Source and Grow

Unlike developed countries where the retail industry is already mature, the

Indian retail scenario is still taking shapeat a faster pace than ever before.

With margins getting squeezed on account of increasing operating costs and

taxes, and competition for customers intensifying, profitable growth is the

biggest challenge for Indian retailers. The focus on growth-oriented product

market strategy needs to be balanced by an efficient and reliable operating

engine that eases pressure on costs and meets the scalability and flexibility

requirements of a growing company. We believe that today alternative sourcing

strategies to source back-office capabilities is a key strategic lever available

for retailers.

Organized Retail



The organized retail sector in India is expected to grow sharply over the

next 5-10 years. The penetration at around 3% is expected to cross 8% by 2011

powered by a 40%+ growth of the segment reaching a size of over $40 bn. Rising

real income, increasing urbanization, availability of quality real estate,

emergence of profitable retailing formats, regulatory environment permitting FDI

in the back-end, and huge opportunity seen by domestic and global retail players

is driving a significant growth in the organized retail.

To tap the growth opportunity, Indian retailers are driving competitive

product-market strategies based on formats, locations, customer segments, and

product categories. While companies like Bharti and Reliance have committed

significant capital in the range of $2-5 bn over the next five years, others

like Vishal Group have recently raised capital by going public to drive

aggressive growth plans.

However, in this intensely competitive hyper growth environment, margin

expansion to meet profitability targets is emerging as one of the biggest

challenges. Uncontrollable factors are driving costs. According to industry

analysts, energy costs are as high as 3% of sales in some cases. Similarly,

service tax on the real estate has added to the space cost burden at a time when

Indian retailers are already struggling with high rentals. As a result, space

costs have reached as high has 10% of sales. Shortage of quality talent is also

forcing companies to witness significant churn in their ranks. While companies

like Future Group and Bharti have created alliances with training institutes and

colleges to tide over manpower problems, this continues to be a concern and is

likely to constrain growth plans of the industry.

Under these circumstances, retailers focus on growth needs to be matched by

a confidence in the ability to deliver through an efficient, scalable, and

reliable back-end.

Strategic Lever



Given the imperative of profitable growth, we believe that Indian retailers

can benefit by evaluating alternative strategies to source capabilities that are

not core to their main business.

Globally, retailers are increasingly adopting sourcing strategies (Sourcing

vs Traditional Strategies) to respond to cost and competitive pressures.

While the retail environment in India is less mature as compared to developed

markets, there are learnings that Indian retailers can adopt from these global

trends. Several global majors like Tesco, Carrefour, and Starbucks, who are

entering or planning to enter India, have already adopted sourcing in multiple

ways.

Sourcing non-core activities can help retailers in more than one ways. At

strategic level, it helps release management bandwidth at the C-level, so that

they can focus more on their product-market strategy and customers. At

functional level, sourcing helps provide access to existing high-grade talent

and technical know-how of the supplier, without the retailer needing to invest

huge capital into building these skills internally. This also saves the retailer

the recurrent cost of training and recruitment, yet benefiting from the best

practices followed by sourcing vendors developed out of their experience with

global retailers. This is a significant area where we feel sourcing can help

retailers relieve operating overheads. Further, it also helps build a higher

employee morale and retention, since the supplier can offer career and

opportunities in their core businesses especially seen in IT where companies

are struggling given their inability to provide careers.

Especially new retailers can benefit by leveraging an outsourced back-office

since it reduces their time to market, streamlines operations, and reduces cost

of their businesses due to limited cost of learning the how of these

activities.

Above all, sourcing helps retailers release precious capital invested in (or

required for) non-core activities, which are taken up by the supplier investing

in back-office infrastructure. The released capital can then be used for key

growth drivers such as customers, inventory, brand-building, and, of course, new

stores. Unlike in the past, today there exist innovative arrangements that

retailers can consider to maintain flexibility under evolving conditions. For

example, a Build-Operate-Transfer (BOT) arrangement allows the retailer to

leverage suppliers ability and willingness to invest capital while ensuring

that a future ownership of the back-office is still an available option to the

retailer.

