‘Big Retail has an incentive to say everyone has miscalculated demand’

Not everyone grows up wanting to become an academic, but Nirmalya Kumar, professor of marketing, director of Centre for Marketing, and co-director for Aditya V Birla India Centre at the London Business School, did. “In a sense, I never really made a decision to get into academics, because from the start, all I ever wanted to be was an academic,” says the author of Marketing as Strategy, published in 2004. He calls himself “a Calcutta boy,” having been born in Delhi but grown up in the eastern city. Kumar spoke to Vivek Kaul on how there’s much Indian retail is yet to see, and on the threat to traditional distribution systems and private labels.

You have talked about commoditisation of products in your book. How does a company tackle something like that?
Basically, the problem today is that the innovation cycle is very short. So, any new introduction is copied very fast. Hence, the innovation has to be such that offering that product or service requires you to set up an entirely different value network because then, it is very difficult for people to copy.

Because they can’t just copy the product, they have to copy the entire value network. And that’s very difficult. Or you follow a model of continuous innovation, so that yes, they copy you, but you are always working on the next level of innovation. So it’s very hard for them to keep copying.

Does that really happen?
Yeah. Take Gillette blades. It’s continuous innovation. They start with one blade, and then introduce two blades, three blades, four blades. So it is a continuous innovation cycle. Even with the Apple iPod or iPhone… every other phone company is now copying their interface but they have now moved to the next generation. Even Sony has the same kind of model.

The Indian IT sector has till now  basically been playing the labour/cost arbitrage game. Do they need to do things differently now?
The cost arbitrage model is still relevant. But if you look at all the top companies, especially the top six players, I think that they have all recognised that the cost arbitrage position is not the only position they can have in the future.

So they have all added front-end consulting capabilities to ensure that they can move into the higher value-adding part of the value chain. They want to compete with IBM and Accenture, but they don’t have the front-end capabilities to compete with them.

So they are doing these small acquisitions, which are front-end consulting companies. This will bring in those competencies, which will allow them to go to companies and say it’s not about selling you cost arbitrage where you give us a small part of an IT project which we then run, but it’s about us, solving a problem, running your systems, which is what IBM and Accenture are doing.

They are not just taking over a project and saying that we will do this project, but they are saying that we’ll run your IT system. Even if you are in a hundred countries, leave the IT to us. But that requires a lot of distributed capabilities across the world. And if you look at the acquisition strategy of TCS or Infosys or Wipro, it is all about adding those front-end capabilities which will allow them to be full service provider of IT services to the major MNCs, who want to get it like what we call Apps on Tap, they don’t want to own the thing, they just want to have the application available whenever they need it.

How much time would it take them to become a major player?
This is a decade-long transformation because the entire solutions mindset is different from what Indian IT companies have right now. In a solutions mindset, you start off thinking, “What is the customer’s problem? And how can we solve it in a serious manner?”

On the flip side, the likes of IBM and Accenture have now got huge presence in India.

So they are also playing the cost arbitrage game?
No. Every company has to source the global supply chain from wherever it’s cheapest and most available. So for IBM and Accenture, when they have a capability in India, it is because that part of the value proposition that they are providing to the customer is cheapest delivered out of India. So, being a solution provider means I am wherever my customer is with front-end capabilities and the back-end global supply chain I put in a place where it is the most efficient, the best quality and the least cost.

And Indian companies have their back-ends in place already?
Exactly. It is very interesting. So the game is that the Indians have their back-end ready and are competing to get the front-end competency. The IBMs and Accentures of the world have their front-end capabilities and they are racing to get the back-end efficiencies that the Indian companies have.

You have been talking about the traditional distribution systems not working anymore. Why do you say that?
In the developed world, customers are moving very rapidly online and the traditional distribution systems are very offline distribution systems. So the challenge over there is, how can we have an online distribution and integrate it with our existing offline channels and not cause too much conflict, while making this transition?

For example, 40% of all books today are sold on www.amazon.com. How do you deal with that? The second transformation that has taken place is that the distribution channels have moved from relatively regional and local players to global distribution systems, which means that the large retailers today account for a large portion of sales.

So, for a company like P&G, the top 10 retailers account for 40% of the worldwide sales. In America it is even more concentrated than that. So companies have to meet this new reality and they are doing that.

In India, the interesting thing that has taken place in terms of transformation of distribution channels is this thing about the organised retail sector. And this sector is growing fast. Again, the competencies required to deal with the organised retail sector and manage large retailers is different from the competencies required to deal with mom and pop retailers. You need a totally different set of competencies. You need a different distribution system. You need different IT. That’s the transformation I was talking about.

But of course, while you make that transformation, 90% of your sales are still coming from mom and pop stores. Again like in the developed world, we want to move online but we don’t want to antagonise our offline people in the short run, even though we know they are dying. And that is a delicate balancing act. How do you create the future while still maintaining the present?

I don’t want to lose my present profitability but I want to make sure that I am ready for the future. You can either be too fast and end up antagonising the current distribution channels, who are giving you most of your sales, or you end up being too slow, in which case you end up being a dinosaur.

