key is to first have a competitive OPP in categories
retailers want to dominate, and then create a compelling range with tangible
benefits to upgrade. The trick here is not just in merchandising (i.e., building
the range ladder) but in equipping the front-end team with the skills to convince
shoppers to upgrade. Our work in building front-line capabilities suggests that
three things are needed: the right mindset (“I generate profits for my store”, as
opposed to, “This is just a job for six months before I move on”); triggers (easy
ways for the staff to know what to cross sell, e.g., we often mark shelves holding
high and low profitability SKUs with different coloured dots); and incentives
(e.g., competition among staff over who sold most and linked bonuses).
 61

Exhibit 3.10
THE FREQUENCY/NEEDS MATRIX HELPS DETERMINE
PRIVATE LABEL PLAY FOR DIFFERENT CATEGORIES
Category role is based on position in frequent/ . . . resulting in different private label
needs matrix . . . plays for each

• Carbonated • Honey
Impulses/

drinks • Sweets, candies

“wants”

• Cheese • Pickles
• Breakfast cereals
• Tea Range Widest range to
innovation maintain parity
Item nature

to facilitate with
impulse competition
• Butter • Aluminium foil
• Sugar • Toilet tissue
“needs”
Basics/

• Rice, wheat • Rava, suji

• Meat and poultry
• Milk
Aggressive Communicate
prices quality and
Frequent Occasional maintain
discounted
Purchase frequency pricing

Source: McKinsey

Retailers in India (and China) also use private brands and labels to establish
a good price proposition in key categories. The role of private labels in each
category depends on the nature of the item and frequency of purchase (Exhibit
3.10).

3. Price communication: Communicating price through in-store environment,

e.g., signage, point of sale displays, fixtures, stocking levels. Our work in
emerging markets suggests that in-store environment is often the first source
of price communication. Notably, it is not necessarily the location of stores
or even the fixtures inside that matter. What matters is the smaller details: a
simple or “grand” entrance; the language spoken by staff (English or a local
language); signage: hand-drawn and colourful, or printed and formal; widely or
narrowly spaced aisles; and welcoming or aloof staff.

One store in Mumbai struggles with a high price perception (even though
its prices are lower than those of the competition nearby) because it has
expensive-looking granite at the entrance, two majestic-looking doormen, the
signs are in English only, and the music played is Western pop (and even jazz).
As a result, some shoppers say, “Not for me!”

Another store in Bangalore changed its price perception literally overnight by

placing large hand-drawn posters showing the price of rice on its glass walls.
In China we have seen retailers create the right price perception through several
62

in-store features: a global retailer created a “wet” floor (literally with water on the
ground) in the seafood and fresh section while another ensured a long queue
in front of its key counters to suggest “a good bargain.” Similarly, in Brazil, large
retailers often have open doors, warehouse-type fittings and no air-conditioning
to signal attractive pricing, even for formats created by global players.

4. Promotions and marketing: Offering high-impact promotions and marketing

focused on price (without unnecessary discounting). Promotions are a tricky
lever to use with shoppers. Done occasionally and for specific reasons (driving
footfalls, creating a “special” sale where you sell a hundredfold more than
usual), they work. But done too often, they can create more confusion, and
more importantly, convert sensible shoppers into bargain hunters. In Latin
America, our research showed that, 30 per cent of shoppers were bargain
hunters in City A while twice as many were bargain hunters in City B. Retailers
in City B had got into a vicious cycle of promotions. As a result, shoppers had
been “taught” to hunt for bargains—and they did.

This is also true in developed retail markets. Some of our recent work on
“value shoppers” across eight European retail markets showed that retailers
get the consumers they create: those that offer too many promotions get
bargain hunters—not necessarily the most profitable or loyal customers nor
those that one can up-sell or cross-sell to. Indeed, a big retailer was quite
astonished to see that it had twice as many “bargain hunters” (80 per cent of
its customers were a combination of “avid bargain hunters” and “high income
bargain hunters”), while its closest competitor had a much higher share of
the more attractive “quality seekers” and “time savers”.

