DISTRIBUTION: Year of Consolidation

It's easier to be at war than to work for peace. However, if peace has to
be brokered there has to be a value proposition that those fighting for would
perceive as befitting for them. And if it's a booming domestic IT industry, as
in this case, and a low entry barrier, as in the channel business, the war has
to be pretty severe and so has to be the outcome.

Over the years, the IT distribution business in India, which overcame the
global slowdown through better planning, restructuring, improvement in processes
and, last but not the least, cost cutting, has emerged as a very competitive
business-cutthroat to a certain extent.

The result: the weak ones withered off, others moved out of the IT business,
and some got acquired or merged with the strategically stronger ones.
Interestingly, while FY 2004-05 saw some major upheaval at the top tier
distribution level, it also saw big names like Almasa, Innovative and Quantus
enter the distribution ring in India.

Besides consolidation, the increased pressure on margins also saw
distribution players shift gear to don the value addition game. What has also
changed the rule of the game is the focused approach to business and the
convergence of consumer electronics (CE) channel with their IT counterparts. The
fiscal also saw continued interest of distributors and channel partners in the
handset business, with HCL Infosystems showing the way as the biggest handset
distributor in the country.

The Year of Consolidation

With fewer options left for the resellers to pit one distributor against
another for a better deal, the channel players had no options but to streamline
their finances and manage credit better. Besides, the segment showed signs of
maturity with better credit policies. This ensured cleansing of the market with
many fly-by-night operators falling by the way side as MNC distributors got down
to business without any credit at all. The Indian distributors continued to pass
credit, but at much stricter terms with regular partners getting seven days
credit and a maximum of 14 days credit for very special partners.

The mother of all acquisitions in the Indian IT distribution business that
triggered of this consolidation was Ingram Micro's decision to buy TechPacific.
And while the industry was still talking about how mergers and acquisitions
(M&As) will be changing the distribution scenario, with companies selling
off "less margin" business to financially stronger companies so that
they can focus on high margin operations, IBM sent the shock wave. The company
decided to sell off its PC business to Chinese major Lenovo in order to
concentrate on its more profitable services business.

Margin was certainly the reason behind Ingram's decision as its profits had
been much lower than Tech Pac and Redington across South East Asia. Experts
indicate that, unlike its rivals, Ingram was losing grounds because it did not
have adequate strong practices and processes to tide over the growing trend of
"high volume, low margin game," where Tech Pac was the strongest.

Next in line was Neoteric Informatique, which decided to sell off 50% of its
stakes in the Singapore-based Neoteric Asia Pte Ltd (NAPL). The buyer was none
other than the erstwhile iron man of Indian distribution business, Prasad
Mamidana who had recently quit Ingram to set up his own venture. Redington India
came in next and decided to sell 36% of its stake to Taiwanese major Synnex.
This was followed by the Frontline's decision to merger with Accel ICIM, and
Zeta Technologies' decision to sell off its agency operation to Rashi
Peripherals.

And this trend is certain to gain momentum. Interestingly, the three biggies-Ingram,
Tech Pac and Redington-completely dominated the market with an estimated Rs
8,000 crore business being transacted in the 2004-05 fiscal. This leaves those
in the second rung with very little to chew on.

The message was clear. One, distribution in the future would lie in the hands
of those who can scale up fast to reach out more regions, either through their
own network or through strategic alliances or mergers. Two, there is more money
in services than in pushing vanilla boxes. Three, lesser number of tier 1
players meant tighter credit policies and hence the need to manage finances
better.

The Name of the Game

While increased competition saw unhealthy price war that led to a race for
volume to survive through the periodic turnover incentive, the pressure on
margins was making distribution unviable for many, particularly for tier 1
players. Instead of succumbing to the pressure, the year saw many of the top and
mid rung players adopt the "value addition" game that Tech Pac had
kicked off nearly four years back. While the company's decision to set up a
Value Division within its organization-the first of its kind for any national
distributor-was taken with a pinch of salt by many, the trend that picked up
in 2004-05 clearly indicated the foresight.

