The Global Economic Impact of Private Equity Report 2008 - World ...

sector. For example, nearly all of the well‐known Indian retailgroups, including the Big Bazaar Group, Pantaloon Retail,and Shoppers’ Stop, have been backed by ICICI Venture.Not coincidentally, this sector exposure reflects the group’sstrategy to capitalize on the domestic regulatory environmentthat until recently has heavily protected the rapidly growingretail sector against foreign investment.India’s retail sectorIndia’s retail sector is vast yet inefficient and underdeveloped.Retail currently accounts for about 10% of India’s GDP,making it a $250 billion industry and India the world’s twelfthlargest retail market. Yet, in 2007, only 3% of this market wascomprised of organized retail (chain stores). 3 The remaining97% consists of more than 15 million tiny “mom‐and‐pop”shops (called “Kiranas”), with an average space of 100square feet, selling groceries and household products atwhat is known as the “maximum retail price”. 4But the sector’s massive inefficiency and under‐developmentis poised for dramatic change. According to a recent study, 5India’s aggregate consumption is projected to quadruple in thenext 20 years, making the country the fifth largest retail marketin the world. Moreover, the middle class will swell from thecurrent 50 million to almost 600 million by 2025, creatingexceptional opportunities for astute retailers who are able tocapture part of this huge market.Despite this enormous potential, however, the Indian retailsector is still fraught with regulatory and political risk. Untilrecently, foreign direct investment was strictly limited inIndia’s retail sector. While new regulations in 2006 permittedmajority foreign ownership (up to 51%) in retail businessesfor the first time, such investments were still limited tosingle‐brand stores. In addition, even domestic playerscannot escape the political pressure from the 15 millionstrong Kirana operators who comprise the second largestemployment sector in India, just behind agriculture. Recently,for example, when large Indian business groups such asReliance and Birla entered the retail market, they weresubjected to frequent store shut‐downs caused by(sometimes violent) protests.Nevertheless, the overall outlook for Indian retail is bright.“Our view is that India’s retail sector sooner or later will followthe trend in China. The shift towards organized retail isinevitable,” said Deshpande, who has been responsiblefor most of the group’s investment in the sector. This viewseems to have been borne out by the huge amount ofinterest shown by established Indian business groupsas well as foreign retail operators. 6Subhiksha – a truly indian retail modelIndian entrepreneur R. Subramanian (RS) founded SubhikshaTrading Services Private Limited (henceforth Subhiksha,pronounced su`biksha) in 1997 in his hometown of Chennai,a city of 8 million inhabitants on the east coast of India.The energetic, fast‐talking RS, as he is known, has anengineering degree from the renowned Indian Institute ofTechnology, Madras, and he graduated at the top of his classfrom the Indian Institute of Management, Ahmedabad in the1980s. Preferring to “do something in front of my own people”,RS decided to stay in India at a time when many fellowgraduates were choosing to go abroad. He quickly became asuccessful entrepreneur, founding two ventures that developedpioneering financial instruments for the Indian marketplace. 7 In1997, RS launched his third venture, Subhiksha, even thoughhe had no experience in the retail sector.The carefully chosen brand name “Subhiksha” means “giverof good things in life” in Sanskrit and was an apt name forthe company’s philosophy. Subhiksha’s business model wasto sell everyday necessities and staples, such as food,groceries, and commonly used pharmaceuticals at asubstantial 8%‐10% discount to the “maximum retail” pricecharged at Kirana stores. For the average Indian middle-classfamily that spent about 50% of its total budget on groceries,a saving of this magnitude was significant. The uniqueness inSubhiksha’s business model is its hybrid feature adapted tothe changing Indian retail market: while its heavily promoteddiscounts resembled Wal‐Mart’s “everyday low prices”, itsstore format was closer to 7‐eleven’s convenience‐storemodel. Subhiksha’s stores are small, ranging from 1,000 to2,000 square feet in floor space, and are located in the heartof residential catchments with a 1‐2km radius.This distinctive retail model was the outcome of a three‐monthstudy of Subhiksha’s target customers that consisted of theburgeoning Indian middle class. As Deshpande explained:“First, the middle class shopper doesn’t have a car to dodestination shopping. Second, Indians are obsessed withthe freshness of their food and prefer frequent shopping. (Ithelps that 85% of the women don’t work.) Third, frequentpurchases in small amounts also helps households bettermanage cash flow… In my view, Subhiksha’s model, whichcombines the front‐end friendliness and familiarity of aKirana, and a back‐end efficiency of a large discount chain,makes a lot of sense and is a meaningful way to address theIndian retail market.”But not everyone was convinced that the model wouldbe successful. “I was questioned so many times about this3Statistics on India retail sector are compiled from “Gently does it – Indian retailing”, The Economist, 11 August 2007; “Setting up shop in India– Retailing”, The Economist, 4 November 2006; and “Coming to market – Retailing in India”, The Economist, 15 April 2006.4In India, producers set the maximum retail price for goods. Kiranas seldom deviates from this price, effectively reducing competition and differentiation.5“The Bird of Gold: The Rise of India’s Consumer Market”, McKinsey Global Institute, May 2007.6Reliance Group has launched Reliance Fresh, a chain of grocers. The Tata Group and the Bharti Group have formed joint ventures with Australia’sWoolworths group and the US giant Wal‐Mart respectively to enter into retail business.7RS’ first company did asset securitization in India in 1992, and his second company offered financing for small investors to make IPO investmentsin the booming Indian stock market in 1994.144 Case studies: ICICI Ventures and SubhikshaThe Global Economic Impact of Private Equity Report 2008