Using promotion as a tool to drive price perception will become imperative as

the market matures and different segments emerge. It is critical that retailers
in India do not foster adverse behaviour in their customers by indulging in
price wars too early. As in other sectors in India, it is critical that the price card
is used when the market is more mature lest a market of bargain hunters is
created. This is already visible in the low-fashion men’s formal apparel (where
an estimated 40 per cent of annual business now occurs at so-called “end
season sales”).

5. Loyalty programmes: Building loyalty offers and CLM programmes. India

is still a relatively small market, albeit one with fast-growing wallets. In the
large retail markets, especially in the top-10 cities, competition is likely to be
intense in the next few years. Smart retailers will build loyal customers, both
 63

to get their repeat business month after month and to continue attracting a
share of their growing incomes.

Owning core customers is very valuable in a growing market such as India.

During our research, every successful store manager talked repeatedly about
the 60 per cent principle: they each had a few core customers who accounted
for 60 per cent of their business. The best store managers knew these
customers by name and, in one instance, the store manager would even call
customers if he needed to meet his monthly target or make an extra sale.
Similarly, another national retailer gets 40 per cent of its sales in north India
in a period of five weeks in winter, and 60 per cent of this from a bunch of
core customers who come back every week to check on new stocks for the
wedding/party season.

Doing this will require a Customer Lifecycle Management (CLM) approach

and not a loyalty programme mindset. Too often retailers we talk to, plan to
launch a card and award customers points. There are too many of these cards
today; since every retailer offers them, shoppers have wallets full of them.
(Incidentally, retailers usually lose an additional 1.5 to 3.0 per cent margin
in the process). Instead, retailers need to better understand customers and
create a win-win retention programme.

Drawing on our work in the telecommunications sector, we have created a

CLM approach that helps retailers develop literally thousands of offers for
shoppers based on actual consumption and not predicted bundles. This
should not affect margins as the targeting of the offers ensures that they are
given only to those who value them most. This also helps customers graduate
as they pass through various stages in their “lifecycle”. In the long term, we
believe this will be the true source of differentiation for retailers as it will help
them understand the needs of their shoppers and hence offer them better
range and services.

The question is in what combination will these five pricing mechanisms work
best? Our research across five Latin American countries in 2004 revealed that
just two—reference price with KVIs and range architecture—account for as much
as 75 per cent of shoppers’ price perceptions. However, this is not true of China.
Given the early stage of evolution of organised retail there, in-store environment
matters as much as reference price and range architecture. We believe this
holds true for India as well (as we will soon test through new research on price
perception to be released later this year).
64

Ensuring the right price perceptions will generate footfalls and sales. In addition,
retailers will need to increase consumption to maximise sales per square foot.

Actively increasing consumption

In more developed markets, organised retailers arrived after the brand players
had established themselves and expanding consumption was left to brands.
But in emerging markets we have seen retailers play this role actively as they
cannot wait for consumption to grow. They also recognise that shoppers today
have many other choices such as mobile phones, entertainment, and travel. And
in markets with small wallets, retailers need to fight for each dollar.

Retailers can shape consumption in four ways:

n Creating new shopping occasions. Retailers can create occasions for existing
categories and introduce new categories, working with product makers or
alone. Specialist retailers have done this in the last decade. An apparel retailer
created and promoted “Friday dressing” to get urban professionals to build
a new wardrobe. Jewellery retailers revived an ancient (and largely unknown)
gold-buying occasion, Akshay Tritiya, which in its third retail-promoted year
emerged as the highest sales day in the year for several jewellers. Retailers
selling sunglasses tried to attract the young with their “How many you have?”
slogan. Similarly, in grocery, we have seen the largest Indian retailer take
the lead in creating huge shopping occasions on 15 August and 26 January,
when an estimated 10 million shoppers throng hypermarkets, often waiting
in queues for over four hours. Equally well known is the 1 January celebration
of a large South Indian electronics retail store. Seasonal calendars in Brazil
now contain all kinds of events such as Mother’s Day and Boyfriend’s Day.
All this attracts footfalls from regular shoppers more often, or introduces the
shoppers of tomorrow to organised retail.

