Retail Traffic

Passage to India

So near and yet so far. That could be the cry of retailers and shopping mall developers eyeing the potentially vast market in India.

On the one hand, recent legislation in that country eliminated restrictions on previously verboten foreign investment in real estate. What's more, only about 2 percent of the retail market there is “organized,” leaving the opportunity for lucrative investments wide open for savvy companies. But on the other hand, non-Indian retailers are still not allowed to do business there.

The upshot: While a handful of major institutional and private equity investors are now making plans to enter the real estate market in India, many U.S. shopping mall developers are holding back as retailers bide their time, waiting for the market to open up. Foreign direct investment for 2004 was only about $5.5 billion — compared with $64 billion in China, the other Asian giant — although the government has pledged to increase that amount to $50 billion in five years.

“India is like China 10 years ago,” says Jacques-Etienne de T'Serclaes, global retail and consumer leader for PricewaterhouseCoopers. “It's hard work. And you have to be prepared to have your fingers burnt before you see any kind of return.”

Certainly, growth in the Indian economy bodes well for foreign companies. Since the country started loosening its restrictions on industry in 1991 and, more recently as foreign companies began setting up shop, the country has been on an upswing. With an annual economic growth rate of about 7 percent, per capita income has nearly doubled in real terms since 1991.

$500 billion by 2010

The average household income in the top urban areas has risen about 10 percent a year during the past decade, according to Indraneel Karlekar, vice president, global research and strategy for ING Real Estate Investment Management in New York. By 2010, the economy is expected to be one of the five largest in the world, according to Karlekar. The $250 billion retail market could double by 2010, he says.

In addition, there's the demographic attraction. More than 50 percent of the country's approximately 1 billion people are younger than 25. And, with an increasingly well-educated middle class, the market holds some cultural appeal, as well. “There is a high level of English spoken, an educated white-collar sector and a legal system you can understand,” says Morgan Parker, president of Taubman Asia, which was recently set up to consider investments in India, China, Japan and Korea.

Year GNI
1990 390*
1991 350
1992 330
1993 310
1994 330
1995 380
1996 410
1997 420
1998 420
1999 440
2000 450
2001 460
2002 470
2003 540
2004 620
*US $/Per Capita
Source: The World Bank Group

As is the case in China, the greatest opportunity for companies entering India is in urban areas, particularly around five to eight of the largest cities, a pattern that should continue for some time, according to observers. The 1.2 million most affluent households in the country — expanding by more than 20 percent a year — live mostly in the top eight cities, according to a recent report from McKinsey & Co. At the same time, there are also 32 cities with a population of more than 1 million, offering plenty of room for growth.

At first glance, it seems to portend a bonanza for retailers, especially those that can introduce a measure of sophisticated business savvy to the market. That's particularly true because the country is dominated by small mom-and-pop outfits, about 12 million in all. In fact, about 96 percent of stores have less than 500 square feet, according to Ira Kalish, global director, consumer business at Deloitte Research. Trouble is, strict government regulations still bar any direct foreign investment in retail. (The country does, however, allow wholesaling. For that reason, Germany's Metro set up its own wholly owned subsidiary several years ago.) As if that weren't enough of a hindrance, many other regulatory restrictions also affect the development of retail, including laws restricting the movement of goods between states, regulating the hours and days of operation and curbing the ability of employers with more than 100 employees to fire their workers.

But while no one knows when the government is likely to eliminate restrictions on foreign investment in retail, the consensus among industry analysts is that the law will be changed. There are some indications, in fact, that “it might be sooner, rather than later,” says Ankur Srivastava, managing director of DTZ Debenham Tie Leung, a global real estate advisory firm, who predicts a shift in the next six months.

A visit from Wal-Mart

According to some observers, the retail card is, in effect, being used by the Indian government as a tool in negotiations with the World Trade Organization to win protections for Indian farmers. In one sign of the change to come, teams of honchos from Wal-Mart have met with high-level government representatives recently to lobby for reform, according to Srivastava. The new law would still place some restrictions on foreign companies — for example, only allowing them to enter the biggest cities — but might be further liberalized later on.

Cities Number of Inhabitants (millions)
Mumbai (Bombay) 19
Delhi 19
Calcutta 15
Madras 7
Bangalore 7
Hyderabad 7
Ahmadabad 5
Poona 4
Surat 4
Kanpur 3
Source: PricewaterhouseCoopers

There is one exception to the current restrictions: Foreign retailers are allowed to operate through a franchise — that is, by working through a local company to sell their products. So far, a handful of companies, in addition to such fast-food giants as McDonald's, Pizza Hut, Taco Bell and Kentucky Fried Chicken, have done so. For that reason, some observers suggest that retailers consider signing two- to three-year agreements with local companies, so they can jump in quickly once regulations are eased. The agreements might also include the option of buying the operation from the partner, “so you have a clear exit,” says Srivastava.

No matter what form a retailer's entry takes, one sure key to success, say analysts, is developing a thorough understanding of the Indian consumer. That might seem like a no-brainer, but Karlekar points to McDonald's, which, he says, struggled for the first three years until it reevaluated its strategy, revamping its menu to appeal to Indian tastes with non-beef fare. (Its Maharaja Burger, made of chicken, is popular). Another example: KFC, which, according to Srivastava, hurt its growth initially by including the name “Kentucky Fried Chicken” prominently in its advertisements — thereby alienating the vast number of Indian consumers who are vegetarian and “wouldn't even be seen entering such a store,” he says. Now, both McDonald's and KFC have separate cooking areas for vegetarian and non-vegetarian foods, he says.

