With modern retail accounting for an increasing share of Indian FMCG sales, consumer goods companies should adapt their strategies to protect their margins and strengthen brand loyalty.
The news headlines may have been dominated by GOI’s failed attempts to introduce FDI in multi-brand retail, but meanwhile domestic organised retailers have been quietly but quickly grabbing market share in India’s Rs.1, 872,000 Crore retail market1. Modern or organised retail currently accounts for around 11.6% of the total market value at Rs. 2,17,000 Crore.
Modern retailers, with or without increased FDI, are transforming India’s retail market and no more so than in the Fast Moving Consumer Goods (FMCG) sector. These new entrants are throwing down a challenge to the existing business strategies of the country’s major consumer brands. Organised retail is putting margins under pressure.
Organised retail is gaining importance for FMCG. In 2011 FMCG has been one of the fastest growing segments within modern retail, clocking up an impressive 31% growth rate. And the rapid pace of growth is predicted to continue. Standing at $1.8bn today, the value of FMCG sales through organised retailers is forecast to almost triple by 2015 to $5bn2, according to a recent study by Nielsen.
Today, the total size of the FMCG sector is estimated to be around $33bn3. Assuming a conservative 12% compound annual growth rate4, the overall FMCG sector will grow to approximately $52bn by 2015. Thus, the share of FMCG goods sold through modern retail will double from around 5% today to almost 10% in 2015.
Driving a hard bargain
Organised players drive a harder bargain than traditional stores. The large number of stores and vast shelf space of modern retailers results in greatly increased stock turnover compared with traditional Kiranas. This is shifting bargaining power away from suppliers and toward retailers.
The typical Mom and Pop store occupies a few hundred square feet and only offers several hundred Stock Keeping Units (SKU’s). By contrast, the supermarkets of an organised player like Big Bazaar are at least 50,000 square feet, allowing it to offer some 200,000 SKU’s5 across its 138 stores.
Modern retailers are acutely aware of the greater negotiating power their expanding retail networks provide and they are extracting a higher margin from FMCG brands.
As large volume buyers they are in a position to demand lower wholesale prices, reducing the margins of FMCG companies. In addition, their shops generate sufficient footfall to charge listing fees for prominent in-store positions and product merchandising. On average, FMCG brands pay India’s large retailers a margin of 15-17%, a significant increase on the 10-15% margin typically given to retailers in the unorganised sector6.
And their bargaining clout will continue to grow. As organised retailers increase scale and market share, the margin they demand will inevitably increase further. The sales figures for India’s organised retailers are rapidly gaining on those of the leading FMCG companies. As their relative size increases, the proportion of an FMCG company’s sales going through a single store brand will rise considerably.
In countries where the organised retail market is consolidated and the competition is concentrated among a few large players, FMCG companies are forced to pay higher margins. In their home markets of the UK and the US, retail giants Tesco and Wal-Mart typically receive margins of 20-25% from FMCG supplier7.
Modern retailers challenge the brand loyalty of FMCG labels, Private labels offer retailers higher margins. With an increasing market share, India’s modern retailers are approaching a scale where private label lines are increasingly viable. As their network of stores and customers grows, so does the level of recognition and trust with their brand.
Private label FMCG sales currently stand at Rs.500 Crore and are predicted to rise five fold to Rs.2,500 Crore by 20159. This will represent close to 10% of all FMCG products sold through modern retail formats. The prospect of higher margins in this intensely competitive sector is the main driver of the growth of private labels.
Organised retailers will typically make a margin of only 2-3%10 on branded FMCG products (once costs are deducted) whereas on private label products this can rise to around 13%11.
The higher margins offered by private labels allow retailers to position their own products at lower price points than branded equivalents. Given the value conscious nature of the Indian shopper, this advantage provides another strong incentive for retailers to increase the share of private label offerings. In Big Bazaar’s own stores, its private label toilet cleaner ‘Clean Mate’ now outsells Harpic, the market leading branded cleaner from Reckitt Benckiser12.
As Indian consumers become more familiar with the quality and consistency of the private label offering, they will be more open to testing it in new product categories and in higher value segments, challenging established FMCG brands on multiple fronts.
Adapting strategies to compete
Faced with the rising challenge of modern retail, there are a number of strategies FMCG companies can adopt to strengthen brand loyalty and protect margins.
Go deeper into the rural market. In spite of its rapid growth, organised retail is still a far-off prospect for much of India’s larger but more remote rural population. FMCG companies should prioritise strengthening their distribution channels to this fast-growing market. With the continued prevalence of unorganised retail in rural India, FMCG players can retain greater control over the supply chain and therefore over prices. This will help offset margin erosion in the modern retail channel.
Hindustan Unilever has long pioneered this approach through schemes like Project Shakti. The company estimates that close to 10% of its rural sales are now generated through this exclusive channel of local Shaktiammas and Shaktimaans.
Add more product lines
A multiplication of product categories and price points will help FMCG companies retain brand loyalty and capture value, as Indian consumers experiment with new products and upgrade their consumption. An increased range will also fend off the challenge from private labels.
The key to a successful private label strategy is a high degree of store brand loyalty. Despite rapid expansion, India’s organised retailers are yet to establish a high degree of attachment among customers in the FMCG segment. In fact, the number of consumers shopping at more than two stores for FMCG products rose from 20% to 36% over the last year13. By contrast, FMCG names still dominate rankings of India’s most trusted brands. Greater trust results in a greater willingness to spend on higher priced (and higher margin) products from the same brand.
It will take time for organised retailers to build the brand loyalty and production capability necessary to develop a full range of private label products. In the meantime, if they are to continue to attract footfall away from both modern and traditional competitors, their vast shelf space needs to be filled with an enticing and extensive variety of new and well-known products.
Accelerated product innovation by FMCG companies will help them stay ahead. Retailers usually launch private labels offerings in categories that have been well established by leading consumer brands. These own brand products live off their comparability with branded alternatives. By making regular changes to packaging and product features, FMCG players can impede such imitation and increase the perceived value of their own brand.
The Internet has great potential as a tool for aiding this process of product development and innovation. Urban Indians are adopting modern retail at a rapid rate but they are also spending more time on the web. FMCG players could build online platforms to co-create and test new products directly with the end user, regaining consumer insights that are increasingly captured by modern retailers. With the high rate of new product failure in the FMCG sector14, these benefits of online collaboration could be particularly appealing to FMCG brands.
Use a segmented approach to retailers
Finally, by adopting a segmented approach to retailers, FMCG brands can exploit points of weakness in a retailer’s bargaining position. The penetration of organised retail is not uniform across product categories. FMCG players can target underpenetrated areas in the product market space to negotiate effectively with organised retailers.
Some 42% of breakfast cereals are sold through modern retail and other new categories like pet food are at similar levels. Where a particular product category is underpenetrated - either by competing brands or private labels - FMCG companies can demand higher margins from the retailer.
The established business strategies of FMCG brands in India will have to adapt if they are to meet the challenge of modern retail.
However, like all developments in India’s economy, the evolution of FMCG retail is unlikely to comply with a one- size-fits-all approach or conform to the past experience of developed markets.
FMCG companies can succeed by strengthening their relationship with the Indian consumer through extending their brand’s range and reach. They can also protect margins by innovating faster and adopting a segmented approach to their negotiations with organised retailers.