Monday, February 25, 2008

Retailers unite against big retailers

Last week there was a state-wide protest organized by the association of small retailers and traders of Kerala. The protest was against the entrance of big retailers like Reliance and Bharti into Kerala. The irony of the situation is that you have small capitalists joining hands together to fight bigger capitalists in a fight seemingly to protect the consumers. First let me take a look at some of the major issues raised by the protesters. A major concern voiced was that the foray of national and multinational corporates into the retail sector is going to cause loss of income, and loss of jobs of people owning and employed in the small and medium retail industry. Another point was that the big retailers would lead to a collapse of the small and medium retail industry, leading to monopolies and ultimately increased prices of everyday commodities. A third issue predicted was that once monopolies were established the farmers, manufacturers and producers would be at the mercy of the retail giants and hence they would be exploited.

Some of the underlying assumptions are a) Retailers and Traders have a right to be retailers and traders and nobody can deny their rights b) The association of retailers and traders are not just fighting for themselves but also for the vast majority of people ie the consumers, c) The existing system as such is very fair to the producers - farmers and manufacturers - in terms of giving them just shares of the retail prices of the products. d) Big retailers are bad e) Multinationals in retail industry are very very bad, f) The retailers and traders form a significant percentage of the population

Before we dissect these assumptions and claims let us take a look at the economics behind this. In any economy people generate revenue by the transfer of goods and services. Correspondingly you have the retail sector and the services sector. The retail sector includes not just the retail shops that sells us the goods we buy, but also the network of systems that exist to maintain these retail stores. Similarly the services sector has the service delivery framework.

From the point of manufacture, or cultivation as the case may be, of items bound for retail trade, to the point of the retailer selling the product to the consumer, there are usually several intermediate processes and people involved in these processes. Some of these would be wholesale purchasers, regional collection centers, transporters, distributors, sub-distributors. There would also normally be several layers of middlemen between these steps.

As the goods move along these chains of people the cost increases at each level until it finally reaches the customer. By the time the product reaches the customer the cost of the product could even have gone up a few hundred percentage points over the original price at which it was bought from the farmer. There would also be other intangible value additions like advertisements, insurances etc along the way which contributes further to the final selling price of the product.

However the real value of the product for the end consumer would not have changed as much as the increase in the cost of the product. Now we could deduce three different things from this. One is that the intermediary steps from the point of production to the final sale are very inefficient in terms of value addition. The second is that if the efficiency of these processes were higher the cost of the product for the consumer would become cheaper. Finally if some of the intermediary steps were avoided and the final price being kept the same a higher price could be paid to the manufacturer or the farmer.

Retailers exist to trade, and trade they do, and their motive is to make profits. The profits that are expected by the retailers would be in proportion to their investment rather than to their livelihood expenses. This rule would apply for all but the small and samll-medium retailers. The right to earn ones livelihood is a universal right, but the means to do that is not a right. A trader has a right to earn his living through his trade. But, the moment the returns are higher than his cost of livelihood his trade will not be covered under the right.

A retailer or a trader sells at a price which will yield him the profits that he is expecting out of his business. The price would also be regulated by the prices of the product at the other retailers also governed by a similar mechanism. A reasonably big percentage of the final price of the product goes towards the overheads in the retailing process discussed above. A percentage would go to the farmer also. This percentage that goes to the farmer and the small percentage that corresponds to the small value addition to the product are the components of the price that is effectively used to maintain productive labor. The rest is used to maintain unproductive labor working in inefficient processes.

A big retail chain in the market would be operating under a different framework. The entire chain of processes from the point of procurement from the original producer to the point of sale to the end consumer would normally be operated directly or supervised directly by the big retailer. This would introduce a massive efficiency increase in the process. Also the advantage of size gives another efficiency increase in terms of the unavoidable overheads. Consequently the big retailer would be able to make two changes - one is to reduce the final selling price for the consumer and the second is to increase the purchase price from the producer.

