Friday, January 17, 2014

The other side of large retail in India

I am amazed by the vociferous opposition in the media to the AAP's proposal to ban FDI in multibrand retailing in Delhi ( Newspapers are full of articles of potential losses of billions and also of more than 10 million job loss ( There is also a lot of talk of how big box retail will improve everything wrong in our country. The opposition may not be completely valid.

The reason that we have high wastage in agriculture is not the lack of systems. It is in fact the existing infrastructure bottlenecks. The cold chains can't operate profitably because of the lack of reliable electricity supply. The truck speeds are slow because of pathetic road conditions. There are high prices and variable quality in the produce because of the fragmented nature of the farm ownerships. All these are crucial issues which if solved would automatically impact the efficiencies of the retail business. The FDI is for direct retailing business. It will have no impact on the infrastructure. As it is the FDI route for cold chains has been open, without many takers, for quite some time now.

There is a difference between the type of jobs created by large retail and the small mom and pop stores. With Mom and pop stores there are entrepreneurs who employ one to four low wage helpers. They are served by entrepreneur distributors and entrepreneur vehicle owners (sometimes with bicycles). Thus the job quality and the level of income is higher for a majority of people. In organised retail, the salary structures and job quality are highly skewed. The super rich but small number of top management would have an extremely high salary as compared to an army of shop floor drones who would barely be able to survive. The salaries of Target and Walmart CEOs are more than 500 times the average salary of their employees (  

Such type of income distribution is never good for any economy. High growth and increase of consumption can only happen in markets where the income structures are relatively level. The type of jobs in multi brand retail are thus not likely to create a favourable impact on the economy. Plus of course there is a possibility that the large retail may cause a job loss in the existing set up.

Proponents of large retail in India are demanding proof to show that if the existing large stores have caused any job loss as of now. However they avoid questions on the issue of the supposed benefits of large retail. Have large retail in India benefited farmers in any way? Have they led a significant price decrease for customers?

Efficiency does not always mean low price. Low prices of cigarettes could possibly cause havoc in the economy. Efficiency calculations with a smaller set in considerations are usually wrong and cause something what is called as 'local optimum'. For an alcoholic (or a cigarette smoker) low prices of his vice would be a great proposition. So, if we limit are efficiency calculations to the immediate satisfaction of the person, the prices must be as low as possible. However, if we extend the calculation to his lifetime, higher prices that lead to lower consumption could be better. (Am assuming that consumption is related to price and in cases of alcohol and cigarettes this could be wrong, but the the point is the nature of example and not the exact relationship).

Thus the low buying prices for the consumer could surely create a short term advantage for her. However in the long term, when the focus of efficiency is shifted from the buying transaction to the entire country, the effects of large retail could be very different. The documentary 'Wal-Mart: The high cost of low price' clearly shows that the public health care benefits that the Wal-Mart employees use are a huge drain on the tax revenue. Thus the low buying prices could be nullified by higher taxes.

I am of course assuming here that the large retailers are honest citizens. There have been multiple cases of policy manipulation (though lobbying) and corruption against most large retailers. Being super large they have a clout to conduct such activities unscathed, but this could be the issue of another article. 

It is disturbing that the media savy and educated section of the Indian population are not even willing to consider the other side of the debate. News papers and TV media cannot be relied on so much to frame and base our opinions on such important issues. They have their own agendas. My appeal is for people to think on their own, to read alternate views, to go beyond 'popular' opinion and then  decide. A society that is led by opinions manufactured by mainstream media can be a very dangerous place to live in.

Friday, June 28, 2013

Nano savings and other such dumb fables

I am never able to understand some acts of the corporate world and from my limited means of understanding find them to be absolutely stupid. One such news is the grand announcement by Go Air in today's Times of India -

GoAir opts for female crew to save fuel

Let us look into this issue. They say that every additional kilo costs the Rs. 3 per flight hour. So, for a Mumbai Delhi flight (accounting for the congestion) the cost would be Rs. 6 per trip. A male purser according to the article weights around 20 kg more than a female purser. Assuming a flight has 4 male pursers and replaces them all, the benefit would be Rs. 480 per flight. Assuming a cost of Rs. 4000 per ticket and 180 passengers per flight, the saving would be 0.07% of the revenue. The fuel savings from reducing magazine pages would be even lesser.

