AUGUST 2015

© Keiko Morimoto Modern grocery and the emerging- consumer: A complicated courtship

In some emerging markets, the response to modern grocery formats has been tepid. What’s a modern grocer to do?

Peter Child, Thomas Kilroy, and James Naylor

Just 20 years ago, modern grocery appeared trade—the family-owned grocery chains, small poised to conquer every consumer market in the world. independent stores, and informal merchants that at Ambitious European grocers, having blanketed their the time accounted for the vast majority of grocery home countries with and , sales in emerging markets. The prevailing expectation began setting their sights on growth both within and was that although there would be local differences beyond the continent. They held particularly high hopes due to cultural specificities, in every country the retail for , India, and other emerging markets, where landscape would eventually consist of a combination fast-rising consumer spending seemed to presage an of modern formats: full-line supermarkets and unprecedented demand for gleaming new stores with hypermarkets, convenience stores, and discounters. large assortments, wide aisles, and bright lighting. These assumptions have been proved wrong. Global In the 1990s, the term “modern grocery retail” was grocery giants are struggling to grow profitably essentially a proxy for a small group of multinational in many emerging markets. Traditional trade has grocers including , , , , proved remarkably resilient. And the market and , , Metro, , and . It was channel structures taking shape in individual widely presumed that these retailers’ entry into any emerging economies are distinct from one another, market would lead to the demise of the traditional following no obvious pattern.

1 Why did this happen? What, if anything, did working so well in the developed world. But, in multinational grocers do wrong? And what retrospect, it’s clear that the countries in which the does it mean for the future of modern retail in prospered had several characteristics emerging markets? in common: good road networks and high or fast- rising car-ownership rates, a large middle class that The hypermarket’s shortcomings enjoyed decent wages and stable employment, and a To understand the disparity between early high proportion of rural and suburban households expectations and the current reality, it’s useful with enough room at home to store groceries bought to examine the roots of the two quintessential in bulk. Also, those markets had grown to maturity modern-trade formats: the and the at a time when many women didn’t return to work hypermarket. The hypermarket in particular— after having children and therefore had time whether in its European form (in which food anchors during the day to drive to and from the store. The a massive selection of nonfood items) or its North hypermarket format draws heavily on consumers’ American one (the “supercenter,” which represents time, ability to travel, and storage capacity. the successful injection of food and grocery into a general-merchandise )—was In emerging markets, retailers encountered an widely regarded as unbeatable. By offering tens entirely different context. Consumers were less of thousands of products in an immense building affluent and lived in urban areas; many didn’t own a just outside or on the edge of a town or city, a car, couldn’t afford to travel to and from a relatively hypermarket could operate at a level of productivity far destination, had no room at home to that other grocery formats struggled to . store purchases, or all of the above. Hypermarket operators passed on these efficiency gains to consumers in the form of lower prices, A new respect for localism which served to reinforce hypermarkets’ advantage. Further complicating matters, emerging markets weren’t just different from developed markets; In their first forays into other developed markets emerging markets also differed from one another abroad, major retailers relied heavily on the in nontrivial ways. That was true in the 1990s hypermarket format. When French retailers Auchan, and it remains true today. Based on our research— Carrefour, and Promodès opened hypermarkets in which involved in-depth study of the retail sector during the first years of Spanish economic in ten developing countries in Asia, Eastern reform, they quickly captured a large fraction of Europe, and Latin America, as well as interviews that country’s overall grocery sales and dictated the with more than 20 local retail and consumer market structure that remains in place to this day. experts and analysis of channel-growth data in these markets—we’ve developed a perspective Expansion across Europe was an exciting growth on the factors that have hampered the growth prospect, but even more enticing to retail leaders of modern trade in emerging markets. and investors was the growth potential of emerging markets. Over the years, that potential has become On both the demand side (what customers want from even clearer: by 2025, we expect emerging markets retailers) and the supply side (the means by which to account for $30 trillion in consumer spending, or retailers can deliver what customers want), different nearly half of global consumption.1 factors shape the retail ecosystem in each country. Together, these factors produce wide variability in When multinational grocers entered emerging markets, the level of modern-trade development in countries they again relied on the grocery formats that were around the world (Exhibit 1).

2 PoRCG_4_2015 Modern grocery and the emerging-market consumer Exhibit 1 of 2

Exhibit 1 Modern-trade penetration and growth vary widely by market.

