January 6, 2012

Ultimately, the market is the winner

The fears over FDI in retail fail to understand the needs of the consumer

The logjam they call it. Cabinet’s simple nod allowing increased foreign investment and control over retail outlets exposed process failures and gaps in the nation’s leadership. Political parties hiccuped a bit before organising around their stance–it took them a while to figure out where their vote bank lay. And then it was all over. The flip flop over permitted foreign direct investments in the retail sector was an embarrassment for the nation, highlighting the lack of cohesion or commitment to reform at the very top of government. Poor internal communication, lack of consensus building across party lines and a general air of confusion was allowed to prevail as interests aligned, and pressure groups asserted themselves. The permission was rescinded, and then almost as if by stealth, largely granted–thereby giving rise to a new term: reform by stealth.

There are arguments on both sides—favouring liberal reform, and for protectionism. The arguments for foreign investments in the sector include the need for scale to bring in efficiencies that will lower costs. Only large players in this sector will be able to invest in the cold chain and improve the patchy infrastructure that has held back the sector for years. Supply side constraints have been named and shamed as the culprits for structural inflation in the country. Additional investment by foreign players coupled with better industry practices are expected to ease out the inefficient players or processes from the market.

On the demand side, consumers who have hitherto been prey to the middleman and serviced only by local stores, will now see greater choice. Efficiencies due to scale and refining of processes should ultimately feed back to the consumer resulting in lower prices. We should, as consumers, now have a better shopping experience than before. The timing of course is political, influenced by a host of issues that do not detract from the economic logic of the proposed reform.

Two assumptions are being made by those who oppose Foreign Direct Investment in the retail sector. Firstly, that the consumer will rapidly, and inevitably change over to the new format store attracted by lower prices and glitzy presentation. The Indian consumer is a very savvy and active participant in retail space. The level of analysis that goes into most purchase decisions is fairly sophisticated and loyalties are not to a brand or shop but to the product—which means quality, access and price.

The second assumption is that the Indian investor will not be able to compete against the outsider with deep pockets. Not just the larger domestic players, even the smaller local stores have much deeper access to their consumers and if they are able to step up to the plate, their market cannot be snatched away by anybody. Those who respond to the pressures introduced by the new competitors will clearly emerge better off. Those who allow their inefficiencies to dominate will (either be positioned very safely or will) suffer. This, in a free market is only fair—you pay for your karma.

In all of this, consider then, the position of the new entrant. A market that is enticingly large, yet notoriously tough. They face consumers that vote with their rupees and are used to being pampered by international standards. They foresee long term investments that need to be made in order to be able to just keep their real estate investments (shelf space) supplied. This, even at normal prices is going to take deep pockets and long term commitment. The lower prices that we expect from them will put them in a tighter spot. The learning curve in the Indian market is going to be steep and the design issues unique.

Indian retailers need to fear competition only if they are not willing to give up their fat margins or inefficient processes

Recent history in the organised retail sector does not offer the new investors much hope, with most chains having suffered and shut down. New investors come in with the knowledge that their Indian counterparts have equally deep pockets, better market insight and the uncanny ability to be ’inspired’ by any previously successful model. This is a challenge for the new entrants. Customer service standards in India are generally excellent, with mass customization almost ingrained in the retail DNA. All this at almost no extra cost.

There seems to be little reason for the local consumer to shift demand away from the convenience of the local shopkeeper’s personalised home delivered service. Can supermarkets match that? Would they be able to provide the instant, on call delivery as the traditional set up does—almost as if it were an ensuite store larder. Can the new entrants provide instant credit as the friendly neighbourhood shop does?

So, what are the opponents to FDI in retail afraid of? The slippery slope argument is well deployed here—“Remember the East India Company?” they ask. “The foreigners will come and take over our businesses and our freedoms will be theirs!” they exclaim. Our traders will suffer, clearly. While farmers groups have reportedly said that they get better prices from larger chains, and that they support the entry of more powerful players—they must realise that they will also be under pressure year on year to improve yields and lower prices. The disintermediation of five layers of middlemen from the process is the destruction of a way of life and income for a significant section of society. Both these pressures, of course, benefit the consumer in terms of lower prices. At the core of this argument is the ceding of economic power to large conglomerates in ways that directly impact the entire supply chain—from the producer to the consumer.

Views expressed so far seem to be guarding and garnering vote banks rather than seeking understanding of the complex needs of the people. Some fears seem valid, such as the possibility of dumping. Initially, foreign supermarkets may take a hit on prices, suffering losses for a few years till smaller players are priced out of the market. These need to be addressed via industry regulation. Proportionate checks and balances can be used —all the way from self-regulation to the World Trade Organisation’s anti dumping regulation—and these must be used well.

Indian investors need only fear competition if they are not willing to give up their fat margins or inefficient processes. Competition is not debilitating. It is a call to rise out of previous lethargy; a signal that old rent seeking patterns are being challenged – patterns that either indicate inefficiencies or unfair practices. Those who rise to the challenge will emerge stronger, regardless of their investors, domestic or foreign; small scale or large. Ultimately, it is the consumers who must decide what they support—not by regulation, but by the choices exercised at the till. And this is where this reform truly wins, in giving power back to the people. Now it is up to the consumer, the people to prove that they can chose well—for their present and for their future. This too is a vote they cast, and this is how they decide who wins the battle of the markets.

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