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Unlike developed countries where the retail industry is already mature, the Indian retail scenario is still taking shapeat a faster pace than ever before. With margins getting squeezed on account of increasing operating costs and taxes, and competition for customers intensifying, profitable growth is the biggest challenge for Indian retailers. The focus on growth-oriented product market strategy needs to be balanced by an efficient and reliable operating engine that eases pressure on costs and meets the scalability and flexibility requirements of a growing company. We believe that today alternative sourcing strategies to source back-office capabilities is a key strategic lever available for retailers.

Organized Retail
The organized retail sector in India is expected to grow sharply over the next 5-10 years. The penetration at around 3% is expected to cross 8% by 2011 powered by a 40%+ growth of the segment reaching a size of over $40 bn. Rising real income, increasing urbanization, availability of quality real estate, emergence of profitable retailing formats, regulatory environment permitting FDI in the back-end, and huge opportunity seen by domestic and global retail players is driving a significant growth in the organized retail.

To tap the growth opportunity, Indian retailers are driving competitive product-market strategies based on formats, locations, customer segments, and product categories. While companies like Bharti and Reliance have committed significant capital in the range of $2-5 bn over the next five years, others like Vishal Group have recently raised capital by going public to drive aggressive growth plans.

However, in this intensely competitive hyper growth environment, margin expansion to meet profitability targets is emerging as one of the biggest challenges. Uncontrollable factors are driving costs. According to industry analysts, energy costs are as high as 3% of sales in some cases. Similarly, service tax on the real estate has added to the space cost burden at a time when Indian retailers are already struggling with high rentals. As a result, space costs have reached as high has 10% of sales. Shortage of quality talent is also forcing companies to witness significant churn in their ranks. While companies like Future Group and Bharti have created alliances with training institutes and colleges to tide over manpower problems, this continues to be a concern and is likely to constrain growth plans of the industry.

Under these circumstances, retailers focus on growth needs to be matched by a confidence in the ability to deliver through an efficient, scalable, and reliable back-end.

Strategic Lever
Given the imperative of profitable growth, we believe that Indian retailers can benefit by evaluating alternative strategies to source capabilities that are not core to their main business.

Globally, retailers are increasingly adopting sourcing strategies (Sourcing vs Traditional Strategies) to respond to cost and competitive pressures.

While the retail environment in India is less mature as compared to developed markets, there are learnings that Indian retailers can adopt from these global trends. Several global majors like Tesco, Carrefour, and Starbucks, who are entering or planning to enter India, have already adopted sourcing in multiple ways.

Sourcing non-core activities can help retailers in more than one ways. At strategic level, it helps release management bandwidth at the C-level, so that they can focus more on their product-market strategy and customers. At functional level, sourcing helps provide access to existing high-grade talent and technical know-how of the supplier, without the retailer needing to invest huge capital into building these skills internally. This also saves the retailer the recurrent cost of training and recruitment, yet benefiting from the best practices followed by sourcing vendors developed out of their experience with global retailers. This is a significant area where we feel sourcing can help retailers relieve operating overheads. Further, it also helps build a higher employee morale and retention, since the supplier can offer career and opportunities in their core businesses especially seen in IT where companies are struggling given their inability to provide careers.

Especially new retailers can benefit by leveraging an outsourced back-office since it reduces their time to market, streamlines operations, and reduces cost of their businesses due to limited cost of learning the how of these activities.

Above all, sourcing helps retailers release precious capital invested in (or required for) non-core activities, which are taken up by the supplier investing in back-office infrastructure. The released capital can then be used for key growth drivers such as customers, inventory, brand-building, and, of course, new stores. Unlike in the past, today there exist innovative arrangements that retailers can consider to maintain flexibility under evolving conditions. For example, a Build-Operate-Transfer (BOT) arrangement allows the retailer to leverage suppliers ability and willingness to invest capital while ensuring that a future ownership of the back-office is still an available option to the retailer.

Sourcing Opportunities
Creating a reliable, fail-proof, and efficient IT capability is key to the success of modern retailers. A retailer typically spends between 1.5-2.5% of revenues on IT, covering areas like supply chain integration, point-of-sale (POS) systems for store operations, merchandizing systems, customer service, and CRM, inventory management, and warehousing solutions. This is in addition to the systems for other support functions like HR, finance, etc. Some examples of how outsourcing can add value to the IT function include increasing retailers online capability through sophisticated and current systems to managing complex and diverse infrastructure spread across stores and the entire supply chain.

Sourcing IT externally allows companies to impact their bottom line through more efficient IT operations and provides the ability to remain current on technology by leveraging supplier investments. In addition, given the cyclical nature of the retail business, outsourced capability provides more flexibility to retailers in managing peak load requirements. Investment in capability to manage peak load requirements can be an expensive proposition as more than 50% of annual sales occurs during these periods.

Everest experience suggests that suppliers can deliver between 10-30% impact on IT costs depending on the current environment and maturity. With margin pressures, this straight impact on EBITDA of anywhere between 10-50 basic points can be a significant advantage (How IT Outsourcing Impacts EBITDA). The cash created from lower operating costs for IT and reduced capital investments can facilitate investments in a new store for every 20-30 stores of the company.

Given the maturity of outsourcing within retail, suppliers, including many Indian majors, are offering specific IT products and services to support retail front-office and back-office functions. Having worked with global retailers, suppliers have developed requisite domain expertise to service end-to-end requirements for Indian retailers. Some major players offering in-depth retail IT offerings include IBM, Accenture, TCS, HCL, Wipro, Infosys, and Satyam. As a measure of their focus on the retail segment, major Indian suppliers derive as much as 5-15% of their revenues from retail.

Other Non-IT Functions
While IT remains the dominant opportunity, there are other business processes where retailers have used outsourcing (Outsourcing in Retail is Dominated by IT). Retailers are increasingly outsourcing finance and accounting, customer care, and HR functions.

The set of functions being outsourced by retailers are driven by a range of considerations, including value creation potential, risk in an outsourced environment, and strategic preferences of retailers. In one of Everest North American clients, the management believed that 24x7 full service call center was a key differentiator and a key value proposition for its customers. While the 200-store retailer outsourced this function, the chosen outsourced solution took its strategic importance into consideration.

Choosing the Strategy
Given their profitable growth imperatives, retailers need not invest time, effort, and capital in setting up the entire back-office or IT support required to ramp up and sustain operations. Scalable alternative sourcing models exist that can significantly accelerate time-to-market and reduce ongoing management effort.

Further, companies should evaluate the alignment of the sourcing strategies with their business objectives irrespective of their size, maturity, or current sourcing model. As an example, new retailers can either invest in consolidating distributed back-office capabilities into shared service centers and scaling them over time, or partner with outsourcers to secure scalable operating capacity in line with growth. Relatively bigger retailers with existing shared services capability of significant size can further improve operational efficiencies or explore options to commercialize their investments to generate cash for investment in their core business.

Though sourcing can be a viable option for Indian retailers, they must address key questions to scientifically evaluate suitability of sourcing for their specific business needs and select appropriate sourcing model. Some of the key questions include: What are my business objectives from sourcing, today and in the future? What are my peers and competitors within India and globally doing? What options exist today and how do they compare in terms of risk to my business and potential value delivered? And, how should I chose a partner in growth to create a win-win relationship while maximizing value and minimizing risk?

A well thought out sourcing strategy can help ensure that Indian retailers stay on course with their growth agenda and create shareholder value.

Vikash Jain and Punish Mishra
The authors are engagement director and senior consultant, respectively, of the Everest Group

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