End of discount stores

They started off with a bang and traded in large volumes but discount stores across the country have folded up

It’s a sunny afternoon in south Mumbai and the monsoon is still a few weeks away. A group of teenagers walk into a store that promises some very fancy deals. They spend a few minutes looking around and do not seem too impressed by what is on offer. After taking a quick look, the teens decide to look elsewhere. By the sound of their conversation, it is clear that one of them is looking for a pair of jeans and thinks the range is quite limited at this outlet. Incidentally, the store — The Loot — was once a big name in the business of selling discounted brands.

Today, this is its only outlet across the country. At its peak, The Loot had 150 outlets spread over 60 cities that stocked a gamut of brands across categories such as apparels, shoes and accessories. While a fraction of this merchandise is still available at the brand’s sole outlet, stock is extremely limited and most of the brands look hopelessly out of sync with what is likely to sell today. The disappointment of the teenagers, then, is not hard to comprehend.

A little while later, the beleaguered entity’s managing director Jay Gupta climbs down from his office a floor above the showroom and has a quiet conversation with one of the salesmen. In early May, SBI decided to auction The Loot’s property in Mahim, a suburb at the edge of western Mumbai, for a reserve price of ₹7.5 crore after the company failed to pay its dues of ₹43 crore, not including interest. Understandably, Gupta is annoyed. He snaps when asked why his company’s strategy failed and refuses to answer questions, saying his lawyers are looking into the issue. Gupta’s is not the only case of failure in the discount store space in India — many others have fallen by the wayside as well.

The reasons behind this are many, starting with the inability to maintain a strict cost structure, limited supplies from large brands and a faulty understanding of the business. Consequently, margins suffered while costs continued to zoom out of control, largely on the back of high rentals. By 2009, the game was up for players such as Promart and Vishal Retail. The lucky ones managed to sell out, while some — like Gupta — have been less fortunate. Others — like Megamart — have chosen to reposition themselves. But the results are yet to be seen.

Things fall apart

Though Ram Chandra Agarwal may not openly admit it, there is a twinge of regret evident when you ask him about what went wrong with his discount store business. Vishal Retail, a business Agarwal set up from scratch, was acquired by private equity major TPG Capital and the Shriram Group in March 2011 for just ₹70 crore.

At that point, Vishal, a loss-making entity, also had a debt of ₹730 crore. With a network of 175 stores, Agarwal was not short on ambition but had little control over debt and inventory, which forced him to sell out. “We paid the price for overexpansion. We had four big factories but I don’t think there was any quality control,” says Agarwal, who today runs the V2 retail chain, whose primary business is selling apparel in states such as Uttar Pradesh and the northeast.

At its peak, Vishal’s 175-store network consisted of formats such as hypermarkets, fashion outlets and even petrol pumps. The global slowdown of 2008 made it difficult for the company to raise money and barely two years later, its debt woes were already underway. “The trick in retail is buying the right quality at the right price and the right time. We did not get any of that right,” says Agarwal.

Gupta’s case is no different when it comes to expanding without rationale, and his financials tell the story. The first store went off the ground in 2004 at Marine Lines in south Mumbai and by FY10, Loot had revenue of ₹107 crore and a net profit of ₹3 crore.

In November 2010, ratings agency ICRA said in its report that The Loot was constrained by a strained capital structure despite capital infusion in the past due to increased working capital requirements. Coverage indicators were termed ‘weak’ on account of higher interest and finance charges.

If that was not bad enough, the company’s rapid expansion and the required high investment in maintaining inventory led to high trade receivables. This was evident in its financials for FY12, when the company, on a turnover of ₹60 crore, reported a loss of ₹40 crore (it was ₹122 crore for FY11, with a loss of ₹14.8 crore), according to its annual report filed with the registrar of companies. By FY13, its turnover was down to just ₹5.23 crore, with a loss of ₹16.5 crore. The company has not filed its numbers for FY14.

The pre- and post-2008 scenario sums up the story for the discount store business in India. If capital-raising activity was at its peak before, including at The Loot, where a ₹100 public issue was planned, things were totally different by the end of 2010, when just survival became the mantra. In fact, it was unbridled expansion that cost the company dear, with key costs such as rentals not being under control.

