If they don't grow fast enough, the economies of scale will not start kicking in. But if they lock themselves into high rentals for long periods, it could be years before they see any money.
Organised retailers in India today are caught in a bit of a bind: on the one hand, they're raring to roll out new stores so that they can grab space and market share. But, on the other, lease rentals are prohibitive and footfalls don't seem to be getting converted into the kind of buying many thought they would. It's not easy anymore.
Take a lifestyle retailer like Shoppers Stop, which has been around for 15 years now and sells mostly apparel, with the bulk of the merchandise comprising expensive branded products.
Typically, such a business allows the retailer to earn a decent gross margin of, say, 30-35 per cent and Shoppers has been able to manage that most of the time. But, it should also fetch Shoppers enough of an operating margin, say, 12-14 per cent.
However, that doesn't seem to be happening because high real estate costs are pushing up expenses: of all the elements of cost for Shoppers, rentals saw the highest increase in the year to March 2008.
Ideally, real estate costs should be limited to about 7-8 per cent of costs or 6-7 per cent of sales. But for Shoppers the real estate tab, at 9 per cent of total costs compared with 7.6 per cent in FY07, is far higher than that. As a percentage of sales too, lease rentals at 8.8 per cent are higher than at acceptable levels. That's one reason profits were down 89 per cent last year.
For a convenience store chain, which sells food and groceries, some of which are perishable and that fetch very low profit margins, real estate costs should probably not exceed 3 per cent of costs since the gross margins here are much lower, varying between 13 and 15 per cent. Otherwise, there is no way the retailer can pay for other expenses and be left with a 3 per cent net margin.
The Subhiksha chain claims its real estate costs are in the region of 2-2.5 per cent of costs; that may be true because about 100 of its 1,300 stores are in Chennai and are more than a decade old so rentals could be as low at Rs 10 per sq ft per month. The pan-Indian weighted average would also probably not be higher than Rs 40-45 per sq ft, because typically Subhiksha's stores are not located on the main roads.
But, newer chains are understood to be shelling out as much as Rs 60-70 per square ft on average and locking themselves into long tenures of 15-20 years with escalation clauses built in. Assuming rentals of Rs 40 per sq ft amount to 4 per cent of costs and the retailer wants to post an operating margin of 14 per cent, the turnover per sq ft would need to be Rs 1,163 a month or roughly Rs 14,000 per sq ft a year.
Subhiksha claims it is clocking sales at least 40 per cent higher than that. But that could be because most of is outlets are new: at least 600 have come up over the past year.
Anecdotal evidence suggests some other convenience chains aren't anywhere close to the required run rate. What's more, over time, the pace at which sales are growing is slackening. Take Pantaloon, which sells a mix of both lifestyle and food and groceries: the rise in same-store sales for nine months of FY08 at 10 per cent is lower than the 15 per cent that it clocked in the previous year.
For Shoppers too, same-store sales grew just about 14 per cent in FY08. Titan's same store volumes for jewellery have been coming off over the last two years.
The fact is, whether it's groceries or clothes, there is too much choice for the customer and intense competition for the retailer. So, while consumers are spending more in organised retail outlets, the spending is being dispersed over an ever-increasing number of stores, with the result that revenue per sq ft, which should be going up, is either staying flat or coming down.
Research put out by KiranaFirst, in Chennai, a city with a high penetration of organised retail, shows that revenue per sq ft, which had peaked to about Rs 1,100 by 2004, has now come off to around Rs 700. For Pantaloon, revenue per sq ft, which was Rs 2,080 in September 2006, tapered off to Rs 1,859 in December 2007.
In their attempt to wean away customers from kiranas, convenience chains are offering discounts -- that is leading to lower realisations. One of the findings of the just released May 2008 Icrier report -- the impact of organised retailing on the unorganised sector -- is that low-income consumers save more than others because they target discounts.
If these shoppers come in droves, it's fine. Otherwise, that cannot be good news for retailers. They want to see big ticket spending and plenty of it.