Size of grocery market, $ billion

689

295 Modern-grocery penetration, 2014, % 8

90 Germany 80 Spain 70 China ($689 billion) 60 Ecuador ($8 billion) 50 Mexico Brazil Thailand 40 Colombia Turkey

30 Peru 20 Vietnam 10 India ($295 billion) 0 –1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

Growth in penetration, 2009–14, percentage points

Source: Euromonitor International; McKinsey analysis

On the demand side, for instance, food-shopping store owner, free home delivery, and habits have turned out to be largely localized and and cash rebates if they remain loyal. deeply entrenched. Emerging-market consumers tend to prepare their own meals and cook more On the supply side, a big factor is the informality than their peers in developed markets do, and of traditional trade: many small retail businesses they are accustomed to shopping at open-air rely on unpaid labor from family and friends, pay market stands or small neighborhood grocery no rent because they own their storefronts, and stores that offer a familiar selection of fresh food don’t pay corporate taxes. Modern retailers cite this and household staples. They don’t necessarily informality as a major challenge when competing perceive customer service at modern retailers with local retailers. A European hypermarket chain as superior to that of the traditional trade. found that its considerable operating-cost advantage Customers of India’s kirana stores—small, family- from better sourcing and supply-chain processes owned retail shops in or near residential areas— was canceled out by the fact that it was paying taxes already benefit from personal service from the while local competitors were not.

3 Another major factor affecting modern trade is they are especially critical in helping retailers public policy. India’s restrictions on foreign direct secure a profitable future in the world’s fastest- investment have limited the growth of modern retail growing economies (see sidebar, “Questions to test there; in China, by contrast, city governments are your emerging-market strategy”). assessed on the level of economic activity and foreign investment they attract, which makes them biased The levers are by no means comprehensive. For one, toward supporting modern trade. As a result, modern- they don’t touch on digital technology, which may trade penetration in China’s largest cities has grown well be just as important in emerging markets as in significantly over the past 15 years. developed ones; indeed, rapid adoption of smartphone technology may allow emerging markets to leapfrog A further supply-side factor in emerging markets is the more mature markets and reconfigure the value chain fragmented supplier base, which places a natural limit farther upstream (for example, by giving smaller on the benefits of scale. A retailer can’t source products suppliers direct access to national and even global as efficiently as it would in a mature market because it markets). Rather, we draw attention to areas that we must buy from a complex network of regional and local believe require deliberate in emerging markets. entities. And even retailers with a national buying team won’t easily find national manufacturers who are 1. Prioritize proximity. eager to partner with them—a point we pick up on later. Urban consumers with limited budgets and smaller homes often prefer to buy small amounts frequently, Incumbent advantage is yet another powerful factor both for immediate consumption and for stocking up. shaping retail ecosystems. Today’s market dynamics And where trading space is constrained, proximity tend to become tomorrow’s market structure—so, formats offer a more realistic prospect of economic for example, in markets in which a highly efficient returns for the retailer. Modern retailers can benefit wholesale system serves the traditional trade, it from their experience operating smaller urban becomes much harder for modern grocers to formats in developed markets—banners such as gain a foothold. That said, wholesalers can also ’s AH to Go in the Netherlands or Tesco be vanguards of modernization. In Turkey, for Express and Sainsbury’s Local in the United Kingdom. instance, some Bizim Toptan stores have developed a substantial retail business. These wholesalers- One market in which small-format stores have been cum-retailers illustrate the fact that ecosystems in the major driver of modern-trade development is emerging markets are partly shaped by players that Indonesia. Sales through the convenience-store can concentrate and coordinate a critical mass of channel are growing at a rate of more than 25 percent what otherwise is a complex set of routes to market. per year across the country. In fact, the increasing dominance of convenience stores, known locally as Seven strategic levers for success mini-marts, has led to a contraction in the number In parts of the world where the market structure of supermarkets and hypermarkets. The mini-mart is itself still in a formative stage, retailers need a chains mimic warungs, which are small family-owned bespoke strategy. Our research and experience retail or restaurant businesses that play a central role suggest seven strategic levers that lead to success in Indonesian social life. Although the mini-marts in emerging markets. These levers—having to do are run by modern retailers—in addition to leading with delivering what consumers want, working national chains and , international effectively with other players in the ecosystem, and players such as and 7-Eleven have moved generating lasting productivity advantages—reflect into the market—the customer’s experience in mini- perennial concerns for retailers everywhere, but marts is not so different from that in warungs.