Other options that have worked include ensuring convenience for occasional
shoppers, primarily by locating stores close to a mass transit point such as a
bus stop or train station. One of the most active retailers in Chennai locates
its stores in this manner and specialises in “big spending” occasions such
as weddings or religious ceremonies or back-to-school days. Creating such
occasions has implications for range and assortment as well as for smart
inventory planning.

n Increasing purchases per occasion. Retailers can induce larger purchases:

bulk buys through “amazing offers” or bulk discounts, difficult-to-refuse offers
 65

in impulse categories and product bundles. These are traditional approaches

of retailers across the world, which appear to work in India too, and will be
investigated further in our 2008 pricing research. The key thing to remember
is that persistence pays.

n Getting shoppers back to the stores more often. If shoppers walk into a
store, they often buy something. They might want to preview the new range or
to check the offers on sale before everyone else does. Hence, many retailers
across the world now offer perimeter services (located in and around the
store) including payment of bills, purchase of telecom cards, and banking
services to draw shoppers in.

n Financing consumption. Credit is offered in India by small retailers but is

yet to take off in organised retail. It has been a huge driver of growth in
other emerging markets such as Brazil, Mexico and South Africa. Retailers
are the biggest financiers of consumption in apparel, electronics, furniture
and even grocery in these markets. In Sao Paulo, a kitchen towel sells in
five monthly instalments of about Real 0.99 each (i.e., 60 cents). In India,
some asset financing is offered in consumer durables and automobiles
through banking services implanted in stores. The trick of retail financing
is to finance consumption. Over time this would also attract those who are
unable to produce the cash upfront. Our experience with helping retailers
build this capability in Latin America suggests that it requires a new mindset
as well as skills in risk assessment and payment collection. But it is doable
and will be one of the biggest drivers of consumption in India.

Other ideas for fostering consumption include online retailing (along with
store presence), where we have seen a huge surge in China and Brazil. For
a young country such as India, where shoppers are increasingly comfortable
with mobile transactions and online browsing, a combination of “touch and
feel” as well as new ordering and delivery channels could create new points
of ordering (if not consumption).

After all this work to bring in shoppers, retailers also have to ensure a positive
experience for them. Developing and retaining talent will be crucial here.

DEVELOPING AND RETAINING TALENT

Talent costs in India are low. For a successful hypermarket in the top-10 cities
they may be as little as 3 to 4 per cent of sales. However this low cost hides
a critical challenge—one of retention and availability issues in certain skills.
This cost will only increase as the total cost is calculated (including recruiting,
66

Exhibit 3.11
ORGANISED RETAIL MAY REQUIRE AS MANY AS
~1.6 MILLION EMPLOYEES BY 2015
Employee Requirement
Cumulative; number of people required *

1,600,000
Assumptions
• 1 front-end customer
associate per 250-300
sq.ft. internationally –
assumed 250 for India
• Support staff/manager 700,000
requirements in line
with global standards
325,000

100,000

2002 2007 2010 2015

* Excludes employee churn, currently between 10 and 20% per annum

training and retaining). If organised retail grows as expected in India, at least

1.6 million people will be required to fill the positions created by 2015 (Exhibit
3.11). According to international benchmarks, at least one customer associate
is needed for every 250 to 350 square feet of retail space. Finding staff in such
numbers should be possible in India, where 5.2 million students graduate from
high school each year and 2.2 million from college. The main cost for retailers
will lie in equipping these entrants into the workforce with the requisite skills.