By giving better prices to the producers big retailers promote productive utilization of labor and by increased efficiency in the retail process the deviation of capital for unproductive labor is minimized. Additionally by reducing the prices for the end customers they are provided with excess capital than if it had been not so. This excess capital could lead to higher purchasing powers and in turn better average quality of living.

Both of the above changes provide the necessary financial incentive for the producer and the consumers to embrace the big retailers. This could result in a collapse of the existing retail framework. Now this is a potential cause for a problem as it could lead to monopolies at the purchase level and at the sale level. If monopolies are established both the above incentives can be taken out or even reversed by the big retailers. However big retailers can not exist everywhere. They will establish outlets only where it would be viable to set up one in terms of the market reach and the purchasing powers of the locality. So there would be big retailers in areas where the population sizes justify the existence of the retail outlets.

The emergence of monopolies in localities where the big retailers exist is a potential risk. This risk however could easily be mitigated by good ant-monopoly laws and regulations. Additionally the monopolies could only emerge even if it does emerge and in cases where it does, local trade establishments can reemerge to bring down the prices. So even in such cases the prices of the products would be cheaper than from an average retailer and the purchasing price given to a farmer would be higher than from an average retailer. If it had not been so the small and medium retail segments could re-emerge to neutralize the situation. So it would be in the interest of the big retailers to maintain the prices at such quasi-monopolistic levels.

Finally it might be good to take a look at the numbers. In an average society the percentage of retailers and traders would be around 10-15% of the population. Even including all the support framework it cannot be more than 15-20% of the population. In the case of big retailers this number would be reduced but would still have to remain significant. This reduction however will have to result in an increase in unemployment. The excess capital saved in the system by a reduction in the costs of retail products and a higher purchasing power for the producers would result in an availability of capital for non-retail use and that would mean the service industry. So this could result in an increased growth of the service industry where the lost jobs in the retail industry could be absorbed easily.

Having said so I still have reservations about multinationals entering local retail industry as it would result in a biased cash flow mechanism in the system in the short term and the Indian economy may not be mature enough to be able to afford that. Also the emergence of Indian big retailers is going to cause a short term aberration in the equilibrium in the system leading to undesirable results like the job loss mentioned above. However in the long run both national and multinational retailers are going to be helpful for the system. Efficiency increases has to be good in itself.


  1. Hi
    You have explained the basic mechanism behind the processes. I will narrate a happening with a retailer which gives an inkling of the modus operandi of the retailers here. My uncle in Chennai who is working in an EOU making "appalams" , (no, not pappadams, this is slightly different) told me that the export quality items can be easily sold in TVM for Rs100 a Kg whereas in Chennai it is only Rs72 per Kg which he said he will arrange to send it to me. I approached a few of the shops in Pappanamcode and East Fort area. I thought I will offer it at Rs86 per Kg so that the profit of rs14 can be there for me as well as the retail shop wallah. But no, they all want it at Rs76 or 74 per Kg only. I just gave it to two shops for 76 and came back. Then I sent my wife to the same shops to buy the same items which was offered to her for Rs100 per Kg! See, they do not want to give fair margin to the intermediary and want to pocket the maximum margin! This attitude of not caring for the Customer is there in all trading establishments in TVM (WWith very few exceptions). The merchant could have reduced his profit and given the same item to customer at a lesser price, but no, he will not do that(Which the Margin free Stores or the So called Big retailer does).He wants maximum profit doing minimum work. Bah! Vyapari vyavasayi Ekopana Samithy! I have little sympathy for these people who were ripping off customers all these years. These people who do not know the price of the itmes they sell unless they see the MRP tag on the cover! Why should the common man support them? Let them stew in their own juice!


  2. In my opinion the traders are only doing what they are supposed to do in a free market - make as much profit given their constraints - profit maximization. The irony about the recent harthal is that they want to have the freedom while restricting others from actually enjoying the same freedom that they enjoy. You might also want to take a look at another discussion I had about fair prices.