4 Questions to test your emerging-market strategy

Proximity • Is your pricing philosophy • Do you understand policy • Do you have a clearly defined small- understood by customers and makers’ concerns, and have you store format? evident in your stores day after communicated yours? day, week after week? • Have you built capabilities for local • Who on your team is in charge assortment tailoring? Productivity of government relations? Are the • If local labor costs were to rise primary objectives clear? • Do you have a nimble supply chain— by 10 percent, would you still one that can make small, frequent be profitable? Traditional-trade partnerships deliveries to stores with limited • How well do you understand the stockroom space? • Who in your organization is existing traditional-trade structure? championing process improvement • What is your property-acquisition plan and labor efficiency? • Who are the best traditional-trade for building a small-store portfolio? players, and what can you learn For example, have you identified Manufacturer relations from them? independent businesses you could • Do you understand the cost acquire or partner with? structure and profitability of • Are there opportunities to build your your major suppliers? retail brand through franchising, supply Pricing agreements, or earn-out acquisitions? • How good is your price perception • Who are your most important among consumers? Are you the suppliers for present and City-based growth acknowledged price leader in future growth? • Do your growth plans match the the market? projected growth of cities and metro • How should you propose sharing areas in your principal markets? • What’s driving price perception? the proceeds of growth? Do you know what your “key • Have you tailored your route-to- value items” are? How well do you Government affairs market and commercial models compete on basket prices for your • How broad and deep is your network to each of your prioritized cities main customer segments? in and around government? or city clusters?

2. Keep prices low—and make sure consumers know. own against supermarkets. In Turkey, for example, The prediction that emerging-market consumers discount stores are the fastest-growing channel, would initially shop at discounters and then largely due to the success of local companies such “graduate” to supermarkets hasn’t come true. as A101, BIM, and Şok (Exhibit 2). Discounters, or retailers that exhibit at least three of four core discounter characteristics—low prices, Perhaps the success of discounters shouldn’t be limited range, low-cost store retrofits, and ultra- so surprising, given the stature they enjoy even in simple operations—have more than held their one of the largest and richest retail markets in the

5 PoRCG_4_2015 Modern grocery and the emerging-market consumer Exhibit 2 of 2

Exhibit 2 The channel structure in Turkish retail is changing rapidly.

Grocery retail by channel, CAGR,2 %1 2013–18, %

100% = ₺143 ₺177 ₺229 5.3 billion3 billion billion

15.0 21.4 22.5 Supermarkets 6.4 1.6 1.0 2.2 0.2 3.3 3.6 Hypermarkets 1.1

10.8

1.3 18.1 Discounters 16.8 80.1 1.2

Forecourts 10.4 1.7 61.9 3.3 Convenience stores 24.5 50.8 Mom-and-pop stores 0.8

2006 2013 2018E

1Figures may not sum to 100%, because of rounding. 2Compound annual growth rate. 3As of Aug 2015, $1.0 = 2.8. Source: Euromonitor International; McKinsey analysis

world: Germany. Low-price stores can establish able to convey that message to enough consumers. a dominant position in markets that are going Some common modern-trade practices such as high/ through rapid increases in disposable income low pricing can actually undermine a retailer’s value (as was the case, of course, in postwar West message. In Peru, where bodegas and market stands Germany). When the first modern-trade stores account for some 80 percent of grocery sales, we to open in a market are discounters, they can set found that modern retailers—despite often having price expectations permanently. lower full-basket prices than traditional retailers— nevertheless lag behind traditional retailers by Other modern formats can also compete on price, but more than 15 percentage points in consumer they have to work harder to get consumers to notice. perception of low prices. Our research suggests most modern retailers don’t get full credit for the value they offer. This is the case 3. Obsess over productivity. with Indonesia’s hypermarkets, which typically are In markets where labor costs are low, it can be difficult cheaper places to shop than warungs but haven’t been to retain a relentless focus on productivity. But wages