Retailers have now recognised this. Established retailers are the natural hunting
ground for staff and retailers often talk about the quick departures of their best
people. This results in a vicious cycle. Retailers often under-invest in training their
employees and often hire “over-educated” graduates for stocking and cashier
roles meant for medium or high school-educated candidates to compensate for
this lack of training. Graduate employees in turn are not skilled to their potential
leaving vacancies in higher skilled sales roles. In addition, there is a growing
shortage of specialist skills: store managers, visual merchandisers, category
managers and those with other retail-related skills such as air-conditioning
contractors and store and warehouse designers. The industry should act
together to bridge this gap.

For now, retailers are tackling these challenges individually. To attract talent,
many are tying up with retail institutes and management schools. To train their
staff, some are developing curricula in collaboration with institutes such as
 67

the National Institute of Fashion Technology (NIFT), while others have acquired
training institutes such as NIS.

These steps and those described earlier in the chapter are direct actions retailers
can take to make their retail offerings competitive and encourage retail growth.
The latter will also require working with the government to shape regulation in
ways beneficial to consumers, the economy and the industry.

INFLUENCING REGULATION TO ENSURE HEALTHY DEVELOPMENT

OF THE SECTOR

Retail is a thin-margin business and so the room for error is equally low. A lot
of value creation at this stage of growth hinges on an effective eco-system for
the sector. As in every other sector in India, regulation holds the key to a lot of
value. In the case of retail, the lack of regulation in several areas associated
with unstable evolution of the sector increases business risk—a thin-margin
business like retail needs fewer risks than the current Indian environment
poses. It is important for retailers to help reform regulation through effective
conversations with the regulators and the government.

First of all, organised retail needs to be made into a sector that India celebrates
and not fears or curtails. This will require the industry to obtain the support
of all stakeholders and get the country to recognise the potential benefits for
India’s shoppers but also for the economy, mainly in creating high quality jobs
(as highlighted in the Introduction to this report).

Second, risks for retailers must be reduced in order to invite the right level and
quality of investment. There are several lacunae in the current regulations—indeed
what is left unsaid is of more interest than what is regulated. For example:

n A lack of zoning and redevelopment laws hinders land acquisition and pushes
up rentals. Indian cities have no zoning laws, making real estate acquisition a
risky affair. Redevelopment laws restrict the use of residential land for retail.
Further, since retail is not classified as an essential service, land is not
earmarked for retail sites in town planning. Most city development authorities
in India equate retail and commercial space, even while redrawing cities and
planning new townships, not giving retail importance as an essential service.
In China, a large part of retail growth has taken place in the new cities,
special economic zones and suburban townships where some parts of each
block are earmarked for high streets and retail in much the same way as
Indian authorities earmark sites for petrol pumps.
68

n Restrictions on foreign direct investment limit the opportunities for

international retailers to develop the retail sector. As of now, only single-
brand foreign retailers such as Benetton or Tommy Hilfiger are allowed to
set up shop in India. Multi-brand retailers can enter only through wholesale
models, i.e., selling to businesses not consumers. The uncertainty about
the opening up of this sector is keeping away expertise in merchandising,
sourcing, store management and other areas. Other countries have adopted
varied approaches to FDI—from banning it to restricting the quantum of
investment/scale to linking it with certain conditions (e.g., local sourcing,
export commitments).

n High tax burdens and excise duty, state taxes, service taxes on rentals and
octroi fees inflate retail prices. India has recently moved to a value-added tax
system; this has not yet been uniformly applied across all states but is likely
to be rolled out by 2010.

n Discriminatory power rates for retailers inflate costs; power is the third
highest operating cost per head for retailers (after real estate and people).

Clearly, working with the government at the state and national level to rationalise
regulation is key to getting the full pay-off from investing in organised retail in
India. Lessons from other sectors that have managed and shaped regulations
(such as telecom and IT) suggest that this is possible but will require a joint
effort by everyone in the industry. Perhaps the time has come for retail industry
forums to craft their regulatory agenda.

