Smart Spending

The Indian retail sector is highly fragmented as compared to other developed
and developing economies. Therefore, there is a great potential for the
organized retail industry to prosper in India, as the market for final
consumption is very large.

The retail industry operates at three parallel levelsthe formal sector, the
informal sector, and the fair price shops under the governments public
distribution system. With the urban consumer being exposed to international
lifestyles, education and more demanding than ever, the modern and organized
retail formats have been registering a stupendous growth over the past five
years (2001-2006).

While modern formats tend to have higher levels of sales per unit of space,
stock turnover and gross margins face lower levels of net margin as compared to
traditional formats. Food and beverage, clothing, footwear, consumer durables,
household goods, and leisure are some of prominent sectors where modern format
of retailing has strongly made its presence felt. Telecom and healthcare are two
other flourishing industries that are making inroads into the Indian market.

Given the complex nature of the retail business owing to its
capital-intensive operations, global supplier base and competitive pressures,
effective management of sourcing, procurement and supplier collaboration becomes
important to the business.

Since the costs of goods sourced (COGS) is 70-80% of the revenue, most retail
companies are confronted with cost management challenges such as developing a
blueprint for sourcing and procurement, prioritizing actions, achieving
sustainable sourcing savings, driving procurement compliance, and finally,
managing the global supplier base.

Getting Organized
The large scale spend warrants that organized Indian retailers become more
organized not just in terms of infrastructure, demand management/planning
inventory or automation, but, more importantly, in terms of their operations and
purchasing functions. It is critical for Indian retail companies to adopt
sourcing and procurement practices at an early stage of their rollout to
establish themselves and boost bottomline growth by increasing operational

Adopting best practices in the nascent stage of their business is not only
easy from a change management perspective, but also would provide them the
desired framework to address their key challenges first time right. In fact,
Indian retail companies can take a cue from the effective best practices and
technology tools (in sourcing and procurement) adopted by global retail giants
like Walmart, Target, Staples, CVS, Office Depot among others.

Critical Concerns
Three key challenges faced by large organized Indian retail companies are
that of business profitability, capitalizing private labels and driving holistic
process efficiency.

Business Profitability: Most large organized retail formats would typically
be operating under wafer thin margins, in few cases lower than 4%. Often,
despite the projected scale, retail businesses face severe challenges in meeting
the profitability targets due to the capital-intensive nature of the business
and price sensitive market.

A well laid out sourcing and procurement strategy can help retail companies
to improve profitability through effective sourcing (especially low cost country
sourcing), bringing in efficiency into the supply management process through
online collaboration with suppliers, bringing in better visibility to the
expenditure areas, faster delivery, and increased operational efficiency.

If we look at the key spends for any large organized retail outfit, they can
be broken down into three key broad areas: merchandise spend (70-80% of the
overall spend), non-merchandise spend (20-30% of the overall spend) and Capex
spend (depending on the business plan).

Effective sourcing and collaboration can also allow sourcing professionals to
expand their sourcing categories across departments, build closer relationships
with key suppliers and negotiate more advantageous contracts. This reflects both
on purchasing merchandise and non-merchandise items. This can in turn lead to
huge savings in sourcing of Capexlike furniture/fittings, services, carpeting,
and temporary labor.

Based on our estimates retail companies can save up to 3-8% on their
merchandise spend, 10-20% on furniture, fittings, mechanical systems, electrical
systems; 10-15% on general contracting and labor related services; 8-10% on
logistics cost, 7-12% on packaging items and 15-25% on Capex items using
effective sourcing and procurement policies.

Capitalizing Private Labels: Private labels are emerging as a strong market
for developing economies. To provide a better perspective, it accounts for 40%
of Wal-Mart sales ($126 bn), 50% for Tesco ($36 bn) and are eating into a larger
chunk of the organized retail sales in developed markets. While Indian brands
such as Stop from the department chain Shoppers Stop and Fresh and Pure
from Food Bazaar have become fairly strong labels, companies are not yet at
their best when it comes to driving higher margins from private labels.
Effective sourcing plays a critical role since it involves identifying the right
suppliers across the globe, minimize cost of goods sourced, and get desired
quality and market private label at higher margins.

For example, a home furnishing retailer has successfully sourced from low
cost countries like Bangladesh, Sri Lanka, China among others and has
successfully used private label as a key profit driver.

Driving Holistic Process Efficiency: Most retail companies have relied
heavily on the demand management, demand planning and ERP systems to bring in
operation efficiencies to their processes. However, these solutions often do not
cover critical spend management needs, ie, sourcing, procurement, contracts
management and contracts compliance both for merchandize and
goods-not-for-resale spends.

Based on our experience, Retail companies typically are unable to capture
2-5% of the negotiated savings due to lack of ordering compliance at the
regional/store level, as they tend to miss out on volume discounts, agreed upon
pricing discounts, and loyalty bonuses.

Automation of the end-to-end sourcing and procurement process can not only
drive significant savings through item bundling (demand aggregation at the time
of order), but also through improved compliance (capturing volume and tiered
discounts). Additionally, the automation results in reduced G&A spend at the
store level by providing easier to use ordering tools and improved turnaround
and reconciliation time.

Collaboration with the supply base plays a very important role in helping
retail companies to achieve holistic process efficiency as they form the
critical part of the supply chain. Retail companies have to be nimble footed and
should try and create an infrastructure which would dramatically lower their
internal costs as well as bring down the cost of doing business for its

Based on our experience, a structured framework that could bring in buyers
and suppliers to a common platform for collaboration and transaction management
would not only bring down the operating costs for the retail companies (through
effective PO management, invoice/discount management) by 0.5-2%, but also
dramatically bring down the sales/marketing costs for the suppliers. This would
drive efficiencies right across the supply chain and would have a long-lasting
impact on the profitability for the retail companies.

In short, an effective sourcing and procurement framework (spend management)
enables businesses to automate key processes in a single, integrated manner
providing transparency, visibility and operational compliance required to fully
source, manage and leverage spend. Keeping in mind the challenges facing the
retail segment, we can see that spend management could deliver the much needed
additional percentage points to the bottomline.

T Sivakumar
the author is group director of Ariba India

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