Retail in India: Capturing the Opportunities of a Complex Consumer Class
May, 31st 2008
According to a McKinsey report, India's consumer goods market is expected to reach $400 billion by 2010, which would place it among the five largest markets in the world.
Yet few subjects elicit both optimism and skepticism as much as the Indian consumer does. To the optimists, India represents a huge, untapped middle market, critical to any company with global aspirations. To the skeptics, India is still too poor by global standards -- with most people living on less than $1 per day -- for mass-market retailers to rush in.
Members of a panel titled, "Retail & Consumer Technology: Selling to the New Indian Consumer," at the recent Wharton India Economic Forum suggested that, broadly speaking, both the optimists and skeptics are right. However, generalizations about the Indian consumer can be misleading. Trying to connect with consumers on an "Indian" level is a mammoth task. For one, India is a diverse country, with 23 official languages and more than 1,000 dialects.
Although attitudes have shifted toward consumerism, being individually poor but collectively rich fundamentally differentiates India from developed markets. Despite having a large consumer base that is growing steadily, the market is complex and the propensity and capacity for Indian consumers to spend depends on a unique blend of price and value. According to the panelists, the companies -- domestic or foreign -- that understand this complexity will be the most successful at selling to Indians, and stand to reap enormous benefits of scale.
Understanding the Indian Consumer
Sunil Dutt, head of Samsung Mobile India, opened the panel discussion with a quote from India's first prime minister, Jawaharlal Nehru: "India, poised as she is, will either account for a great deal, or nothing at all." India's economic growth has accelerated significantly over the last two decades, along with the spending power of its citizens. Real average household disposable income has roughly doubled since 1985. With rising incomes, household consumption has increased, and a new Indian middle class has emerged.
As Indian incomes rise, the shape of the country's income pyramid will also change dramatically. More than 291 million people will move from desperate poverty to a more sustainable life, adding a number of first-time consumers to the market. While much of this new wealth and consumption will be created in urban areas, rural households will also benefit. According to Dutt, "Indian spending patterns have evolved, with basic necessities such as food and apparel declining in relative importance, and categories such as communications and health care growing rapidly. Much of this shift can be attributed to the consumer electronics and telecom sectors that have provided a platform to increase consumer awareness. In fact, the mobile-phone's penetration and impact on the Indian economy have earned it the new title of FMCD" -- or fast-moving consumer durable, versus the traditional marketing category of fast-moving consumer goods.
Awareness around the power of information technology to solve problems, create employment and improve lives has trickled down to the lowest socio-economic class. India has close to 261 million mobile subscribers, many of whom live in rural areas. "The connectivity, communication and literacy leap that India has gone through over the past decade has been a major driver of aspiration," said Rajeev Karwal, founder and CEO of Milagrow Business and Knowledge Solutions, a Gurgaon-based venture-capital firm geared to small and medium-size businesses.
Through word of mouth, their own observation and the media, consumers now can visualize a better life, and they demand it, Karwal said. The historical pattern in India -- and in most developing economies -- shows that as incomes rise, consumers spend proportionately less on basic necessities. As millions of deprived households move into the "aspirant" segment, they will begin to be able to afford products and services beyond their immediate needs for food and clothing.
Arvind Singhal, chairman of the Gurgaon-based management consulting firm Technopak, said that "it is a myth that rural India is less aspirational. There might be a larger distribution of wealth in the cities, but there is no demographic-based difference in aspiration. In fact, rural India has been badly served; most large retailers have concentrated on the top 200 cities, with very few even having distribution channels in the villages."
Most companies have not tapped the vast rural consumer base for two reasons. First, the volume of potential customers, based on income, is small as a proportion of the total rural population. "Tier 1 and 2 cities will continue to control and drive approximately 62% of consumption of high-end products in 2025," Karwal said. Second, the rural population is scattered over a vast geographic area, making them hard to locate and expensive to target, given the country's poor infrastructure. However, "new technologies like the Internet and wireless broadband can solve both these problems," Karwal noted, "making it economically viable for companies to offer a range of services such as banking, distance education and health care to rural India. This, in turn, will transform the expectations, aspirations and economy of the rural consumer."
Although price and value are important considerations, recent research shows that Indian consumers increasingly demand brands that are relevant to their experience and that reflect local preferences. For several years, leading multinationals attempted to sell global brands in India at global prices. Companies were confident that the country's consumers would move in a premium direction because of the technological sophistication that the IT boom engendered. They also chose not to establish well-planned marketing and sales channels, assuming that brands alone were strong enough to attract consumers. This assumption turned out to be wrong: Over time, companies tailored their products and production methods to Indian market conditions and slashed prices by more than 50%.