Meanwhile, some retailers in India are making money already. Others can too by
creating a sustainable, scalable profitable business by tailoring formats to local
shoppers and costs; driving growth in basket size; and building a supply chain
with the right talent, supply depth and costs. Doing this will require thoughtful
individual choices as well as collaboration at the industry level.
4. A Call to Action: Emerging Priorities
for Retailers and the Industry 71
In the first three chapters of this report, we have argued that organised retail in
India is set for rapid growth, offering a lucrative growth opportunity for domestic
and international players. To capture this opportunity, retailers need to do two
things: one, understand and shape the unique characteristics of the emerging
Indian shopper; and two, create locally tailored business models (and formats)
that can generate long-term profitability. They will also need to create an enabling
eco-system for this sector, working with suppliers, government and most criti-
cally, with each other.

In doing so retailers should take note of four emerging imperatives for India and
focus on building the capabilities to address them.

EMERGING IMPERATIVES FOR RETAILERS

This is an exciting time to enter retail in India. Most Indian players are building
positions and have been doing so for the last few years. Global retailers are
equally interested and pause only for one of two reasons: because the regulatory
requirements do not appeal to them or because they do not have the capacity
(usually senior management strength) to explore several emerging markets in
parallel. Most of them are in China and Russia or part of the Eastern European
complex, which offer more ‘familiar’ and ‘immediate’ opportunities, albeit small-
er in the long term than India. But nevertheless, all big retailers with high growth
aspirations will enter India one day.

The key thing to note is that this phase of establishing wide presence will soon
give way to the next increasingly competitive ‘exploratory’ phase (as is already
visible in some cities). The critical factors of success till now have been acquiring
locations and getting stores up and ready to acquire shoppers. Soon, this will no
longer be sufficient. In the next phase, the skills to retain shoppers (and grow
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consumption) as well as tailor the offering will be essential and this is already
being recognised. It is also critical to note that the value of the retail brand is
likely to be the highest at the switch from phase 1 to phase 2 of market evolu-
tion, a key consideration for those driven by valuations.)

What will winning retailers do in India? We believe they would be wise to keep
four ‘mantras’ in mind as they explore this high-potential market:

n Develop innovative formats for material differentiation. Three decisions will

be critical—where to participate in the retail value chain; which geographies
to play in and what price points to offer. The biggest challenge for most
retailers will be to develop the right mix of formats that will win with Indian
shoppers even as they make money for the retailers. This will require a sharp
understanding of the core customer as well as clarity on how each store will
make money.

In the absence of a vibrant eco-system, retailers with big dreams should

determine in which parts of the retail value chain they want to participate.
Innovation will require finding sustainable sources of value and capturing
value through strategic participation in the end-to-end value chain. At the very
least, most retailers will need to develop a supplier network and craft a viable
logistics network. In several cases, we expect retailers to actively shape
(if not participate in) real estate. The most aggressive will include financial
services in the retail offering as well as retail of services (with partners in
most cases). The relative value of participating in different elements of the
value chain will evolve over time. Innovation and flexibility will be key to
ensuring the model continues to stay relevant in India.

A second critical choice will be in which geographies to compete. Scale

matters in India; being subscale in the future could mean certain death.
Nevertheless, building a national footprint is not mandatory for retailers in
India. Indeed, we believe there is tremendous value in ‘dominating’ a small
number of geographies (whether regions or even cities or even types of towns),
a strategy followed in other geographically dispersed markets such as Brazil
and China. The choice will also depend on which categories retailers operate
in and the (mix of) formats they offer.

Finally, a critical choice for any retailer will be price points. While this
might appear an operational choice in most markets, any retailer with big
aspirations must debate its pricing. Critical to note is that this debate is
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not just about the actual price but also about price perception. That will
dictate several elements of the retailer business model: from the location
(mall to high street to inner street) to format design to opening price point
and deportment of front-end staff.