Sourcing Opportunities



Creating a reliable, fail-proof, and efficient IT capability is key to the

success of modern retailers. A retailer typically spends between 1.5-2.5% of

revenues on IT, covering areas like supply chain integration, point-of-sale

(POS) systems for store operations, merchandizing systems, customer service, and

CRM, inventory management, and warehousing solutions. This is in addition to the

systems for other support functions like HR, finance, etc. Some examples of how

outsourcing can add value to the IT function include increasing retailers

online capability through sophisticated and current systems to managing complex

and diverse infrastructure spread across stores and the entire supply chain.

Sourcing IT externally allows companies to impact their bottom line through

more efficient IT operations and provides the ability to remain current on

technology by leveraging supplier investments. In addition, given the cyclical

nature of the retail business, outsourced capability provides more flexibility

to retailers in managing peak load requirements. Investment in capability to

manage peak load requirements can be an expensive proposition as more than 50%

of annual sales occurs during these periods.

Everest experience suggests that suppliers can deliver between 10-30% impact

on IT costs depending on the current environment and maturity. With margin

pressures, this straight impact on EBITDA of anywhere between 10-50 basic points

can be a significant advantage (How IT Outsourcing Impacts EBITDA). The cash

created from lower operating costs for IT and reduced capital investments can

facilitate investments in a new store for every 20-30 stores of the company.

Given the maturity of outsourcing within retail, suppliers, including many

Indian majors, are offering specific IT products and services to support retail

front-office and back-office functions. Having worked with global retailers,

suppliers have developed requisite domain expertise to service end-to-end

requirements for Indian retailers. Some major players offering in-depth retail

IT offerings include IBM, Accenture, TCS, HCL, Wipro, Infosys, and Satyam. As a

measure of their focus on the retail segment, major Indian suppliers derive as

much as 5-15% of their revenues from retail.

Other Non-IT Functions



While IT remains the dominant opportunity, there are other business

processes where retailers have used outsourcing (Outsourcing in Retail is

Dominated by IT). Retailers are increasingly outsourcing finance and accounting,

customer care, and HR functions.

The set of functions being outsourced by retailers are driven by a range of

considerations, including value creation potential, risk in an outsourced

environment, and strategic preferences of retailers. In one of Everest North

American clients, the management believed that 24x7 full service call center was

a key differentiator and a key value proposition for its customers. While the

200-store retailer outsourced this function, the chosen outsourced solution took

its strategic importance into consideration.

Choosing the Strategy



Given their profitable growth imperatives, retailers need not invest time,

effort, and capital in setting up the entire back-office or IT support required

to ramp up and sustain operations. Scalable alternative sourcing models exist

that can significantly accelerate time-to-market and reduce ongoing management

effort.

Further, companies should evaluate the alignment of the sourcing strategies

with their business objectives irrespective of their size, maturity, or current

sourcing model. As an example, new retailers can either invest in consolidating

distributed back-office capabilities into shared service centers and scaling

them over time, or partner with outsourcers to secure scalable operating

capacity in line with growth. Relatively bigger retailers with existing shared

services capability of significant size can further improve operational

efficiencies or explore options to commercialize their investments to generate

cash for investment in their core business.

Though sourcing can be a viable option for Indian retailers, they must

address key questions to scientifically evaluate suitability of sourcing for

their specific business needs and select appropriate sourcing model. Some of the

key questions include: What are my business objectives from sourcing, today and

in the future? What are my peers and competitors within India and globally

doing? What options exist today and how do they compare in terms of risk to my

business and potential value delivered? And, how should I chose a partner in

growth to create a win-win relationship while maximizing value and minimizing

risk?

A well thought out sourcing strategy can help ensure that Indian retailers

stay on course with their growth agenda and create shareholder value.

Vikash Jain and Punish Mishra



The authors are engagement director and senior consultant, respectively, of the
Everest Group