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FDI in Indian Retail: The Big Benefits Will Come Tomorrow, Not TodayPublished : September 20, 2012 in India Knowledge@Wharton

The Indian governmentrecently announced a slew of reforms, including allowingforeign direct investment (FDI) in multi-brand retail up to a level of 51%. A policyrequiring that single-brand retail multinationals source 30% of products andmaterials from small businesses and craftsmen was changed to mandating that thesame amount come from Indian firms. In this op-ed, Johns Hopkins UniversityprofessorRavi Aron, who is a senior fellow at Wharton's William and PhyllisMack Center for Technological Innovation, argues that opening up FDI will notonly lead to a greater variety of products for sale and increased consumer choice,but also penetrate deep into the hinterland of Indian economic activity and domuch to improve the country's "shunned sectors" -- infrastructure and logistics.

The direct FDI impact in the short term from retail chains will be modest. If youlook at the numbers -- as per [financial information services firm] CEIC Data --FDI in 2008 was in the ballpark of US$35 billion and declined in 2009 and 2010.FDI in 2011 came in at around US$27 billion or so. So if we ask the question: Willinternational retail chains in the shorter term -- an 18-to-24 month horizon -- bringin US$8 billion to get back on track, the answer is probably not.

Large retail chains when they venture abroad do so in three phases. In Phase One, they often set up a testcase/pilot project. This can be done through a partnership with local chains (with risk and revenuesharing), or a few flagship stores that serve as brand broadcasters. The chains employ this initial-phaseentry strategy to learn lessons about the local markets. They assess demand, test merchandizing strategiesand set up operational capabilities. In this phase, they bring in some investment to cover their set-up costsand for establishing their sourcing (supply) footprint. This usually takes 18-to-24 months.

In the second phase, firms expand their demand footprint; they open more stores and increase both thescale of operations (volume of products sourced) and scope of products that they feature. There isconsiderable investment in this phase in the form of real estate acquisition, putting in operationalinfrastructure, establishing sourcing relationships, establishing supply chains and massive logisticscapabilities. This is volume-independent investment -- that is, investment meant to gear up for volumes ofbusiness to come, but not calibrated to the current volume of business.

In the third phase, the investment keeps pace with the rate of expansion. As volumes grow and urban andsemi-urban retail locations get saturated, companies look for new locations and bring in investment that iscalibrated to growth in volumes. It is in the second phase and the third phase -- which come after theinitial 18-to-24 months -- that large investments manifest themselves.

Other Impacts

The arrival of foreign retail chains has twofold impact. First, those companies set up supply chains andlogistical capabilities, spurring significant improvements in the infrastructure needed to source, ship, storeand deliver products (covering all aspects of value chain and supply chain activities, including storage,warehousing, and information-intensive operations). Second, their entry and expansion induce domesticcompetitors to invest in infrastructure and logistics, as well as greatly speed up the emergence of productstandards (especially in perishables and personal consumables), and begin the process of bypassingmonopsony buyers and traders that dominate procurement in many product categories today.

For these reasons, foreign investment in retail has an impact that goes beyond its direct investment

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For this reason alone, farmers and producers should welcome this development (and for this reason alone,traders oppose it). Indeed, the Indian Farmer and Industrial Alliance (IFIA), a joint venture of theConsortium of Indian Farmers Associations (CIFA), recognized the potential benefits of eliminatingmiddlemen and has expressed its support for opening the retail sector to foreign investment.

As with any other sector, the entry of foreign players introduces competition that will benefit some andwill work to the detriment of others. The beneficiaries in this case are the Indian consumers, the lowermiddle class, which will benefit from the well-paying jobs that will be created, and the producers of goods-- including farmers -- that have been at the mercy of middlemen and monopsony buyers and trader

monopolies. As usual, the interests that are threatened have sought to portray this move as detrimental toIndia. In another time, it was said in the U.S. that "what was good for [General Motors] was good forAmerica." It took some time for that belief to lose its status as an axiomatic truth. It is time that Indiareexamined its axiomatic beliefs. The East India Company left more than 100 years ago.

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