Sunday, December 4, 2011

My views on FDI in retail

A little digression from my past few blogs on travel. I will get back to travel soon!!!

The question of FDI in retail has divided people all over India. There are various views both for and against the move. I believe that FDI in retail is a good move. Those who are against it feel differently for some or all of the following reasons:

a) Farmers will be hurt more
b) Will increase dependence on foreign bodies (why are MNCs needed? why can't Indian retail giants do the same?)
c) Agriculture reforms are needed, not FDI
d) Government should set up cold chains, if they are so much needed
e) Middlemen would become unemployed

In this lengthy post, I will try to address these points one by one. And reason as to why FDI in retail would be helpful to the Indian economy.

Let us analyze the system in its present condition and probably we would be able to find a reasoning as to why the Indian retailers weren't able to build efficiencies needed. I am basically looking at the farmers (the producers) and the final customers. If a newer system is able to give them a chance to be well off, then I would like to take that chance. As for the middlemen, I will address them later.

As of now the produce of the farmer passes through multiple traders and then to the final consumer. Is there a value-add in the chain? No. There is simply a transfer of goods. Let us try and first understand why the Indian chains haven't been able to develop a sustainable supply chain. The Indian companies who have entered the segment have no prior exposure of operating in this segment. So, they are basically competing with the traditional system which doesn't force them to develop an independent supply chain. All firms respond to competitive environment. And when a firm is faced with such heavy investments, only an external force can make them move. When an international chain steps in, things will change. Why? Coz they have a certain way of operating. They work on the system of independent supply chains to lower their procurement costs. Such a competitor would force the Indian retailers into action and look at supply chain optimization leading to better market control.So, it is not a point of dependency on the foreign investors but its about triggering the system into action.

Now to the point of them further dominating the farmers. For simplicity, let us assume that there are two middlemen in the system, between the farmer and retailer who sells it to the end consumer. The price earned by the farmer is say x, the price paid by the end consumer is z, the price paid in between being say, y1 and y2. (x < y1 < y2 < z). Is there any value addition taking place which justifies the rise in the price? No. Is there anything stopping a retailer who is ready to make investments in a supply chain from paying the farmer a price greater than x but less than y1 (keeping in mind the investment costs)? No. Would the farmer benefit? Yes. Can the free market ensure this? I believe so.

For a self-sufficient supply chain, a firm needs to have all links in sync. The supply chain that exists now doesnt share in the risk-return part of the producer. They take part in the return but not in the risk. As crops are harvested seasonally, the middlemen walk away with huge gains at the expense of the farmer and the end consumer, coz the farmer cant store the produce and needs to sell asap. And the consumer needs the produce through out the year. I expect the international players to be ready to make contracts with the farmers to have reliable supply, especially because they would have the supply chain ready to take advantage of the seasonal variations.

Coming to agriculture reform. An agriculture revolution is desperately needed. Coz cultivable land in India is very high. But productivity per hectare is very low coz of the primitive methods being used. So, first of all we produce less than we should and second, we waste a good part of it coz we cant store it. This results in high cost to the end consumer and low revenue to the producer. There are many techniques available in the modern world (and no, I am not referring to GM crops. I can give references of pioneers in this if anyone needs) which can raise productivty. A farmer's revenue depends on how much he can sell and at what price he can sell. The government can only provide cheaper loans to the farmers. The part about improving productivity is left to the farmers or to some NGOs. If a firm is interested in developing a robust supply chain, then I believe that at some point of time, it would be inevitable that such practices would be implemented. There is more possibility of this change happening through a firm with business interests rather than in the existing system. And again, if there is a chance, then I would risk taking it.

Onto government developing supply chains. This is an idea that I have heard often in the recent past on many forums and to put it bluntly, it is ridiculous. Have we forgotten the inefficiencies that exist in all government machinery? Why do we want to create another such demon? Have we forgotten how the FCI functions? And most importantly, the government must realize its role. Its role is to make the economic environment conducive for investments, not to make investments where it has no expertise. In some ways, the last decade has seen some measures taken in this regard. Our national and state highways have improved and are closing in on world class levels. A system is being pushed for wherein transportation vehicles need not wait for hours at octroi points. Efforts are on to improve irrigation facilities. These are the measures that the government needs to take. To cut the red tape. Not think of investing in cold chains. It will end up being more inefficient and just increase the burden on the tax payers.

Now to the middlemen. The growth of an economy happens when its citizens are engaged in gainful employment. Adding more people to a system just increases its inefficiency, not its productivity. The middlemen in this system are not doing any value-addition to the products. And when there is no value-add, you are simply inflating the final cost for transfer of products. Employing 5 people to do the job of one is not a way to improve the economy of the country. You are just reducing the value of that job. Yes, the government must have plans for employment for these middlemen. But just because of them, it doesn't make sense to drop the idea. Entry of multi-nationals brings forth lot of opportunity. For example, there is a shortage of industry level cold storage builders in India. They can find an opportunity there. They would have good people skills. And these businesses just need management of the technical people. Or else, they can enter into cold storage themselves. There is not dearth of opportunity, if one cares to look for it. But it will surely drag them out of their comfort zone, which no one likes.

It would be ideal if agricultural reforms can occur without any intervention. But it won't. It should have taken place a decade back but its still waiting in the wings. And I believe that without an external impetus, this won't happen.