The airline hopes to save Rs. 2.5 crores - 3 crores using this. Assuming the Rs. 480 savings per flight and 360 days in a year, the savings would require Go air to have around `175 flights of 2 hours each everyday. This is almost double their existing flight plan.

My first objection is that these supposed inefficiencies have been brought into focus because of the rupee depreciation. A Non Value Adding activity is a Non Value Adding activity irrespective of the rupee price. Even if this fairy tale of savings was true, that it was not done earlier is a mark of inefficient management team at Go Air. Why wait for the dollar to be worth Rs. 60 to reduce the potable water tanks or install sharklets? These items would have served the firm in reducing costs irrespective of the rupee dollar exchange rate.

In terms of cost reduction by reducing assets, it is important to understand the behaviour of costs. For the fight pursers, there is of course the cost of their salary and benefits. But, there is sometimes a much higher cost for their control and management. There are a set of people who create the schedules for these pursers, people who monitor them, people who train and recruit them, etc. In a hypothetical situation that a flight can be managed without the pursers, the cost benefit would be significantly higher than the Rs. 3 per kg per flight hour or the direct salaries of the pursers. This is because the entire set of activities related to the flight pursers could be junked.

All other cost reduction would be very minor and have a very limited impact on the cost performance of the firm. Given that the complete elimination of the activities would not be possible, the focus must then shift to maximising the impact of the activity. The airlines would save a lot of money from eliminating the inflight magazine. But, if that cannot be done, it might be prudent to increase the pages of the magazines, increase customer satisfaction, and thus increase the load factor.

All the savings being talked here are what i call nano savings. To expect these nano savings to save the firm would be very amateur. However the business world has always been fond of such hypothetical fables. Even if one customer chooses not to use the service because of such measures the benefit from days of such nano savings would be lost. One social media savy customer who does not get water to drink may cause a huge PR mess for the firm. The point - especially in times of recession, such nano savings are not at all worth the risks they create. Creating higher customer satisfaction and retention should be given much higher importance than such nano savings.

Tuesday, April 30, 2013

Extraordinary Maruti results? Where art thou common sense?

Going by the mainstream media reports, Maruti Suzuki seems to have achieved an extraordinary increase of profits in a subdued market. This is as per the quarterly results of March 2013. In spite of a reduction in sales Maruti Suzuki has been reported to have an 80% increase in net profits over the previous year. Business journalists have been going head over heels on this announcement. The success is attributed to better product mix, lower discounts, price hikes, localisation and favourable price of yen. Truly amazing indeed.

The major and only contributor to the high profits is the reduction in cost of materials. There is a direct 7% reduction in cost of material consumer. The cost of material consumed has fallen from being 21.4% of sales to 18.3% of sales. In the quarter ended March 2012, an average car would have Rs. 2.46 lakh worth of materials. In 2013, in spite of inflation and in spite of a higher proportion of larger cars being sold this cost has come down to Rs 2.39 lakhs per car. Larger vehicles would clearly demand more material and thus this cost should have increased. Surprisingly, the cost choose to come down.

Let us first try to understand the imported materials. An average of weekly prices from April 2012 to March 2013 is Rs. 1.52 for one yen. For the previous year in the same period this was Rs. 1.64. This is around a 7% depreciation of the Yen versus the Rupee. Maruti Suzuki imports around 25% of its raw material and of this around 80% is from Japan. Applying this formula to the cost of material consumed, the imports from Japan for quarter of March 2012 would be Rs. 177,482 lakhs. A 7% reduction to this, because of currency depreciation by 7% would create an import bill of Rs. 165,058 lakhs. If we apply the formula (80% of 25% of the total cost of material consumed) to the quarter of March 2013 we get a remarkably similar actual value of Rs. 164,514 lakh. This is less than half a percent off the predicted value. We can safely assume that the yen depreciation has caused a 7% reduction in the import bill. Also, we must note that as the Yen rises this saving is bound to vanish. (In fact the Yen has already appreciated by around 5% in April 2013)

Since the total material cost reduction was 7% over the two quarter, it means that there has been an equal 7% reduction in the domestic procurement of the year. When prices of metals (steel and aluminium) have remained more or less steady, this 7% reduction seems hard to believe. There is no definite word on how this 7% cost reduction has been achieved without a corresponding reduction in the prices of basic inputs. Maruti Suzuki attributes this to reduction of suppliers and other techniques which have been standard industry practices for decades. To attribute the dramatic reduction to such standard techniques seems highly improbable. And if it was actually due to these techniques, that Maruti Suzuki avoided doing this for so many years also points a finger at the ability of the management. 