  3. Agree with your points. On the whole the producers and consumers should benefit. There are dangers of monopolization of course, but those as you say could be averted by good regulations.
    I think what they really need to think of is to unite to compete, rather than unite to protest.

  4. @nithin - I liked the way you expressed that - unite to compete and not unite to protest. Hope that was under Creative Commons :).

  5. I've been thinking about the same thing . Now , I know two people. One is my uncle who owns a small shop at Pattom. Other is my friend who is managing the activities of a retail chain that will soon open shops all over Tvm. My uncle understands the idea of fair price . He has a loyal customer base. He wasn't afraid when Margin free people started up because margin free people could offer only packaged items ( Horlicks ? ) with an MRP tag at lower prices. He could offer stuff like onions and rice at competitive prices and he still manages to make a decent living. My retail shop managing friend , however can offer competitive prices for things that aren't sold with MRPs attached. Now its natural that my uncle feels threatened. That's the reason for the harthal. He cannot do much. He predicts the demise of his business within two to three years. Contrary to what people think , there are many local small businesses who offer fair price. They are the ones who thrive when faced with competition. Now they are afraid of loosing their businesses. If there was some kind of mechanism by which these people could be absorbed into the retail system ( yeah my 9th standard educated uncle knows more about retailing and sources to procure stuff from than my friend with an MBA ) they wouldn't have made a ruckus. but in my opinion , they should form some kind of co operative society which would compete with Reliance and the likes. I've already told him about it, he thinks its a weird idea. Lets see how things work out.

  6. I think forming cooperatives is a good way to compete with big retailers. In addition to bringing in the size advantage it will also help in ironing out the inefficiencies of small retailers.

  7. Having gone through the article and the comments, I must say that some of the arguments are compelling. But I would like to stretch the analysis a bit more to include more variables. The argument that producers and consumers are likely to benefit if proper frameworks are in place to avoid monopolies have an inherent merit in it. But measuring the overall efficiency of the retail system within itself (using these variables of price to producer and consumer) and not within the context in which it is embedded may not be a very good idea. You have pointed out the fact that while right to livelihood can be accepted, a right to a particular means of livelihood cannot be accepted. This would hold true if there was easy mobility between means of livelihoods for people. Given the disparity in availability of opportunities for building capacities for such a mobility (literacy rates of 65 percent is only one indicator of it) one might have to subsidise and maintain inefficiency. In spite of this, I shall agree with you (with a very high degree of optimism) that in the long term things might work out. But policies are not made only for long term, your short term is also important because in the short time you might push a lot of people to poverty and even beyond. I am sure you dont go by the very loosely defined idea of survival of the fittest because otherwise we might as well forget the idea of modernity and go back to the days of living in pre historic eras.

    The other thing that I would point out is that efficiency of the nature that you have pointed is not 'right' in itself. The American government has a history of buying farmers produce at high costs and dumping it into the sea to ensure that the prices dont fall leading to farmers becoming severely indebted. Another example would be the Dairy industry in Europe. The government was willing to buy milk in a situation of over supply at a good price and give it away free to developing countries. The good side of it is that it led to the Operation Flood in India.

  8. @thomas
    1) Yes I do not agree to a policy of "survival of the fittest" per se. My ire was against the middlemen who tap into the system and sap out the juices. My sympathies are with the mom and pop retailer who has to struggle to make his existence but not with the rich wholesale purchaser who buys from the poor farmer nor the rich wholesale dealer who sells to the mom and pop store
    2) I did not quite understand why efficiency as is, is not good enough and did not understand how the action of the US government is justifiable in terms of efficiency. I guess by doing this the government ensured the survival of the industry so as to avoid a collapse of the industry which could have resulted in far bigger problems.

  9. I dont know whether someone has lready pointed out these things.

    1. A huge majority of the small retailers dont pay any tax at all. On the other hand, I think it is not easy for the big retailers to evade tax. Blame it on the bills they give or the records or the goodwill they have!