The trend surely caught on, and today majority of the national distributors-including
Ingram Micro, SES Tech, Neoteric, Iris and Rashi Peripherals-have their value
divisions. The trend is picking up at the lower level of the pyramid as well.
While, many of these companies have been adding products that required high
amount of value additions in their portfolio, others are focusing on pre and
post sales support and technical know-how on integration of the products.
According to estimates, most national distributors today generate about 15-30%
of their revenue from such value added businesses, many of them through their
separate value-division.

Specialize to Grow

The year also saw companies working towards skill enhancement with many of
them working towards specializing in specific product categories. Few others
decided to focus on gaining vertical specific domain expertise, and moved
towards setting up proof-of-concept centers and engaging certified personnel
within the organization.

The networking market boomed and more players decided to get into the
business. Storage and security solution also registered good growth with end
users focusing on data protection and storage growing high.

There were, however, others who decided to focus on providing complete
solutions and tied up with industry partners, rather than specializing
themselves to hawk their service. These companies decided to specialize more on
the marketing front, thereby emerging as lead consortium bidders in verticals
such as BFSI, government, education and BPO.

While the bigger players were busy streamlining operations through M&As,
smaller solution providers and system integrators (SIs) were joining hands to
not only reach out to newer geographies, but also to work as a consortium to win
bigger deals. With more clients' looking for an end-to-end solution, it had
become imperative for them to leverage on each other's strengths-both in
terms of sharing technology and supporting each other in their respective
geographies. This also meant more work for SIs through sub contracts from
solution providers and bigger players.

Beginning of the End Game?

Not satisfied only by joining hands with other SIs and solution providers,
the year also saw some of the SIs shift gear and jump on to the 'value-addition'
bandwagon by scaling up their operation to become end-to-end solution providers.
While this is not a new trend, the year saw many of the strong SIs, which had
embarked on the new path, completely turn a new leaf and emerge as bigger and
better entities, complete with ICT expertise. These companies-the likes of
Allied Digital Services, Ontrack Solutions, Orient Technologies, Omnitech
Infosolutions, SK International, Wysetek Technologies, Sai Info Solutions,
Accutech, SK International, KayBee Infotech, Team Computers, Nirmal Datacomm and
Lauren Technologies-clearly demonstrated the capabilities as end-to-end
solution providers.

Looking forward, it's likely that the thin line that differentiates SIs
from solution providers would disappear with most of the existing players being
forced to invest in the skill-up process, thanks to the growing competition
triggered by improving economy. Experts suggest that while M&As have become
a way of life elsewhere, the same may not happen in India as not many of these
channel players have any real value to offer. They neither have R&D
capabilities nor unique asset base for acquirers.

What this means is that while in the short-term some of the weaker players
might be weeded out, in the long run distributors might see it as a prudent move
to merge with a competitor and tap each other's strengths in a more effective
manner.

At the next level, sub-distributors would certainly be under tremendous
pressure considering the fact that none of them bring in any significant
value-add on the table except acting as stocking partners. With many of the
large stockists today looking forward to the direct marketing model, there would
be little space for such players. Resellers, on the other hand, will act as
conduits to reach the user and would continue to flourish. However, they too
would be forced to specialize in select goods and segments to command better
margins for their sustenance.

No wonder then that hardcore resellers like Mumbai-based Creative Computers
and Pacific Infotech have scaled-up to become SIs, while few others like
Radiant, SP Technologies and JayDee Electronics have graduated to become master
resellers. Many of the master resellers aspiring to become national distributors
have also been upgrading their infrastructure and logistics.

The market also saw LG Electronics kick-start the concept of regional
distributors (RDs). While the trend did not really pick up during the fiscal, it
saw emergence of some new players, thanks to the company's policy of
continuous performance evaluation. While some vendors successfully played the RD
model, there were few vendors who chose to revert to the national distributor
model for want of wider reach and lesser effort to manage them. The trend might,
however, pick up during the FY 2005-06 fiscal if other MNC brands also decide to
tread the same path.

The Era of Convergence

If the booming telecom market saw many a big distributor follow in HCL
Infosystems' footsteps to sign up with handset manufacturers in FY 2003-04,
fiscal FY 2004-05 clearly emerged as the era of convergence. The trigger: the
shift in mindset from computing to communication and now to entertainment. The
result: Consumer electronics (CE) channels have started taking up convergence
products like digital cameras, MP3 players, LCD TVs, mobile phones, PDAs and
other digital entertainment devices. Interestingly, there still remains a lot of
gap because while CE channels have moved towards selling convergence products,
the IT channel is still shying away from consumer electronics.