Obviously the financial reporters have not cared to question the company and have not done their homework. They merely choose to report directly from the company data and for reasons best known to them, create a feeling of exuberance, when no reason exists for the same. The future for Maruti Suzuki seems quite bad to me. The appreciating Yen would hit the imports hard. It would also not be possible to keep the local procurement costs low when the input costs are rising or at best steady. 

The quarter ending June 2012 was a very poor one for Maruti Suzuki. Any decent performance for the quarter ending June 2013 would thus again show a significant increase in profits. However, given the skills of financial engineers within firms, it would not be correct to base company analysis on the data and information supplied by the company itself. Analysts must dig deep, get a thorough understanding of the firm's business, ask relevant questions. Only after this, should any kind of analysis be submitted.  My prediction for Maruti Suzuki is that I do not see a significant change in the profits over a year. What do you feel? 

Sunday, April 28, 2013

The issue of low truck speeds in India

It is very well known that the average speed of trucks in India is only around 20 kmph. There are estimates of a loss of Rs. 60,000 crores because of this. The Global average speed is said to be 60 - 80 kmph. These numbers point to a significant cost reduction opportunity in logistics.

The toll plazas, checking points and the poor road conditions are the familiar culprits for this ailment of low speed. Firms have been pointing fingers at the government and are painting a picture of them being in a helpless position. However the frequent truck breakdowns, vehicle overloading and poor driving discipline are also major causes of this low speed. These factors can easily be regulated and are in complete control of the firms. 

A two lane road (with one lane for each side) with all vehicles moving in an exact straight line can easily have vehicles travel at a very high inform speed. There are many assumptions in this statement however. The first assumption is that all vehicles are moving at a uniform speed. Because of over loading and also poorly maintained vehicles the speed of a very few vehicles is at around 20 kmph. Especially in cases of two lane highways such vehicles can easily slow down all the other vehicles. Given that only about 14% of the national highways have 4 or more than 4 lanes, this problem affects more than 85% of the Indian National highways.

In most cases the truck drivers are also least likely to follow the discipline of lanes. For four lane roads (with two lanes for each side), if all the slow vehicles could drive in one lane, the other lane could accommodate fast moving vehicles. Because the truck drivers choose to use the lanes that they deem fit at the spur of the moment, the entire highway network is slowed down.

Frequent breakdowns are also a major cause in slowing down the vehicle movements. For various reasons we have had poor maintenance management in professional as well as the owner driven vehicles. The high average age of vehicles (debated to be around 12 - 15 years) is also partly to be blamed for the high rate of break downs. Like the issue of a slow moving vehicle mentioned above, a vehicle breakdown would also cause a reduction in speed for all traffic on that route.

The altruistic answer to this problem would be for all firms to pay attention to vehicle maintenance and driver training and also ensure that all instances of overloading are avoided.  Easier said than done. Low margins in business are forcing logistics firms to minimise the immediate expenses on maintenance also to resort to over loading and such tactics. It would seem that any firm that stays 'honest' would obviously not be able to survive. The honesty and survival issue are topics for another blog.

The main point here is to get the industry to work on the same set of rules that minimise road disruptions and thus lead to high overall speeds. Such industry wide change can only come by forcing the application of the relevant laws in earnest. Instead of lobbying for easier rules, Organised firms should in fact push for strong rules and strict application. Given their expenses, it would be close to impossible for single truck owners to survive without overloading. Such changes would easily throw the unorganised players out of business and allow the organised players to expand their business footprint. That such strict rule implementation could also improve vehicle speed and thus profits would of course be an extra added advantage 

Saturday, March 23, 2013

Accidents are cheap and safety expensive

There was a blast in the Tarapur unit of Aarti Drugs Limited at the Tarapur MIDC yesterday. Five young people lost their lives. It seems these young people were screaming with pain for 2 - 3 hours before giving up the struggle.

