Global Business 3rd Edition by Mike Peng

Exercise 67

Do the benefits of foreign direct investment (FDI) in the Indian retail industry outweigh its costs?
The Indian Retail Industry
India has the world's highest density of retail outlets. It has more than 15 million outlets, compared with 900,000 in the United States, whose market (by revenue) is 13 times bigger. At present, 95% of retail sales in India are made in tiny independent momand- pop shops, mostly smaller than 500 square feet (46 square meters). In Indian jargon, this is known, quite accurately, as the "unorganized" sector. The "organized" sector refers to more modern supermarkets and chain stores. The organized sector only commands 5% of the country's $435 billion retail sales. In India, the retail industry is the largest provider of jobs after agriculture, accounting for 6%-7% of jobs and 10% of GDP.
Given the two distinct groups of outlets, competition primarily takes place within the unorganized sector and within the organized sector. Customers tend to be price sensitive and purchase in small quantities. The mom-and-pop shops are too small to negotiate good deals with middleman companies such as wholesalers. But the majority of Indians shop at momand- pop shops-often because of a lack of choice. Organized outlets simply do not exist in many rural areas. Because of the scarcity of outlets, competition among supermarkets is relatively tranquil. However, it is heating up. Reliance Group, one of India's largest conglomerates, is now making huge waves by investing $5.5 billion to build 1,000 hypermarkets and 2,000 supermarkets to blanket the country in the next five years.
Gradual Opening to Foreign Direct Investment (FDI)
With a booming economy, a fast-growing middle class, and fragmented local competitors, this industry is the world's biggest untapped retail market. Not surprisingly, foreign giants such as Wal-Mart, Carrefour, Metro, and Tesco are knocking at the door trying to expand the organized sector. However, here is a catch: The door is still officially closed to FDI in this industry. Ever since the 1991 opening to FDI brought India into the global spotlight, investing in India has become one of the top items on the corporate to-do list of many multinationals. Yet, there are industry-specific restrictions, and the retail industry is conspicuous in being one of the last four industries still officially closed to FDI-the other three being the more sensitive atomic energy, gambling, and agriculture.
Given the Indian government's and the public's general appreciation of the contributions made by FDI, the retail industry, according to an Economist editorial in 2011, is now "the most glaring example of the need for foreign investment." One of the leading arguments is that super-efficient retail operations will enhance efficiency throughout the entire supply chain. At present, about a third of fruits and vegetables spoil while in transit, a catastrophe in a country where so many go hungry. In countries with more modern retail systems, less than a tenth is lost.
For years, a side door has been open to FDI. Until 2011, foreign firms could take up to 51% equity in singlebrand shops that sell their own products, such as Nike, Nokia, and Starbucks. Foreign firms could also set up wholesale and sourcing subsidiaries that supply local mass retail partners. In 2006, Australia's Woolworths started to supply Croma stores owned by Tata Group. In 2010, Wal-Mart teamed with Bharti by operating nine Best Price joint-venture wholesale stores. But until November 2011, FDI in multi-brand stores (such as supermarkets) had been banned.
The Political Storm Over FDI in the Retail Industry
To attract more FDI, the Indian government in November 2011 announced that foreign firms could now own 51% of multi-brand retailers (up from zero) and foreign firms' stake in single-brand retailers could now reach 100% (up from 51%). The reforms would be very limited-only to be implemented in 53 cities with a population of more than one million. Consumers would benefit from increased competition. The shares of listed local retailers soared, on speculation that they might be bought out by foreign firms. Farmers would gain from greater investment in the supply chain. Currently farmers have little bargaining power. They sell to a wholesale market, which dictates prices. The wholesaler then sells the produce to another middleman, which further passes the produce to a distributor. By the time food reaches the consumer, it will have been marked up three to four times, but nearly all of that goes to various middlemen, not farmers. Easy profits provide little incentive for middlemen to enhance efficiency and invest in modern supply chain (such as refrigerated storage), and food spoils along the way. To attract farmers, foreign retailers would have to offer higher prices. Wal- Mart set itself a target of increasing farmer income by 20% over five years. Cost-conscious foreign retailers would then invest in modern supply chain to minimize food spoilage.
A huge political brawl erupted after the announcement. Many shopkeepers, supported by middlemen, protested against the alleged onslaught of multinationals and cited the controversial "Wal-Mart effect" being debated in the United States and elsewhere. Interested in shopkeepers' votes, the government thus faced a dilemma. In December 2011, a mere two weeks after the announcement of the retail reforms, a humiliated government announced that it would suspend the reforms that would bring lower prices for consumers and better prices for farmers. The incumbents won the day. However, the reforms were "suspended," not "cancelled." So stay tuned for the evolution of FDI in this industry.
Case Discussion Questions
From an institution-based view, why is the opening of this industry to FDI such a political issue?