No wonder then, while digital cameras are moving through both IT and
photography channel routes, MP3 players, cell phones and PDAs are being sold by
IT and electronics goods players. The step in the right direction has been taken
by LG and Sony. While the former is pushing its MyPC also through its CE
outlets, Sony launched its Viao brand of laptop exclusively through its CE
outlet Sony World. The convergence also strengthened IT retailing, a trend which
started in 2002 but did not really pick up till 2004. The year saw CE channel
players investing money in this segment, with higher margins on retailed
products acting as the biggest motivator.

Mobile business, however, proved to be "de growth" for most of the
players due to changes in the market dynamics and duty structure. The only
exception was HCLI, which went on riding the Nokia wave cornering 62.3% of the
overall GSM market share. In revenue term it was 99.9% growth for HCL-from Rs
2,301 crore to Rs 4,600 crore.

'Brand' Gains Ground

The year saw the fight between assembled and branded products intensify.
This was primarily triggered by reduction in excise duty on PCs, from 16% to 8%
in January 2004, and subsequent reduction to 0% in July 2004. This made sure
that there was a substantial drop in branded PC prices. Besides, in order to get
foothold in the white box segment, Xentis triggered off a new war of price by
announcing its sub-10K PC. Celetronix followed suit with its Rs 8000 version.
Amongst the big vendors, HCLI came up with the Rs 12,990 version.

The impact was massive. While MNC and Indian brands were gaining market
share, some of the big distributors were firming up their plans for branded PCs.
While Singapore-based eSys decided to set up its assembling facility in Delhi
soon, Raipur-based Merlin Multitech decided to soft launch its own brand of PCs,
laptops and UPS, with the full rollout expected in December 2005.

Unfortunately, many of the disti brands-from Ingram's Vesta to Rashi
Peripheral's RPTech and Aditya Infotech's foray into the peripherals market
with the launch of its Crusader brand-failed to impress. While Ingram decided
to revamp its Vesta brand by expanding its product line, Rashi RPTech PC
continued to remain as the niche brand of sorts with the company focusing only
at the government sector.

An exception to the rule was the eSys initiative. The company, which is
primarily a component distributor, is aiming at the entry level PC as just a
packaged bundle of these components, with the objective of commoditizing the
entry-level white box. The company has invested in two captive assembly plants,
one each in India and Dubai and also working with two contract manufacturers.

Then, there were players like Kolkata-based Syntech Informatics, which
decided to introduce its own brand of MP3 players, USB flash drives, UPS, plasma
TVs and air conditioners besides PCs and laptops. The company also decided to
stop selling IBM's products to take it a step further, and is mulling over
getting out of the reselling business, if sales of its own products moves up
substantially.

The fiscal also saw another Kolkata-based distributor of PC components and
peripherals, Supertron India, enter the USB and accessory segment with the brand
name 'Supercomp'. The company also has plans to launch its own brand of
notebooks but is waiting for viable pricing structure to maintain a price
differential of 25% over the MNC brands available in India. Supertron plans to
import knocked-down components of the notebooks and assemble them at its units
in New Delhi and Kolkata.

Overall, while the balance between the assembled and the branded PC seems to
be leveling off at a 50:50 ratio, it would need, beside financial robustness,
the ability to scale in size and R&D efforts to meet the aspiration of
low-cost, no-compromise PCs.

New Frontiers

Another trend that has been talked about over the last two years was the
emergence of smaller towns and cities as potential markets. The fiscal saw real
penetration happening in the 'B' & 'C' class cities with vendors
focusing on these cities for the first time by designing special schemes.

The year saw both Distis and vendors starting to create hubs to tap these
markets. While the 'B' & 'C' class cities showed year-on-year growth
between 60% to 70%, the metros were limited to 25% to 30%, albeit at a much
larger base. On the profitability front, however, both fared equally.

While majority of the national distributors have created their presence
across the country, the top 12 players together cover only 30-40% of these
growing cities. Entering the new markets also helped many mid-tier distributors
to improve on margins and retain customers to a large extent.

Shubhendu Parth