Karwal cited the mobile phone as an example of a product that offers a high degree of functionality at a good price. "It is equipped with features such as a dust-resistant keypad and a built-in flashlight that not only aid truck drivers on India's poorly lit highways, but also take away the villager's embarrassment over the lack of electricity. Customized to the Indian market and reflecting the importance of price and value rolled into one, the mobile phone now serves as a great benchmark for market penetration. It is no wonder that the number of mobile phone subscribers far outweighs the number of Internet or credit card users in India."
Getting the price right is just as important. Although income levels are rising, Indian consumers still have many competing demands on their modest budgets. Winning companies have learned the importance of affordability. "India has the fastest-growing mobile phone market, and handsets are sold cheaper than anywhere else in the world," Dutt said. "Steep and continual price cuts have led to levels of market penetration that took television sets 25 years to achieve."
The Road to Consumption
India's consumer demand structure is fundamentally different from that of developed markets. Since 1990, the country's economy has grown on an average of 5.7% per year. Its per capita income has nearly doubled in real terms. But different consuming classes drive market growth in different ways, and an appropriate mix of strategies is required to capture this growth.
An estimated 1.2 million affluent households sit atop the Indian income and consumption pyramid. These consumers buy branded products and behave like their counterparts in developed markets. Moreover, they are largely concentrated in the top eight cities. At the bottom of the pyramid are the large but poor segments. Struggling households number more than 100 million, followed by 40 million destitute households that are poorer still. The real drivers of the growing consumer goods market occupy the center of the pyramid -- India's 40 million middle-income households, which purchase more than just the basics.
"A 1% change in income opens up a $25 million retail opportunity," Karwal said. "As economic growth occurs, the destitute will transform into aspirants and enter the consumption arena. Aspirants will become climbers with increased per capita consumption, creating an automatic volume growth for several categories. The socio-economic transformation of consumers offers a large window of opportunity for marketers, as 100 million to 150 million consumers have just begun their journey, while another 100 million are on the road to consumption."
The population's demographic profile also plays a role. Indians constitute a fifth of the world's citizens below age 20. So a youthful, exuberant generation, nurtured on success, is joining the ranks of Indian consumers. These people are deeply rooted in Indian culture and traditions yet connected to and curious about the outside world. Their incomes may be growing but their budgets are still limited. Together, these characteristics have big implications for the product categories and brands they select. With basic needs satisfied and the future taken into consideration, these consumers will consider purchasing products that represent "the good life."
"In the past, youth were perceived to be disconnected with no consideration for value," Dutt said. "However, a closer look reveals that they are extremely discerning individuals who know what they want. The challenge facing manufacturers is to come up with products and services that appeal to this group of consumers who have a short attention span coupled with rapidly changing needs and preferences. We need to understand them and synchronize our products with their aspirations."
Additionally, youth often spend beyond their means. They are willing to experiment with high-end brands because they have a high level of disposable income. "Unlike the previous generation who witnessed slow economic growth, young Indians have been raised in the post-liberalization era of fast growth and underlying optimism, and are thus more confident about the future," said Y.V. Verma, director of human resources and management support for LG Electronics India.
Expansion of Organized Retail
When India opened its economy to the global marketplace in the early 1990s, many multinational corporations rushed in to pursue its middle-class consumers, only to confront low incomes, social and political conservatism, and resistance to change. "In the past, retail conglomerates avoided the Indian market because they did not find the large investment a worthwhile opportunity, as India accounts for a very small percentage of the U.S. market in pure dollar terms," said Technopak's Singhal. India also lacked the infrastructure, supply chain, foreign direct investment regulations and value-added tax required for retailers to succeed.
"If the government permits foreign direct investment in retailing, consumer goods companies would have greater opportunities to sell products in the modern formats they understand," Karwal said. "Currently, about 60% of all purchases are made in the food and grocery segment, which has a unique supply chain that multinationals don't understand. The optimal retail format in India mimics a local bazaar experience, vastly different from the neat aisles and structured store layout present in other countries."
Skeptics point out that even if government policy works in favor of large retail, understanding of the consumer's psyche is paramount to cracking the Indian market. Karwal went on to say that "most bleeding happens at the front end, as real estate prices are exorbitant. To combat these expenses, companies such as Zara and Best Buy have set up their own buying houses in India. If foreign retailers are able to get their back end in order while regulation evolves and rental prices cool down, the government policy is likely to work in their favor."
At the same time, the government has a responsibility to make sure that foreign inflows do not disrupt employment or functioning of smaller, homegrown players. Karwal minimized that concern: "Even though large conglomerates have a 7% to 10% buying advantage, small retailers benefit from the close proximity to customers. The necessity to buy fresh food due to a lack of electricity and inefficient public transportation systems serves to check the displacement of traditional retail. The network of local retailers will remain an important segment for years, even if modern retail continues to grow at the current pace."