Wednesday, February 20, 2008

Why retail margins are low?

The consumer is the king, atleast in terms of pricing. He is demanding better quality products with more features and customized to his requirements, and all that at the same or even lower price!

Two articles - one by James Surowiecki in the New Yorker, Greenback Blues, and the other by Rama Bijapurkar in the Economic Times, Testing times for consumer goods - describe the competitive pressures facing retailing in US and India.

Both claim that while retailing topline has been growing, the bottomline is being squeezed due to a variety of factors. The fast changing consumer habits and preferences, multiple segmenting of the market, and need for flexibility in the supply chain management, have all contributed to making retailing one of the most rapidly evolving business sectors in the country. Faced with intense competition, retailers are not in a position to pass on the increased costs to the consumer despite rising input costs. The low inflation and the cuts in excise duties have also contributed to keeping prices from rising and even falling.

An increasing share of the products sold by large retailers and big malls are that category of consumer durables which exhibit relatively high price elasticity of demand. The demand for these goods, which have subsitutes and whose purchase can be easily postponed, falls as the prices rise and rises as the prices fall. With the margins being very small for the regular consumption goods, retailers rely on the other products to boost their toplines. But the stiff competition reduces their ability to maintain high margins for even these category of products.

The presence of the informal retailers are a strong deterrent on the big brand retailers increasing prices. As the success of Wal-Mart confirms, the overwhelming share of consumers even in a mature market and rich economy like the US remain extremely price sensitive. Further, entry barriers have become high, thereby forcing existing retailers to adopt all possible means to stay on as long as possible in the hope of cashing in on any future windfall.

The low interest rates and the consequent availability of easy finance has brought a larger number of consumers into the market. The relative stability of the financing market and the resulting fierce competition among these companies has also played its part in keeping prices low.

Retailing is one of the sectors profoundly influenced by the forces of globalization. Globalization has created a massive global retail supply chain, which integrates raw material producers, intermediate goods manufacturers, wholesalers and retailers. It has brought out the benefits of comparative advantage among producers and manufacturers, and lowered costs across the entire supply chain. This has kept prices down and maintained a tight lid on global inflation. In fact, there is a strong merit in the claim that the most important Chinese export has been low inflation.

It is also arguable that the richer nations (and the consumers there) have benefited disproportionately from the lower prices and the consumption boom that emerged from it. It not off the mark to claim that the Chinese and other Asian tax payers and workers have been subsidising US consumers by keeping domestic currencies weak (in relation to the dollar), fiscal and other incentives for exporters and low wages.


footnotz said...

A visit to two roads - Daba Gardens and RTC Road - in Visakhapatnam would make it very clear why the retain margins are so low in consumer durables!

I guess customer is NOT yet the king in India in most of the areas but for this. There are way too many number of dealers, retailers and resellers in this area.

gulzar said...

Competition arising from fragmentation and multiplicity of intermediaries is good for the consumer in terms of lowering prices, but may not be a good indicator of the health of retailing. In an open market, such market structure is extremely inefficient and unsustainable. such competition weakens the market participants, leaving little margin for investments in innovation and expansion. The existing retailers become easy prey to the more organized players with deep pockets.

However, in isolated markets, and there are plenty of such markets within India itself, both geographically and in terms of specific products, such structure can survive longer.