This is not the first incident of an accident at Aarti Drugs Limited. As recent as October 2012 a major boiler blast in the Dombivali unit of Aarti Industries had led to three people being hospitalised and more than 125 others treated for vomiting, burning eyes and breathing problems. Coming back to Tarapur, this is just one of the many incidents which have been reported from Tarapur MIDC. In December 2012 a reactor blast in Sunrise Process Equipment had led to injury of four people. In September 2011 a hydrogen sulphide gas leakage at the Sequent Scientific plant at Tarapur had caused death of 4 employees.

Tarapur is not a town secluded from the mainstream. It is less than 100 kms away from Mumbai and has the Atomic Power station. The industrial town also boasts of organisations like Tarapur Management Association (TMA) and Tarapur Industries Manufacturers' Association (TIMA). Such frequent accidents do not show these organisations, factory owners and professionals working in Tarapur in a positive light. 

Why is it that the accident rate is so high in the Tarapur MIDC and also a few select companies like Aarti Industries? The only possible reason is that it is cheaper to manage accidents and more expensive to prevent them.

The low probability factor

Human minds are known to ignore all risks that have a very low probability of occurrence. That is why people avoid wearing helmets and seat belts. Even though the impact of a traffic accident is high, possibly death, the extremely low probability makes the human mind think - it can't happen to me. This is precisely why these firms, their owners and the senior professionals have a lax attitude towards accidents.

What they fail to understand is that a series of low risk situations would lead to a high risk probability. For example, assume that one process has a probability of failure as 1%. If five such processes are kept in a series, the cumulative probability of failure would be higher than 60%. This is a very simple probability calculation and I do not think that the firm owners are oblivious of this fact.

Accident prevention is a mindset. It starts with not tolerating even the slightest deviation from the operating norms. Equipments have to be maintained as per some fixed processes. Piping and valves have to be changed routinely. People working in the plants have to be trained continuously for safety procedures. But, all these activities are very expensive. It is probably easier to 'manage' a boiler inspector rather than shut the firm and have a honest boiler inspection. Same could be the case with pollution inspectors who are generally 'considerate'. As it is, it very rare for a business owner to get jailed for such acts of wilful murder.

Is it Tarapur and Aarti alone?
Of course not. The lax attitude towards industrial safety seems universal in India. A major automobile OEM has different safety standards for its own and contract employees. It is rare to see a worker on scaffolding in industries and around new constructions wearing safety belts. There are many offices in Mumbai where adequate fire protection  measures are avoided and extinguishers even when present are past the due date.

May be, the government authorities who are responsible to monitor and the business owners who are responsible to provide have both enough incentives to not do their jobs. At such times it is the professionals and professional organisations (like TMA and TIMA) who are responsible towards highlighting lax procedures and forcing firms to implement safety procedures. Businesses surely have to run to create profits and every action of businesses would be directed towards creating higher returns. However, human life should be above all such calculations. It might be okay to work around excise, transport and all such officials. But, anything that could even have the smallest probability of impact on human life must be non negotiable. 

There of course will be some exceptions. I am sure that some plants in Tarapur and such industrial clusters have a very elaborate safety mechanism. But at the same time, there would possibly be a large number who would consider safety as an unnecessary burden. The article is directed towards these firms.

I do not have data of accident rates at other locations and I consider even a single occurance of such accidents as an untoleratable act.

Wednesday, March 20, 2013

Question of Scale in Indian retail

An issue very close to my heart has brought me back to blogging. It also gives me an opportunity to say - "I had told you this". It was the news in the Economic Times dated 19th March, regarding Office Depot and Staples putting a halt to their India plans.