What are companies doing about it? 
Basically they have a very fair system of dealing with the two systems. You tell everybody, these are our prices, whether you get a lower price or not depends on what you do for us in terms of reducing our cost as a supplier. The larger retailer can get a bigger price discount, but then they have to order full lots. So it’s cheaper for the company to do the logistics.

Maybe they can pick up the stuff from my warehouse. If the small retailer or a mom and pop store wants to do the same thing, he can get the same price. So what you do is set up a very fair system. And that’s how Procter & Gamble and other top companies are doing it in the developed world.

Music is one business where traditional distribution systems have gone for a toss totally. How do you see the business changing?
The traditional business model of the music industry is totally dead, in the sense that nobody is going out and buying CDs anymore. Every year, the number of CDs sold is declining.

So, either you are online and you sell your music through that, i.e. digital distribution, or you give away your music for free and you make money on the ancillaries like concerts. In concerts, there is merchandising. That is the best thing. You make your money by selling your play rights to radio, television, hotels, advertising etc. That’s where you make your money.

Do you see that happening in an Indian context?
Yeah, it will happen, because in India piracy is higher. So the old model for selling boxes for a digital product is dead and it died faster than I thought it would.

Do you think big retailers in India have overestimated the size of the market?
No. The market is 100% of the market. It’s not like it is a small market. But capacity never comes online at the same time as demand because you have to add capacity in chunks, whereas demand goes up as a smooth function.

Capacity comes in chunks and people generally add capacity at the top of the cycle, rather than at the bottom of the cycle because at the bottom of the cycle, everybody is hurt and nobody knows when things will turn around.  I cannot set up a cement plant every time there is a 100-tonne more demand in the country, because when I set up a cement plant, I set up a 2 million tonne cement plant.

There will be times when there will be a shortage and there will be time when there will be lots, right? So this boom and bust always takes place. And it’s the same thing today. There is a lot of property development going on because people add retail stores in chunks. The demand will catch up to that, though for some time, all the retailers will be hurt because maybe they have built too much. And then there will be shortage and so on.

Kishore Biyani recently said in an interview to Wall Street Journal, “I was an eternal optimist; now I have become a realist. Everybody has miscalculated…”
Since he is the first mover, he wants to say that because that is going to reduce the number of new stores coming up. If I am an existing player in the cement industry, I will feel that all these cement companies are mad because they are adding all this cement capacity.

They are going to hurt like crazy. It’s a part of the game. The existing players are going
to articulate for their self-interest and they don’t like new competition.

As organised retail gets bigger, do you see the power of private brands increasing?
There is no doubt. As the share of retail in the country consolidates, the share of private labels goes up. This is a fact that has been seen in every country because to develop a good private label you need to have a certain size. Without a certain size of the retail chain, it doesn’t make sense for you to spend money to develop and launch a new private label.

So you are saying that organised retailers initially have to sell big company owned brands, but as they grow the share of private labels increases?
If I develop a new product as a private label, there is a fixed cost that comes with it, whether I sell it to one customer or one million customers the cost is the same. When I advertise it, it’s a fixed cost. So unless I have a certain size, I cannot recoup that investment.

In the West, which are the biggest private label markets?
Switzerland is the biggest private label market, followed by the UK and Germany.

Which are the biggest private label products?
One of the biggest private label players in the world is Tesco in the UK. In fact, the best selling MP3 player in the UK is Dixons, which is a private label, and not Apple iPod. Dixons is an electronics retailer and their market share is more than iPod. It is interesting because you think that there can’t be any competition there.

So Dixons doesn’t sell at any other store?
Dixons MP3 player sells only at Dixons stores. They have hundreds of stores. Of course, they sell the Apple iPod, too. You can buy an MP3 player from Dixons during Christmas for £5.

The world over, a lot of FMCG firms have been cutting down on the number of brands. Hindustan Unilever cut down the number of brands from around 100-110 to around 30. But since they cut down on the number of brands, they have more or less stopped growing…

See, when you make this transition and cut down the number of brands, you will lose out on sales, and you know that. This strategy is about increasing profitability in the short run and increasing sales only in the long run.

But is that happening? It’s been almost eight years since HUL started implementing this strategy?
I don’t know about HUL. But worldwide, no doubt it has worked because what happens is that with large retailers you cannot support weak brands. So there is no point in having weak brands. You will not make any money because the retailers are very clear — “We will take the number one brand, we will take the number two brand, but after that we will take our private label.” For brands, number three to ten, if they want to be on the shelf, it’s a question of who gives the biggest margin to the retailer.

So if you are number three to ten, you have to give away any surplus you have to the retailer to stock you and so making money on the brand becomes difficult.

As organised retailers become bigger in India, will this strategy be at work?
Yeah, right now, it might be a bit early. So HUL might have jumped the gun a bit. But with the big retailers coming in, this is the only strategy that will work. As a weak brand, how do you become strong? You need to have more innovation and more advertising.

But if your sales are lower than number one or two in your category, you cannot afford to have more innovation and more advertising spend. We find that except for the top two brands in a category, the profitability of all other brands is declining. Unless of course if you are a premium niche brand.
 k_vivek@dnaindia.net