Leveraging Franchisees for Profitable Growth in Retail

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Published by Franchisee India Magazine

“If you give me a lever and a place to stand, I can move the world” – Archimedes

The Indian retail market is considered as one of the most attractive markets in the world in terms of market size and potential. This is reflected in the Rs 30,000-crore Retail Franchising industry in India, which is growing at an annual rate of 30%. However there are kinks in the growth story. As per study, by Vector Research Team, of top 21 retail companies (amounting to a cumulative turnover of Rs 21,000 crore in FY’12), close to 60% of the retailers are making losses. Most companies reported growth in sales but the increase in sales growth is not reflected in the profits – 67% of these companies reported lower profits in FY’12 compared to that in FY’08.

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At the same time most retail companies have tremendous growth potential in terms of reach in the country. They can grow by expanding the retail footprint by way of own stores and of late-through franchising. However, many established players are still to take the growth route forward in a rapid pace, possibly because of their current declining profit trend.

A profitability pressure has always been a reason for a cautious approach toward growth. Thus, rapid growth in retail can be achieved only when profitability is maintained (if not increased) along with growth. Franchisee appears to be one such option where growth can come without increasing the operating expenses. On face value, it looks like the key leverage for the growth story. However, often, what appears obvious may not be as easy! If most retailers are struggling to make money, a franchisee can turn out to be just an exercise of transferring the “monkey” off one’s back to someone else. Hence, making the franchisee model profitable is closely related with making the retailing profitable in the first place.

To understand why retailers are not on a solid ground, let us reiterate the pressures that a typical organized retailer faces today in the existing business:

  • Increasing competition in home markets, other retailers looking to expand, internet retail, and global retailers entering India
  • More demanding consumers looking to extract the best value for money
  • Limited negotiating power to increase margin with established brands
  • Increasing operating costs due to inflationary pressures
  • Slowdown in the Indian Economy, resulting in decreased number of consumers and reduced discretionary spend

We can appreciate the implications of the above by taking the instance of an Indian retailer who is making the business plan for the next year.

Let us take the case of a Retailer who is gaining a typical throughput (gross margin) of 25% and is at breakeven, ie, fixed costs constitute 25% of sales. Considering the inflationary pressures on salaries and other fixed costs, it is reasonable to budget a 10% increase in fixed costs.

To maintain break-even in the next year, such a retailer needs to grow by 10%!

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In fact, this gives us a thumb rule: A retailer who has reached break-even must grow throughput at the rate of fixed cost increase, irrespective of the gross margin %.

To this, let us add another factor that retail is facing – the pressure to reduce margins to protect/gain market share. Assuming a 2% lower gross margin in the same example, sales need to increase by 20% just to maintain break-even.

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Let us examine a case of a retailer having 14% gross margin, with 10% increase in fixed cost and 1% margin reduction. Such a retailer needs to grow sales by 27% to maintain break-even!

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