These choices should help winning retailers craft an innovative (and evolving)
portfolio of formats that position them distinctively. It is interesting to see
the evolution of formats in India – the starting point (i.e., multi-brand, multi-
format) is very different from that in most other markets. And retailers are
already working at addressing the complexity this demands: tailoring formats
to clusters; tailoring merchandise for each format; experimenting with margin
models and becoming comfortable with modifications (when formats do not
work or when shoppers evolve). Again, learning and flexibility will be key.

n Craft a customer-insight-driven merchandise strategy to stimulate

consumption and lock in core customers. To sell what is more profitable
and create the right mix of categories, retailers will need to shape shopper
behaviour. This will require gaining customer insight, activities similar to
those of ‘brand’ companies in the West but with a much higher focus on
catchment activation and lower cost, targeted activities. It will involve
creating shopping occasions, continuously offering a differentiated range and
exciting price points (to stimulate trial) and offering price ladders (to upgrade
shoppers). Moreover these strategies will need to be tailored for tier I, II and
III cities, to localise the offer and to help shoppers make the right trade-off
across categories. In addition, activating local markets will be essential:
understanding local community and catchment flows, recognising the local
religious and cultural calendars and creating an ‘empowered community-
inside’ team to execute low-cost events, a few times a month.

Winning retailers will also use customer insight to lock in core customers in
a market that is still growing in size and depth of consumption. They will invite
core customers to shop more often and with increasing basket sizes through a
range of efforts: special offers tailored to customers needs; intimacy through
recognising and rewarding them; and most importantly evolving their offers
as shoppers change. This will require skills at the store: retaining front-end
staff; data mining and using these insights to learn what to keep and what to
change at the store. This will also require that retailers learn specific skills:
range definition, clustering of stores, planning and allocation of merchandise
and finally reducing merchandise risk.
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n Create an efficient end–to-end retail operating platform consisting of a

self-sufficient eco-system of suppliers, logistics providers and even loyal
shoppers. Winners will also create and manage the profitability of the whole
chain from suppliers to shoppers. As retailers worldwide do, they will make
their money from buying low and selling higher while managing efficient stores
and maximising asset turns. But in India, for some time to come, they will
also have to shape the cost structure of their suppliers, logistics providers
and eventually their shoppers. To do this, retailers will need a much larger
(and more skilled) back-end team that creates this eco-system and manages
it proactively (as described in chapter 3). Many retailers have not planned
for the talent and commitment required to create this essential driver of
sustainable profitability.

n Create a thinking, evolving organisation, especially an empowered front-

end selling team. As mentioned above, owning core customers will be key,
both in terms of involving them to try out new categories and SKUs, and
understanding them to create opportunities for bringing them back into
stores. The front-end teams will be pivotal in this.

Perhaps the greatest challenge for retailers will thus be to create an

organisation that is comfortable with a focus on profitability but with inbuilt
learning and flexibility. The role of the store manager is critical in any retail
business across the world. In India, given the early stage of evolution and
lack of ‘stable, predictable’ catchments or store clusters, this and a few
other roles will be critical. For example, the local regional manager will be
pivotal in deriving lessons from the market as it is at this level that insights
on what is and is not working with shoppers will be codified. Similarly, the
merchandise managers will struggle with shaping a winning assortment and
will need to learn for each frontier of retail, whether new tiers of towns or new
communities. The big challenge for retailers is likely to be retaining these
skills and building the organisation’s ability to learn from its early days. This
will require a targeted effort to create the right mindset for its leaders and
the kind of ‘ownership’ created among the first set of employees as well as
the behaviours that are rewarded (and not rewarded). Equally important,
retailers will need to acknowledge that a lot of things will not work at this
stage of growth and make the organisation comfortable with learning from
experiments that do not turn out as expected.