There's also the matter of price. Indians tend to be very price-sensitive, conservative shoppers. While the typical middle-class family owns a TV, a DVD player and the like, “Indians are not impulsive buyers,” says Srivastava. As a result, prices have to be set accordingly.

For shopping mall developers, prospects took a 180 degree turn earlier in the year when the government rescinded laws that forbade foreign companies from making direct investments in real estate. Some non-U.S. developers are already moving in. For example, Emaar Properties of Dubai recently announced plans to spend $4.1 billion to build 100 malls in India, Pakistan and various countries in the Middle East. More than half will be in India. Still, the largely unorganized nature of the retail market makes some developers wary. “If retailers aren't there, how can we be?” asks Parker. “We don't want to be in a market where we're only housing 100 small specialty shops.”

For now, there are about 40 malls in the country, but about 200 are under construction, according to Kalish. (Seventy-five of them are in the New Delhi area.) Most, or all, are being developed by local companies. They're considerably bigger than older malls. India's first mall, Crossroads in Mumbai, opened about six years ago and was 150,000 square feet. The Unitech Mall in Noida, on the other hand, which is now under construction, should be about 1.3 million square feet.

Ticket to shop

By many accounts, however, most malls are highly unsophisticated — poorly designed, with little in the way of real management or planning. “The early ones were examples [of] how not to build a mall,” says Srivastava. For example, to get in, shoppers had to buy a ticket, and they could only do so if they had a credit card, membership in a club or a student ID. Worse, even in more recently built malls, developers mostly sold space on a shop-by-shop basis, giving no thought to merchandising mix. “They're a conglomeration of shops,” says Srivastava. Stores have tended to sign two-year leases, waiting to see whether the mall was a success. If it wasn't, then they would simply pick up and leave at the end of the contract.

Current Forecasts
2002 2003 2004 2005 2006 2009
Consumer expenditure on durable goods $22,887.54* $24,485.67 $26,268.2 $26,754.91 $27,026.72 28,417.81
Consumer expenditure on semi-durable goods 15,019.72 15,803.82 17,038.51 17,612.66 17,933.07 18.512.3
Consumer expenditure on non-durable goods 198,633.4 209,378.8 224,072.4 232,896.1 237,707.3 250,460.9
Consumer expenditure on services 101,623.9 109,237.6 117,476.7 118,931.8 122,167.8 129,738.4
*$US millions
Source: Euromonitor International

That could spell a big opportunity for the most sophisticated U.S. developers. Unfortunately, private equity investors have indicated they plan to do little investment in retail, according to Srivastava. And they're unlikely to take a position in most of the existing malls. Still, even the small investments they are considering could have a big impact, Srivastava believes. “There are billions of dollars ready to go to India,” he says. “And some of it can be tapped for retail.”

He points to the mid-1990s, when foreign companies and banks insisted that developers build larger, modern office buildings, and a new crop of state-of-the-art commercial properties went up. “The more sophisticated investor will come in and put their foot down and insist that they won't accept substandard malls,” he says. Another area of opportunity: several large integrated townships that are under construction.

Perhaps the most essential ingredient for any player is finding a partner. “I can't overemphasize the importance of having a local partner,” says Karlekar. That goes for shopping mall developers and retailers alike, say experts. While U.S. companies can provide a wealth of expertise that local developers and retailers lack, they simply don't have the requisite understanding of Indian tastes and culture, the complexities of the tax system — taxes vary from state to state — and, more important, the intricacies of the Indian bureaucracy.

“You need to have knowledge of the Indian consumer psyche and how to manage the system,” says Srivastava. For example, while local government officials can't exert the power to control zoning and other decisions that Chinese authorities have, they are, in many instances, swayed by bribes. Then there's just the sheer volume of paperwork. Indian senior managers spend about 14 percent of their time dealing with regulatory issues, according to a study by the World Bank.

What's more, many states place tough environmental planning restrictions on construction, with specific rules, for example, on how close to “green zones” businesses can build. And, for real estate developers, there's another consideration: The minimum investment for foreigners setting up a wholly owned subsidiary is $10 million, compared with $5 million for those who go in with a local partner, according to Karlekar.

Creaky utilities

Perhaps the biggest stumbling block to entry is the crumbling infrastructure. In 2003, 61 percent of businesses owned power generators to address frequent interruptions in service, according to the World Bank. While the state has pledged to increase infrastructure spending, the country has a long way to go before many of its problems are solved.

Ultimately for retailers and shopping mall developers, tackling the Indian marketplace will call for a delicate sleight of hand. For example, while developing the right relationships and a thorough understanding of the market's complexities is a long-term effort, speed is also important.

Now is the time to start seeking the most strategic partnerships and promising locations, advises Karlekar. Companies that position themselves in the early stages can build a space that will be next to impossible for latecomers to challenge. Then again, he suggests, U.S. players could hold back and wait for a few private equity firms to make the first moves. Says Karlekar: “They might want to watch and get a better understanding of the risks first.”

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