Published: 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 to be one of the most attractive markets in the world, both in terms of size and potential. This is reflected in the ₹30,000 crore size. The retail franchising industry in India is growing at an annual rate of 30%. However, there are kinks in the growth story. As per a study by the Vector Research Team, out of the top 21 <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/industries/consumer-goods-retail/">retail companies</a> (amounting to a cumulative turnover of ₹21,000 crore in FY2011-12), about 60% of the retailers are making losses. Most companies reported sales growth but the increase in sales is not reflected in profits - 67% of these companies reported lower profits in FY2011-12 compared with FY2007-08. <figure class="image"><img style="aspect-ratio:4000/2695;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//cg-article-27-img-1-1734850933_1776863189.jpg" width="4000" height="2695"></figure>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 owning their own stores and, of late, through franchising. However, many established players are yet to take the growth route forward at a rapid pace, possibly because of their current declining profit trend.Profitability pressure has always been a reason for a cautious approach towards growth. Thus, rapid retail growth can be achieved only when profitability is maintained (and ideally increased) alongside growth. Franchisee appears to be one such option where growth can come without increasing the operating expenses. At 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 to making the retailing profitable in the first place.To understand why retailers are not on solid ground, let us reiterate the pressures that a typical organised retailer faces today in the existing business: <ul><li>Increasing competition in home markets, other retailers looking to expand, internet retail, and global retailers entering India.</li><li>More demanding consumers are looking to extract the best value for money.   </li><li>Limited negotiating power to increase margin with established brands.   </li><li>Increasing operating costs due to inflationary pressures.   </li><li>The slowdown in the Indian economy, resulting in fewer consumers and reduced discretionary spend.   </li></ul>We can appreciate the implications of the above by considering the case of an Indian retailer preparing a business plan for the next year.Let us take the case of a retailer with a typical gross margin (throughput) of 25% and is at break-even, i.e., fixed costs constitute 25% of sales. Given inflationary pressures on salaries and other fixed costs, it is reasonable to budget for a 10% increase in fixed costs.To maintain break-even in the next year, such a retailer needs to grow by 10%! <figure class="image"><img style="aspect-ratio:4000/2535;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//cg-article-27-img-2-1734850954_1776863063.jpg" width="4000" height="2535"></figure>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 percentage.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, the same example shows that sales need to increase by 20% just to maintain break-even. <figure class="image"><img style="aspect-ratio:4000/2175;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//cg-article-27-img-3-1734850964_1776863250.jpg" width="4000" height="2175"></figure>Let us examine a case of a retailer having a 14% gross margin, with a 10% increase in fixed cost and a 1% margin reduction. Such a retailer needs to grow sales by 27% to maintain break-even! <figure class="image"><img style="aspect-ratio:4000/2175;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//cg-article-27-img-4-1734850973_1776863129.jpg" width="4000" height="2175"></figure>In the current environment, retailers find it difficult to grow at more than 10% from existing stores. Hence, the expected way forward for retailers is as follows: <ul><li>Increase throughput/gross margin by way of private-label sales </li><li>Grow sales by increasing the number of stores   </li></ul>The option of private-label sales, though increasingly popular, is difficult for most retailers to adopt because: <ul><li>Establishing private-label acceptance requires high branding investments.   </li><li>The share of the product range available for private-label products is limited, as customers visit multi-brand retailers for a wide variety of brands. Most customers need a minimum range of credible brands to finalise their purchase. This is especially true for products that are not repeat buys, such as durables, IT, and furniture.   </li></ul>Hence, the only way forward for growth appears to be adding stores. However, each store added to the retail chain has numerous investments and risks: <ul><li>Capital is blocked for store set-up and infrastructure</li><li>The recovery period of investment in a store is typically long and not assured</li><li>Stores in new locations need high promotions and brand-building support</li><li>Requires attracting, training, and retaining store managerial talent</li><li>With each store added the growth rate to cover fixed costs increases </li></ul> Clearly, using its own stores for growth is not a very attractive option. Therefore, the only option for growth with a low investment of one’s own capital is to set up franchisees. At first glance, expansion via franchisees addresses all risks: <ul><li>Capital invested in the store is that of the franchisee.   </li><li>The recovery period of investment would ensure a long-term association.   </li><li>Brand building and promotion costs are shared with franchisees.   </li><li>The franchisee is responsible for managing the store; thus, the investment in training the franchisee would be for the long term.   </li><li>The cost increase for retailers to manage franchisees is relatively small.   </li></ul>However, to be a true replacement for its store, the franchisee association needs to be for the long term. This is possible only if the franchisee sees value in the relationship, i.e., the relationship ensures the franchisee’s success.Unfortunately, the reality is that most franchisees face severe hurdles: <ul><li>Franchisors push slow-selling range/inventory to franchisees.   </li><li>Unfriendly terms of the contract - high one-time fees, security deposits, royalties, etc.   </li><li>Most performance-related risks are borne by the franchisee.</li></ul>Apparently, most franchisors structure the franchisee contracts to protect their own interest. This implies that franchisors do not have high confidence in the franchisee’s success, possibly because their existing stores operate very inefficiently, with low inventory turns and low ROI. This forces the franchisors to insist on one-sided terms in the franchisee contract, thereby ensuring their protection in the event the franchisee fails.   However, franchisors with high inventory turns and high ROI are better equipped to dramatically alter the terms with franchisees, since they can extend their successful model to them. In retail, high inventory turns and ROI can be achieved through a ‘pull’-based <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/research-and-publication/articles/dealing-with-variety-in-the-supply-chain/">supply chain</a> - sales-based replenishment to stores through a central warehouse in conjunction with tight control on the range. Such a model ensures: <ul><li>Rapid replenishment of sold items</li><li>Continuous availability through the central warehouse, which allows stores to operate at lower inventory levels, thereby improving store ROI </li></ul> Low excess stocks free up capital to source the entire range and avoid margin erosion due to discounts on excess stocks.   <ul><li>Dynamic sourcing and stock management based on seasonality and item-wise demand changes.   </li><li>Lower additional investment in commencing a few new stores since the central warehouse serves as the aggregation point.   </li><li>The increase in sales from the first few new stores provides the capital to add inventory for further new stores. A virtuous loop!   </li><li>Identification and replacement of slow-moving items. Such items are pulled back to the central warehouse and then made available for other stores.   </li></ul>Retailers with such a pull-based supply chain, as their place to stand, can offer franchisees a win-win: <ul><li>Tailor-made range and store formats based on location potential</li><li>Range control with support for handling slow-moving inventory   </li><li>A guaranteed minimum ROI  </li></ul>Liberty Shoes is a classic example of a retailer using the franchisee route to expand, which succeeded only after revamping its supply chain to a pull-based model. Liberty was in the red, and its franchisees operated at the industry norm of 1.5-2 inventory turns (i.e., 6-8 months of stock), with very low profitability. The introduction of a central warehouse, ‘pull’-based supply chain, and new store planning with only 45 days of stock helped franchisees to achieve around 40% ROI. For Liberty, the revamped supply chain reduced overall discounts from 16% to 4% while also improving the strike rate of new products from 30% to over 60%. Thereafter, Liberty opened 150 new franchisee stores over 18 months, resulting in a dramatic increase in sales and achieving break-even. This year, Liberty Shoes plans to open an additional 125 stores. This is possible because Liberty’s supply chain model has resulted in a paradigm shift, enabling franchisees to achieve sustainable, higher inventory turns and ROI (above the industry standard).Liberty is now working towards replacement in addition to ‘pull’-based replenishment, where any product not selling for more than a decided period will be pulled back and replaced by best-selling products. This will ensure that franchisees always have the latest, best-selling range available for sale. Having tasted the fruits of a win-win offer, Liberty is continuously looking toward taking the next step. In contrast to Liberty, we have the average organised retailer who cannot secure high inventory turns and frequently holds discount sales to clear excess stock. Such retailers can only operate on a win-lose model with franchisees, which ensures the franchisee definitely fails sooner than later. Hence, only retailers with a ‘pull’-based supply chain can grow rapidly and profitably using the win-win franchisee model. Perhaps it is now time to add the ‘right supply chain’ to that oft-quoted maxim - “Retail is all about location… location… location!”

Key Takeaways

Retail companies choose franchisees as a route without increasing operating expenses. Yet, may struggle to deliver profits. Why?