Whatever the choices, India’s retail sector will develop in a way beneficial to all if
the industry and government work to a common vision rather than let the current
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haphazard development continue. For this to happen, retailers will need to help
create the right environment for the sector as a whole.
A VISION FOR THE SECTOR AND A CATALYST OF CHANGE

In addition to the specific challenges for each retailer, a lot of value (and
considerable risk) is associated with the overall evolution of the retail sector in
India. The industry and the government can provide that direction by deciding
together a vision for the sector’s development and then setting a common
agenda to realise that vision.

To start with, regulations will need to change to encourage investment where

it is most needed and create a level playing field for all. We believe this is
the joint responsibility of all retailers, working together to guide industry-level
development. Success stories from other sectors underscore the importance of
such an effort at this stage of a sector’s evolution. NASSCOM’s effort for the IT
and BPO industries is a case in point (Exhibit). Five key factors in NASSCOM’s
success suggest an agenda for retail industry forums:

Exhibit
NASSCOM’S SUCCESS CAN BE ATTRIBUTED TO FIVE KEY FACTORS
Reasons for
success Descriptions

Build a • Software Industry leaders established NASSCOM in 1988 with 30 members. Today the association
committed has 850 members that represent 95% of the industry’s revenues
leadership • Hired a committed, media savvy, full-time professional to head the association
• The executive council meets every 2 months to discuss aspirations and define agenda

Create a
• Developed a clear vision and mission and a well-articulated implementation plan
common agenda
• Got different entities to agree upon it

Widely • Publicised industry achievements through national level events, thereby taking ‘software’ to the
communicate common man
industry potential • Remained in the media glare, association head penned a column regularly in a national newspaper

• Identified key stakeholders and discussed agenda with them

Help shape • Presented government with workable, practical solutions
regulations and • Asked for concessions against performance of industry
environment • Maintained continuous interaction with bureaucrats and ministry. Presently, have official
representation in many ministries

Prioritise role over • Prioritised agenda from time to time. E.g., Initially NASSCOM started as a local lobby association. On
time achieving most of its purpose on that front it is presently focusing on building the India Inc. brand

Source: Interviews; websites; press searches; team analysis

n Build a committed leadership. Indian retail needs a leader to represent it.

This leadership has to be inclusive and represent all industry players. For
example, NASSCOM was established by software industry leaders, headed
by a full-time, dynamic professional, and guided in its development by an
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Executive Council that met every two months to discuss aspirations and
identify actions.

n Create a common agenda. A clear vision and mission, with a well articulated
implementation plan, is critical to create a common aspiration (within the
sector) and a common voice (with the rest of the economy and government).
Such an agenda was developed by NASSCOM, debated within the sector and
agreed to by all members.

n Widely communicate industry potential. The industry’s growth potential

and achievements need to be acknowledged and publicised and the right
media presence must be created. There should be a situation where states
(and towns) should invite retailers to create better jobs, create the broader
eco-system (of suppliers and network providers) and eventually improve tax
collections for the state and a better shopping environment for its citizens.

n Help shape regulation and environment. Given the multiple government

bodies and types of government (central, state, local, municipal) involved
in overseeing retailing, helping shape regulation is the best way to reduce
the risks in the retail business. Retailers need to identify all key industry
stakeholders and assess their agenda. The NASSCOM experience suggests
that success lies in understanding the key issues for each stakeholder and
offering them workable solutions. Concessions were won for the industry
based on its performance, with clear benefits for the economy.

n Prioritise role over time. NASSCOM’s agenda was refocused from time to
time. It started as a local lobbying association. On achieving its purpose,
NASSCOM began to focus on building the India brand. It is now increasingly
focusing on talent creation and issues such as security. Clearly the retail
association will also have a long-term role, albeit one that will evolve over
time.

With this kind of focus by industry forums, retailers and the government, India
could soon have a thriving organised retail industry. The benefits will be more
choices and better prices for consumers, job creation and significant contribution
to GDP growth—in short, a winning situation for all.
Retail Practice
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