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Implications Of The FDI Reforms In Retail

Posted in Finance Articles, Total Reads: 6538 , Published on May 14, 2012

The Department of Industrial Policy and Promotion (DIPP) had announced earlier that the FDI limit in single brand retail is now opened completely. That is a 100% foreign investment is allowed in this sector. The reform has come about after a rather prolonged deliberation and anticipation. Debates on whether FDI upto 100% should be allowed in multi-brand retail had an unfavourable result. Parliamentary opposition and protests by several state governments like TMC and AIADMK led to the dismal end of the much awaited reform.

Though the Manmohan Singh government continues to block the entry of supermarkets like Wal-Mart and Carrefour, it has allowed 100% FDI in single brand product trading under the government route. Foreign investors can freely enter the market below Rs. 1200 crore investment and need to take the FIPB route for larger amounts.

The market expects the sector to grow 3folds in the next 5 years due to this reform. The sector worth approximately $7 billion is expected to grow to $20.25billion by end 2016 according to the US India Business Council. India has opened up its market at a time when economic opportunity is certainly welcome amidst global uncertainty. "FDI in single brand has led to emergence of some global majors in Indian market. This will provide stimulus to domestic manufacturing value addition and help in technical upgradation of our small industry," Commerce and Industry Minister Anand Sharma said.

PWC Associate Director, Goldie Dhama adds, “The decision would help in bringing latest products and technologies and provide more choices to the consumers.” The total retail pie in India is around $500 billion (Rs 26.5 lakh crore, approx), of which organized retail is less than 10 per cent. Single-brand is just a small fraction of organised retail at present. But, things are set to change as big global brands, including Ikea, GAP, Prada, Abercrombie, Hennes & Mauritz and Arcadia, may want to set up shop after the policy change.

Now the question is whether this hike in FDI in single brand retail really helps or do we see some of the finer prints of this particular circular stall or delay the actual benefit coming to the market? The clause in the reform states that the international investors need to source 30% of the products locally from the small enterprises, village and cottage industry, artisans and craftsmen. The small industries have again been defined as those with less than approximately Rs. 5.2 crore investment in fixed plant and machinery.

The general perception of the people is that the reform at least sends out a positive signal to the players in the marketplace. The timing of the reform is said to be very appropriate. The global markets have dried up and companies do not have an option but to enter India. They see it as a precursor to allowing the supermarket giants to trade in the country. As Mr. Kumar Rajagopalan, CEO Retailers Association of India, puts it,"The caveats were inevitable. (The reform) is not going to break in into inflows immediately. It is all about time…" If we go back a few years, FDI upto 51% was opened in the single brand retail sector on February 2006. Since then the response has been quite dry. In the last three and a half years, only Rs. 196 crore has been received in this sector.

The major hurdle for companies is the designing and establishment of a supply chain with 30% local sourcing. Not only does it have to be from within the country, but from an SME. This condition that the amendment is subjected to dampens the initial enthusiasm. Rating Agency Fitch has pointed out that the local sourcing clause will limit the pace of change to a large extent. Retailers need to determine whether they will get the same value and quality of goods from local firms. Single brand retailers usually cater to the premium segment of the market. As such, the dependence and trust in their suppliers is a lot. Finding efficient suppliers from the Indian SMEs is a rather big challenge for them.

The luxury clothing brands will not be looking forward for raw materials or textiles from the small manufacturers as it might result in a compromise of the quality of their products. The sourcing clause will dilute the brand appeal and also compromise the intellectual property rights as brands will be forced to work with multiple small vendors.  As such, high end luxury brands will have an issue and be hesitant to invest. Tahera Kachwala, Director Fitch Ratings, says, “The issues of quality control and cost control are sure to come up.” Brands would like to import their raw materials from their own lands or suppliers and not want to involve a rather small manufacturing firm in the sourcing scheme.

Removal of the investment cap is likely to help global fashion brands to strengthen their interests in the growing Indian market

Another very important question pops up. What happens when the SMEs become large? It is true the clause in the reform will lead to the direct benefits of the SMEs and thus they are sure to grow in due time. So, what happens to the retail giant when the local supplier becomes too large to be classified as an SME? Do they have to change their supplier again? Marks and Spencer, one of UK’s leading retailers, obliged to operate in India with a local partner today has raised the same question. The company, along with Burberry and Mothercare, are satisfied in continuing in the present state with a local partner in a joint venture rather than taking the reins of total operations into their hands. The reasons for this are mainly the shooting real estate costs, the nascent luxury market and the knowledge possessed by the local partners.

Knowledge of the local market is very important in the country. Joining with a local player in India who understands the policies and procedures and the languages across various geographies has proved to be one of the major factors for players like Adidas. Having a local partner has been very useful to some of the international retailers. These retailers would not want to move out from the existing arrangement. Coffee giant Starbucks continues to move forward with the Memorandum of Understanding (MoU) with Tata Coffee even after the government has allowed 100% single brand retail FDI.

A minor problem raised by some retailers is the unavailability of a proper repository or database to seek out the SMEs, artisans, craftsmen and locating suitable vendors. The Small Industry has been defined in such a small limit (around Rs 5crore in plant and machinery) that there would be plenty of players in the Indian market. As such evaluating such a large number of enterprises in terms of cost, quality and feasibility is too much hard work.

The reform also poses a major threat to the ethnic handloom and handicraft industry in India. This industry does not have many large players but plenty of small ones. It is feared that the industry might disappear as they will become manufacturers for the bigger retails and divert from the age old traditional products.

On the other hand, the reform will be welcomed by retailers like Hernes who already source designs, textiles and crafts from India. They would not face any significant disruptions in their operations and be more than willing to buyout their local partners and take the entire Indian operations into their hands. Major retailers and brands may look forward for fresh Green Field Developments while others may look for buyouts. The reform will surely increase foreign presence in home and apparel. High-end luxury brands hesitant to invest in local players may look forward to expanding their businesses.  

For example, a luxury clothing label may look to establish themselves in the accessories’ market.  With the announcement of the single brand reforms came a rise in the shares of retail giants like Pantaloons, Koutons, etc. The Foreign Investment Promotion Board (FIPB) has already cleared French retailer Christian Louboutin to set up stores all across the country.

Investors perceive this move by the government to allow full foreign ownership in the country’s single brand retail market as a precursor to opening up multi-brand format to global supermarket chains. The opening of the retail sector to foreign investors will have 3 key impacts- wide scale mergers and acquisition due to entry of foreign players in front end retailing, a gush of investments in logistics, realty and manpower training and job creation in the organized sector of the economy.

The more contentious multi-brand card is likely to be picked again up post the Feb-March elections and people across the globe are waiting for the result. The government has hinted that the major opposition to the multi-brand retail reform is coming from the kirana stores mainly pertaining to food. Non-food multi-brand retail reform thus seems likely in the coming six months.

Harish Bijoor, Brand Expert and CEO, Harish Bijoor Consults Inc, opined, “I do believe this is a positive early signal of what is due in multi brand retail. In many ways, this is the trailer of the movie to come, hopefully post the assembly elections. This will excite single brand retailers. I hope this sends the right message to the right retailers.”

This article has been authored by Rubayet Chakraborty & Ahana Chakraborty from NITIE.

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