Future of Retail in Emerging Markets

Can Big Box Stores Succeed in the BRICs?

For decades, the U.S. consumer fueled global growth. With daily U.S. consumer spending down roughly 40% since June 2008, many economists and investors believe the return of global growth will have to be fueled by consumerism in the developing world. Recent reports indicate that emerging market consumers are answering the call – China’s real consumer spending has increased 15% in the past year, and Brazil, India, and China have the highest consumer confidence ratings in the world. These billions of new spenders are seemingly ideal targets for big box retailers. But then why have so many of these chains failed in their attempts to penetrate emerging markets? Who will be the beneficiaries of this new wave of emerging market consumer spending? Will consumers flock to established local retailers, or will big box stores be able to offer the new global middle class products they desire at prices they can afford?

Insights from the Ergo Network

Ergo asked four experts to provide insights into the future of big box stores in the BRIC economies, and to illuminate the roadblocks and pitfalls they may face in growing their business overseas.

• Expert 1: Leading Brazilian business consultant with decades of experience in international trade and commerce

  "The government’s policies to assist the poor resulted in the inclusion of nearly 20 million people in the market economy. New consideration should be given to the habits and interests of these classes. Doing so requires that companies conduct market studies on the tastes and the interests of consumers in different parts of the country, and learn about regional differences – it’s one thing to open a big box store in Sao Paolo, quite another in the East or the South. The principal roadblock in Brazil is that there is always bureaucracy and thus inefficiencies. But there are several advantages Brazil has over its BRIC peers: most importantly, we speak the same language – everyone knows what a “warrant” is. The commercial and regulatory practices are similar to those found in European and American markets, and Brazil is closer culturally, financially, and commercially to Europe and the United States. Too often this is not appreciated."

• Expert 2: Prominent retail analyst with extensive experience in the Russian market

  "At first glance, the Russian market has two ceilings. One is the socio-demographic situation – the two main centers (Moscow and St. Petersburg) are inundated with new retail stores opening. The second is the highly flamboyant approach to local government regulations, and what it takes to put the wheels in motion. There are already a number of big box retail operators in the market, such as SPAR and Auchan. It’s an exciting market because it’s transitioning from traditional to modern retail. This transition takes time because the frequency [of visits] changes and the basket size increases as well. Russia sits in the middle of the BRIC big box space – it has a highly advanced Western-style retail sector with a lot of untapped potential, and there is a lot of M&A activity that could be completed by Western retailers…if they can stomach the corruption."

• Expert 3: Leading Indian lawyer specializing in cross-border transactions, FDI, joint ventures, and M&A

  "Under the prevailing FDI regulations, foreign investment in retail isn’t allowed except in certain sectors. What is allowed is that you can have foreign investment in ‘cash and carry wholesale’ and up to 49% investment in single brand retail (i.e. a Nokia phone store). Essentially you cannot have foreign investment in multi-brand retail stores. What happens, as with Wal-Mart, is that big box stores sign up with local stores to provide wholesale goods to mom-and-pop shops and cash and carry stores. Another significant impediment is infrastructure – both in terms of finding large enough parcels of land, and then having the road infrastructure for people to get there conveniently. The poor roads and toll taxes mean that companies must examine their supply chains and logistics lines within India. Many stores will need to build up large inventories to compensate for these impacts. The positive is that India is a democracy, and so while that may slow things down from time to time, the agreements are broad based. Of course the other strength is the population. There’s a lot of potential for growth in Indian earning power. The Indian consumer is underserved at present, so if the stores offer products at a reasonable price – Indians are extremely price sensitive – they will be successful."

• Expert 4: Managing Partner of a Chinese private equity fund focused on China’s retail and consumer goods sectors

  "Big box stores came to China about 14-15 years ago, and they have learned and evolved their business models over this period. The learning phase is over and now it’s the expansion phase – the next opportunities will be part of China’s regional development. There will be expansion to lower-tier cities, and there will be a lot of acquisitions. M&A is the next big thing to come in the industry, which is consolidating with or without foreign retailers. But foreign big box stores will face many barriers, from regular trade barriers, to government approval processes, to local protectionism. What will be very difficult for Western companies is the very low degree of homogeneity of consumers. In China you go from one city to the other and the retail demands change completely. This makes supply chain management very demanding. Carrefour, for example, has given store managers more buying power so they can adapt to local consumer tastes and behaviors. Logistics is a challenge too because very few distributors can supply nationwide. An additional challenge is the margin structure – efficiency improvements are critical because China has lower margins than mature markets. As always with China, the biggest hurdle is the regulatory hurdle, and the perception of foreigners taking over makes the anti-trust process very subjective."

Looking Ahead

Each of the BRIC economies has unique opportunities for big box retailers, but also unique challenges. A one-size-fits-all strategy is doomed to fail. Retailers must base their market entry plan on a sophisticated understanding of the heterogeneous demands of consumers within these countries – no doubt a challenge to Western big box stores whose models have been successful in predominantly homogenous consumer markets. Another challenge will be to make goods affordable to these new consumers while maintaining sufficient margins.

Trends to watch that could indicate further ripening of the retail sectors in the BRIC countries:

• Russian and Indian investments in transportation infrastructure. If these countries modernize their roads and railways between major cities and into rural areas, large retailers could take advantage of supply chain efficiencies to increase margins and create opportunities for scale.

• Brazil and China’s moves to develop their hinterlands. This development presents rich opportunities for big box retailers to expand into untapped areas. Most of China’s retail development has been on its eastern coast, and Brazil’s in the large population centers in the southeast. In both countries there are vast, virgin markets in smaller towns and cities in the interior.

Companies that “do their homework” on these markets – developing entry strategies based on a nuanced understanding of the market dynamics, competitive landscape, and regulatory environment – are most likely to avoid the pitfalls of predecessors. Big box retail is a scale business – and the companies that can increase profit margins and gain a foothold in emerging markets now will be poised to ride the next great wave of consumerism.

Ergo has conducted numerous studies on the retail sectors of emerging markets. Our experience in uncovering key insights on shifting regulatory policies, identifying and conducting due diligence on acquisition targets, and producing market landscape studies has helped numerous clients ensure a positive return on their investments.