    2. From the consumer rights point of view, the weights and measures used by small scalers are often tampered. It may be not be the case with big players. Again the goodwill factor comes to play. And you can lodge a complaint in any legal forum, since these players have an address to which notices can be sent. How many of us know the name and addresses of the retailers esp ones in the traditional markets?

    3. Once, the middlemen are eliminated, the deals will be between the producer and retailer. I believe that one of the reasons of farmer distress in India is due to unscientific farming practices. When you start doing farming as a money making business with huge investment, there has to be professionalism, as in any successful business. But, often, due to low levels of education among rural farmers, their approach towards farming may not be the best. The point I am trying to make is , when the retailer buys directly from the farmer, he would naturally step in with improvements in farming practices. The big retailer does the design/architecture and the farmers do the implementation. Again, there is a risk of the greedy biggie doing an overkill of the soil as some farmers are already doing.

    The best way forward is to let the biggies play a fair game with the government acting as an unflinching watchdog and uncompromising regulator.

  10. @Anand

    You have pointed out things which I have missed.
    In addition to the maximum profit desire doing minimum work,the retailers, not huge as you mention, but almost 95% do not pay tax. If you question, "enthu cheyyam saare, jeevikkande" will be the reply you will get.
    People will not be inclined towards efficiency in the work, do something which is neither oriented towards the customer nor the producer, but the sustenance should be provided to them with all the inefficiencies included.
    Any takers?

  11. i have been a user of both ubuntu/gnu/linux and windows xp and i would state with confidence that ubuntu is a better os than windows. and i hope you people too agree with me in this regard.
    still if you look at the population, windows xp is the os they have on their desktop.

    the market is a very complex system, (non-linear in mathematical terms). There are a lot of chaotic points in the system. And we don't want the system to collapse at these chaotic points (the collapse of system is not the issue, but many a human lives will be affected in such a situation).
    And for which we need regulations for a short time.
    These are ad-hoc measures and not exact solution. I can't figure out any better method to evade chaos.

  12. @kake
    But how do we know which action is going to cause a collapse at the chaotic points? ie whether regulation is going to cause more quantitative harm or whether deregulation is going to cause more harm?
    As an aside and with reference to your first statement about GNU/Linux vs Microsoft - the success of a product does not have to (probably never is) depend solely on the quality of the product. I would say it is more about market perceptions and manipulation of these perceptions. Marketing does a lot to do this. The strategic tie up of Microsoft with IBM was a marketing success in that aspect. Check out this post on Impact of advertisements to see two other factors. Microsoft has been a marketing success while GNU/Linux has not been. Ubuntu is trying to make up a lot on this side and the results are slowly beginning to materialize.

  13. look at the share market. The market , the price fluctuates occasionally. At these instances of fluctuation, do u think that the industry is being represented by the price of the shares.

    At certain instances, market goes extremely unpredictable that sebi has to impose certain regulations on trade; in order to protect investors (especially small investors).

    what do you say about the sebi regulations
    and can you compare it with regulations with other businesses too.

  14. Share market is a speculative market where people speculate on prospects of making money through the sale of the stock that they are planning to buy or through the dividend that the share is going to give them. The cost of the share is not really indicative of costs of ownership or operation of the company. Prices of shares fluctuate based on perceptions of people in the share market and based on volume transactions of large players. I don't think that the industry is truly represented in the price of the shares.

    Regarding SEBI regulations, again these are targeted at preventing large players from exploiting small players. I am perfectly fine with that. It should be noted that the large players are still allowed to operate.

    This is exactly what I would like to see in the retail industry too. Let us see how the large operators are going to operate and let us see it under environments where we can regulate their operations if we see exploitation.

  15. management efficiency counts.
    we need diverse players in the market, as then only the process of natural selection will select the efficient and fittest business model.
    we need a vigilant authority with power to exercise regulations as and when needed to protect the human lives associated with the system.

  16. Yes natural section is a simple way of explaining that.