6 5. Educate policy makers on the benefits of are rising fast in emerging markets and bad habits are modern trade. notoriously hard to unlearn. Retailers that have been obsessed with productivity have achieved striking As mentioned earlier, government intervention can results. BIM’s decisions on new-store openings in play a critical role in how, and how quickly, modern Turkey are driven as much by logistics-network trade develops. In China, the strong central mandate optimization as by local demand attractiveness. BIM to provincial and municipal authorities to create the follows a “mushroom” expansion model: it grows necessary infrastructure for modern retailers—not to high density in specific neighborhoods within just thousands of miles of new roads, but also urban a city, using retail formats that require low capital planning that integrates modern-trade requirements expenditures. The high density of deliveries has into traffic patterns and -estate zoning—has allowed it to solve the small-format logistics puzzle yielded extraordinarily rapid development. that has tripped up many big-box players. Modern-trade players would do well to communicate Corporación Favorita in Ecuador offers another the benefits of modern retail to government officials. example of operational excellence: its just-in-time They could, for instance, make a strong case that inventory model of daily deliveries essentially modern retailers can do a better job than traditional eliminates backroom stock. To ensure full control trade in providing safe and cheap access to high- of store operations, it eschews direct store delivery, quality food and household goods. managing all flows through its central warehouses. This focus on operations has enabled the company to 6. Consider partnering with the traditional trade. successfully manage a complex format portfolio. One growth strategy for modern-trade players involves partnership with—rather than competition 4. Make the business case to manufacturers. against—the traditional trade. The strategy has clear A rarely discussed obstacle to the expansion of advantages: it allows a modern retailer to leverage the modern trade in emerging markets is the fact network and personalized service of the traditional that established manufacturers don’t have much trade while minimizing capital investment. incentive to do business with modern retailers. Branded manufacturers enjoy high margins in Poland is an example. Although its supplying small shopkeepers, who have little cash-and-carry stores and distribution centers negotiating leverage. Why would they want to play a wholesaler role, Eurocash also welcomes jeopardize that business in favor of modern-trade traditional-trade retailers as franchisees under retailers with initially limited volumes and terms its abc convenience-store banner (approximately that are often less vendor friendly (especially if the 6,000 stores) and its Delikatesy Centrum banner retailer is a subsidiary of a global company)? (approximately 1,000 stores). This franchising approach has allowed Eurocash to grow quickly To woo major manufacturers, modern retailers may and profitably. Another example of partnership need approaches that are as creative, collaborative, with the traditional trade comes from Grupo Éxito and mutually beneficial as those they employ in in Colombia: small retailers that join its Aliados developed markets. One argument full-line modern Surtimax network receive Surtimax signage and retailers can make is that branded manufacturers fixtures, access to Grupo Éxito’s portfolio of private ought to support them rather than discounters. brands, and business and management training. After all, in markets where discounters dominate, Grupo Éxito has rapidly built a network of more than consumers can shift en masse away from branded 500 stores at an extremely low capital-expenditure products toward private-label goods. rate of less than $500 per store.

7 7. Adopt a city-based strategy. retailers thus need to become experts at local When a market is in a relatively early state of tailoring. That said, operating in emerging markets modern-trade development, national borders still unquestionably requires excellence in core can be unhelpful in scoping and designing a retail retailing competencies: marketing, merchandising, network. Rather, retailers should concentrate supply-chain management, and talent development, 2 on getting to scale in cities or city clusters. to name just a few. Retailers that excel in all Thus, Supermercados Guanabara, the market these areas in the context of markedly different leader in Rio de Janeiro, has confined itself to emerging-market structures will, in a sense, have the metropolitan area and operates just conquered the world. 23 stores—yet it outperforms formidable competitors, including Carrefour and Walmart. 1 For more, see Yuval Atsmon, Peter Child, Richard Dobbs, and Laxman Narasimhan, “Winning the $30 trillion : Going In China, some retailers have chosen to concentrate for gold in emerging markets,” McKinsey Quarterly, August 2012, first on one city or city cluster, be it or on mckinsey.com. 2 For more on how to develop a city-based strategy, see Udo Shenyang, before expanding nationally. Similarly, Kopka, Stefan Rickert, and Markus Schmid, “Pinpointing the modernization in India’s retail sector will most likely markets with the highest growth potential,” Perspectives on happen through a series of players expanding in retail and consumer goods, Winter 2013/14, on mckinsey.com. 3 individual cities and states, rather than through a For more on growth opportunities in India, see “Understanding India’s economic geography,” October 2014, on mckinsey.com. “big bang” national expansion plan.3

Download the full issue in which this article originally appeared, Perspectives on retail and consumer goods, Number 4, Autumn 2015, on mckinsey.com. For any modern retailer, success in emerging markets isn’t guaranteed. Our research confirms Peter Child is a director in McKinsey’s Hong Kong office, the complexity and local specificity of market Thomas Kilroy is a principal in the Chicago office, and development and the degree to which it depends James Naylor is a senior expert in the London office. on initiatives taken not just by retailers but also by governments, manufacturers, wholesalers, and Copyright © 2015 McKinsey & Company. others in the local retail ecosystem. International All rights reserved.

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