 It is very clear that the large format retailers have a significant overhead and would need a huge scale to be able to sustain their business model. The MD's salary for Shoppers Stop is around 0.15% of the total revenue. For Walmart, this percent is 0.000045%. Well there are lots of difference between WalMart and Shoppers Stop, but the differences in the proportion mentioned above are too large to be ignored. (WalMart does not reveal the salary expenses and based on newspaper reports the remuneration for Mike Duke has been assumed to be 20 million USD). To put this into perspective roughly one third the gross margins (not profits) of one Shoppers Stop store are expnesed in paying the MD's remuneration. With only 53 stores this is way too much money spent on one person. (The expenses of Shoppers Stop considered for Gross Margin inclde the COGS and the employee costs)

According to a report, 90% of Americans have a WalMart within 15 minutes of their house. It is only with this huge scale and the superlative use of technology that WalMart makes the money that it does. For a population around 2 million, Dubai has six super stores of Carrefour. Thus there is one Carrefour for every three hundred thirty three thousand (333,000) people. Mumbai metropolitan area which is about the same size as Dubai and a population of around 20 million has six Big Bazaar stores. This makes it around one Big Bazaar store for 3.3million people.

Again, it is debatable if Mumbai and Dubai can be compared. The idea here is to indicate the stark difference and the lack of scale among Indian retailers. Overheads like salaries, IT expenses, etc are not very linear to the scale of Operations. Shoppers Stop is not even 0.1% of the size of Walmart in terms of revenue, but the compensation to the Shoppers Stop MD is around 3% of the WalMart CEO compensation.

Unless these large retailers in India plan for scale, it will be impossible for them to sustain. They have to have planned growth that has a significant multiplier effect to the number of stores. Shoppers Stop has managed 53 stores in 20 years, and in ten years Big Bazaar has managed 214 stores. That they still have such a small footprint does not seem right. Walmart has 3000 stores in the US. Even Toys "R" Us has around 875 stores in the US. Tesco has 471 super stores in UK which is 80% of the size of Maharashtra. In all formats combined Tesco has almost 3000 stores in the UK. France, which is just around twice the size of Maharashtra has 1200 super and hyper markets of Carrefour. Across formats the number of stores is more than 5500. An Asian country like Taiwan, which is around 12% of the size of Maharashtra has 70 Carrefour stores.

It is clear here that scale is an essential component for survival in organised retail. And, this scale is more about the stores in the same retail format than across formats Given this common knowledge the behaviour of Indian retailers is surprising. McDonald's India has managed to create around 250 restaurants in 15 years and now they plan to double the number in West and South India in the next two years.The message here is that it is okay to have a lower number of outlets now, but without a significant increase in capacity the survival of the organised retail market in India is questionable. 

Saturday, April 23, 2011

Is it really the Kirana?

Foreign FDI has been blocked in multi brand retail on the pretext of protecting the small kirana (mom and pop) stores. Sometimes I wonder if this is the real reason. I strongly believe that the restriction is actually to help the large Indian organised retailers. They are the ones to be first affected by the direct entry of Wal-Marts and Tescos of the world in retailing.

The typical design of the large foreign retailers is that they have a very strong but investment intensive back end. In order to get good returns from their investments, the stores have to be necessarily large formats. In addition, in one given market there have to be a high number of stores.

The high lease rates in urban areas of India make it impossible for retailers to have many large stores inside the city. The Wal-Mart model of having the store outside the city would be difficult given the traffic and road infrastructure bottlenecks. In rural areas the scale of operations is generally very low. Indians typically do not have a spend oriented culture like the Americans. So, it would be difficult for a retailer to set up and sustain a large store in a Tier 3 city.

The kirana stores in India have created a very low cost selling model. A pan shop could sustain itself at a monthly profit of around Rs. 5000 only. This number could be much lower in rural areas. This was not the case in the USA. These players can never be threatened by the foreign retailers. The existing so called organised retailers in India would probably have the most to lose.

Indian organised retailers are still in an experimentation mode. They hastily set up the front end and are now trying to make the back end work. Most have poor systems. Some companies have closed down and most of the rest are not making money. They have tried to copy the IT systems in foreign retail as this can be easily bought. But, the human systems and discipline needed are sadly missing.

By getting the government of India to form rules banning the foreign retailers, the organised players seem to be creating space for themselves. Foreign companies wanting to enter India would be forced to tie with the existing Indian players. It clearly seems that the rule has been created in the first place to benefit these large Indian retail players.

Now suddenly there is a talk about relaxing the rule. Nothing has changed for the small kirana owner. But all the large format foreign retailers have already been subdued to partnerships with large Indian firms – this includes Wal-Mart, Tesco, Woolworths, etc. Having done this, and needing more investments, it seems that the large Indian players are now getting the government to allow more direct investment in multi brand retail.