The logic of retail FDI

Financial Express, December 1, 2012

The logic of retail FDI
With multi-brand retail FDI finally set to be allowed in India, it is useful to reflect on what we know and don’t know. Reviewing various surveys, opinion pieces and expert reports, one finds copious statistics on various aspects of the retail market in India, the character of potential entrants (especially Walmart, of course) and long lists of possible negative and positive impacts. But we actually do not learn too much that will help us predict what exactly will happen. The best we can do in this situation is try to clarify the logic of possible effects. Here is my attempt to take us forward in that direction. My goal is not to argue for or against retail FDI, but to sharpen the policy debate.

The primary case being made for FDI in retail is that it will increase efficiency. One source of this is improvements in the supply chain. In particular, this argument is applied to perishable agricultural produce. The claim is that increased investment will reduce wastage. Efficiency gains can potentially lead to gains for producers, intermediaries and consumers. There is some evidence that, starting out in the US, Walmart improved the efficiency of wholesale and retail distribution, and later of manufacturing, through its hub-and-spoke distribution system and use of information technology to link different stages of the supply chain. But the US story was not one of building an agricultural supply chain from scratch. In fact, groceries were a later addition to Walmart’s offerings. This kind of history does not provide a solid base for the claim.

Turning to the recent Indian experience, Walmart and other foreign firms have been involved in the wholesale trade for some years. For example, the Bharti Walmart joint venture works with over 6,000 small farmers across six states. Indian corporations have tried to create retail chains without foreign help. What do these experiences teach us about the potential for transformation? In neither case has there been a huge change in the supply chain. Logically, either FDI in wholesale or domestic retail chains could have made investments to improve the efficiency of the supply chain. There have been small improvements, but no great transformation.

One can counter that domestic retail chains do not have either the capital or the managerial quality to do what needs to be done. But that excuse would not apply to a Walmart or Tesco operating at the wholesale level. In fact, after testing the wholesale waters, Tesco decided to avoid further physical investment and instead focus on providing expertise only. The question of why wholesale FDI isn’t enough also raises a logical issue for another claim for retail FDI, that it will lead to more exporting from India, as firms like Walmart will get to know suppliers and source from the best for global markets.

The response to these objections can be that controlling the retail portion of the value chain is important for making investments at the scale required. Why could this be so? Why has Walmart not roared ahead with its entry into wholesaling in India? In fact, the typical argument that inefficiencies and market power of intermediaries hurt producers and consumers suggests that wholesaling should be where the potential profits lie. There are two possible efficiency-based arguments to counter this—one is that there are efficiencies to be gained at the retail stage through modernisation and scale, and the other is that integrating wholesaling and retailing increases efficiencies. But domestic firms have had this option forever, and have not capitalised on it. Perhaps these potential efficiencies are not easy to come by in the current Indian situation, or at least have not been in the past.

One fear of those who oppose retail FDI is that, even if efficiencies do come about through this process, they will come at the cost of employment. Another fear is that large foreign entrants will lead to the traditional groups of powerful, profit-squeezing intermediaries being replaced by another, even more powerful. In this view, gains in efficiency, if any, will be swamped by losses through redistribution of the surplus generated in the value chain. Evidence for this fear is often drawn from the history of companies like Walmart in other countries.

In my opinion, the analogies used are often too loose and the conditions too different to allow for convincing logical claims, whether for or against retail FDI. Even claims about reductions in inflation are suspect, since they do not distinguish between one-time and continuing efficiency gains. Another logical gap is the focus on food and food products, without considering the experience of food processors or restaurant chains. Yet another is the neglect of any systematic discussion of non-food items, by different categories, including fast moving consumer goods as well as various consumer durables. Maybe I have missed something, but it seems to me that policy-making in such cases needs more data as well as better reasoning. It is not too late.