Leveraging franchisees for profitable growth in retail

Published: 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 to be one of the most attractive markets in the world, both in terms of size and potential. This is reflected in the ₹30,000 crore size. The retail franchising industry in India is growing at an annual rate of 30%. However, there are kinks in the growth story. As per a study by the Vector Research Team, out of the top 21 <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/industries/consumer-goods-retail/">retail companies</a> (amounting to a cumulative turnover of ₹21,000 crore in FY2011-12), about 60% of the retailers are making losses. Most companies reported sales growth but the increase in sales is not reflected in profits - 67% of these companies reported lower profits in FY2011-12 compared with FY2007-08. <figure class="image"><img style="aspect-ratio:4000/2695;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//cg-article-27-img-1-1734850933_1776863164.jpg" width="4000" height="2695"></figure>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 owning their own stores and, of late, through franchising. However, many established players are yet to take the growth route forward at a rapid pace, possibly because of their current declining profit trend.Profitability pressure has always been a reason for a cautious approach towards growth. Thus, rapid retail growth can be achieved only when profitability is maintained (and ideally increased) alongside growth. Franchisee appears to be one such option where growth can come without increasing the operating expenses. At 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 to making the retailing profitable in the first place.To understand why retailers are not on solid ground, let us reiterate the pressures that a typical organised retailer faces today in the existing business: <ul><li>Increasing competition in home markets, other retailers looking to expand, internet retail, and global retailers entering India.</li><li>More demanding consumers are looking to extract the best value for money.    </li><li>Limited negotiating power to increase margin with established brands.    </li><li>Increasing operating costs due to inflationary pressures.    </li><li>The slowdown in the Indian economy, resulting in fewer consumers and reduced discretionary spend.   </li></ul>We can appreciate the implications of the above by considering the case of an Indian retailer preparing a business plan for the next year.Let us take the case of a retailer with a typical gross margin (throughput) of 25% and is at break-even, i.e., fixed costs constitute 25% of sales. Given inflationary pressures on salaries and other fixed costs, it is reasonable to budget for a 10% increase in fixed costs.To maintain break-even in the next year, such a retailer needs to grow by 10%! <figure class="image"><img style="aspect-ratio:4000/2535;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//cg-article-27-img-2-1734850954_1776862983.jpg" width="4000" height="2535"></figure>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 percentage.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, the same example shows that sales need to increase by 20% just to maintain break-even. <figure class="image"><img style="aspect-ratio:4000/2175;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//cg-article-27-img-3-1734850964_1776863224.jpg" width="4000" height="2175"></figure>Let us examine a case of a retailer having a 14% gross margin, with a 10% increase in fixed cost and a 1% margin reduction. Such a retailer needs to grow sales by 27% to maintain break-even! <figure class="image"><img style="aspect-ratio:4000/2175;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//cg-article-27-img-4-1734850973_1776863114.jpg" width="4000" height="2175"></figure>In the current environment, retailers find it difficult to grow at more than 10% from existing stores. Hence, the expected way forward for retailers is as follows: <ul><li>Increase throughput/gross margin by way of private-label sales  </li><li>Grow sales by increasing the number of stores   </li></ul>The option of private-label sales, though increasingly popular, is difficult for most retailers to adopt because: <ul><li>Establishing private-label acceptance requires high branding investments.    </li><li>The share of the product range available for private-label products is limited, as customers visit multi-brand retailers for a wide variety of brands. Most customers need a minimum range of credible brands to finalise their purchase. This is especially true for products that are not repeat buys, such as durables, IT, and furniture.   </li></ul>Hence, the only way forward for growth appears to be adding stores. However, each store added to the retail chain has numerous investments and risks: <ul><li>Capital is blocked for store set-up and infrastructure</li><li>The recovery period of investment in a store is typically long and not assured</li><li>Stores in new locations need high promotions and brand-building support</li><li>Requires attracting, training, and retaining store managerial talent</li><li>With each store added the growth rate to cover fixed costs increases </li></ul> Clearly, using its own stores for growth is not a very attractive option. Therefore, the only option for growth with a low investment of one’s own capital is to set up franchisees. At first glance, expansion via franchisees addresses all risks: <ul><li>Capital invested in the store is that of the franchisee.    </li><li>The recovery period of investment would ensure a long-term association.    </li><li>Brand building and promotion costs are shared with franchisees.    </li><li>The franchisee is responsible for managing the store; thus, the investment in training the franchisee would be for the long term.    </li><li>The cost increase for retailers to manage franchisees is relatively small.   </li></ul>However, to be a true replacement for its store, the franchisee association needs to be for the long term. This is possible only if the franchisee sees value in the relationship, i.e., the relationship ensures the franchisee’s success.Unfortunately, the reality is that most franchisees face severe hurdles: <ul><li>Franchisors push slow-selling range/inventory to franchisees.    </li><li>Unfriendly terms of the contract - high one-time fees, security deposits, royalties, etc.    </li><li>Most performance-related risks are borne by the franchisee.</li></ul>Apparently, most franchisors structure the franchisee contracts to protect their own interest. This implies that franchisors do not have high confidence in the franchisee’s success, possibly because their existing stores operate very inefficiently, with low inventory turns and low ROI. This forces the franchisors to insist on one-sided terms in the franchisee contract, thereby ensuring their protection in the event the franchisee fails.   However, franchisors with high inventory turns and high ROI are better equipped to dramatically alter the terms with franchisees, since they can extend their successful model to them. In retail, high inventory turns and ROI can be achieved through a ‘pull’-based <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/research-and-publication/articles/dealing-with-variety-in-the-supply-chain/">supply chain</a> - sales-based replenishment to stores through a central warehouse in conjunction with tight control on the range. Such a model ensures: <ul><li>Rapid replenishment of sold items</li><li>Continuous availability through the central warehouse, which allows stores to operate at lower inventory levels, thereby improving store ROI </li></ul> Low excess stocks free up capital to source the entire range and avoid margin erosion due to discounts on excess stocks.   <ul><li>Dynamic sourcing and stock management based on seasonality and item-wise demand changes.    </li><li>Lower additional investment in commencing a few new stores since the central warehouse serves as the aggregation point.    </li><li>The increase in sales from the first few new stores provides the capital to add inventory for further new stores. A virtuous loop!    </li><li>Identification and replacement of slow-moving items. Such items are pulled back to the central warehouse and then made available for other stores.   </li></ul>Retailers with such a pull-based supply chain, as their place to stand, can offer franchisees a win-win: <ul><li>Tailor-made range and store formats based on location potential</li><li>Range control with support for handling slow-moving inventory    </li><li>A guaranteed minimum ROI  </li></ul>Liberty Shoes is a classic example of a retailer using the franchisee route to expand, which succeeded only after revamping its supply chain to a pull-based model. Liberty was in the red, and its franchisees operated at the industry norm of 1.5-2 inventory turns (i.e., 6-8 months of stock), with very low profitability. The introduction of a central warehouse, ‘pull’-based supply chain, and new store planning with only 45 days of stock helped franchisees to achieve around 40% ROI. For Liberty, the revamped supply chain reduced overall discounts from 16% to 4% while also improving the strike rate of new products from 30% to over 60%. Thereafter, Liberty opened 150 new franchisee stores over 18 months, resulting in a dramatic increase in sales and achieving break-even. This year, Liberty Shoes plans to open an additional 125 stores. This is possible because Liberty’s supply chain model has resulted in a paradigm shift, enabling franchisees to achieve sustainable, higher inventory turns and ROI (above the industry standard).Liberty is now working towards replacement in addition to ‘pull’-based replenishment, where any product not selling for more than a decided period will be pulled back and replaced by best-selling products. This will ensure that franchisees always have the latest, best-selling range available for sale. Having tasted the fruits of a win-win offer, Liberty is continuously looking toward taking the next step. In contrast to Liberty, we have the average organised retailer who cannot secure high inventory turns and frequently holds discount sales to clear excess stock. Such retailers can only operate on a win-lose model with franchisees, which ensures the franchisee definitely fails sooner than later. Hence, only retailers with a ‘pull’-based supply chain can grow rapidly and profitably using the win-win franchisee model. Perhaps it is now time to add the ‘right supply chain’ to that oft-quoted maxim - “Retail is all about location… location… location!”

<h5>Leveraging franchisees for profitable growth in retail</h5>

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Discover why most retail franchises fail despite high market growth. Learn how a pull-based supply chain can transform inventory turns and ensure ROI.