In this business, the thumb rule is that rentals should never exceed 7-8% of revenue, while for these companies it was as high as 17-18% at its peak. But these things did not matter as long as there was enough business. And once that scenario changed, things only worsened. Interestingly, the slowdown changed the story for apparel manufacturers as well. In India or, for that matter, in any part of the world, discount stores basically sell what a brand has not been able to sell or what has been left over. Typically, a discount store buys these products at a price that is 50-70% less than the MRP. This would then be sold at about 25-60% less than the MRP.

“There was a credit period of 60 days and it was possible in many categories to make a margin of at least 60%,” says Susil Dungarwal, former CEO, The Loot. Most of what was bought would be sold, with an affordable price tag being the USP. “No more than 2% of the merchandise remained unsold and that would eventually find its way into the grey market,” he points out. 

What changed the equation during the slowdown was when manufacturers themselves started facing pressure on sales. If the end of season in the good times was typically no more than three weeks, that got extended to almost two months now.

“That meant that we would not get reliable supply from the manufacturers,” says Nikhil Chaturvedi, founder and managing director, Provogue (India), who ventured into the discount store business with the Promart brand. According to him, it was never easy to get fast-moving products such as chinos or a good white shirt. “If I was getting the leftovers, I was not making a complete offer anyway. We entered the business when retail was expanding and, in no time, consumption dropped,” he explains.

According to a former apparel CEO, of the 200 menswear brands, only 14-15 actually bring in revenue. “This includes Louis Philippe, Van
Heusen, Arrow, Wrangler and Levi’s. If you do not have enough of these brands, it is a suicidal situation,” he says. 

In a typical retail format, the thumb rule is to have four pieces per square foot, which means that a store with an area of 250 sq ft will need to have at least 1,000 pieces. Of this, around 400 will be on the rack and an equal number unopened in the godown, with at least 200 pieces in transit. In that sense, for what is present on the shelves, there will be twice that many pieces invisible to the consumer.

At a discount store of the same area, where aesthetics is not a factor, over 2,000 pieces can be stored. For any brand-owner (apparel, footwear and the like), what is unsold or goes out of fashion first makes its way to factory outlets and what remains goes to a discount store. For brands such as Lifestyle or Shoppers Stop, not having a factory outlet means an extended discount season. A former Puma official recalls Loot defaulting on a payment around 2010.

“There was never a situation when more than 10% of what we made was sent to discount stores. Typically, The Loot accounted for half of that,” he says. Following that default, Puma did not have any further business with the company, with its own factory outlets selling products at a 60% discount. This is where the supply crunch hit discount stores and they did not recover. A company like Promart, which was looking to expand significantly, could not go beyond two stores (one each in Ahmedabad and Indore) and by FY09-10, Chaturvedi had sold the brand to Vemb Lifestyle, a franchise for international brands, for ₹90 lakh. 

Global foibles

Globally, the discount stores business is big and one that thrives, albeit with a difference. Many of these stores are company-owned and it is not unusual to see brands such as Gap or Levi’s running them on their own. “There are some stores that could be franchise operations but even those are driven by the companies,” explains Harminder Sahni, founder and managing director, Wazir Advisors, a management consulting firm. In a market like the US, he points out, there are many more seasons and a lot of multi-brand outlets, but most run with skeletal staff.

“In a city like Atlanta, you will see at least three large discount stores with just one cashier each. There is no promise of service and the big promise is only discount,” says Sahni. Contrast that with India, where in a scenario of limited supply, there are many players, with four to five people working at the store at any point. “People here have not understood that brands do not work to create a surplus. The market here is not large enough to accommodate so many discount stores,” he adds.

Chaturvedi, while agreeing with this, thinks many players made the mistake of creating a private label when the going was tough. “It ends up defeating the purpose of getting into the business in the first place,” he argues. In the same breath, he says a discounted store with a 100% private label format might have worked.

“It really comes down to the consumer offer and that could have been a smart way of going about it. It would have allowed us to be very focused.” But how to run a profitable discount model is something that has eluded most people. Brands such as Max Retail, positioned as a value-fashion store, tried taking the discount route in 2012 and that did not work. Max opened an outlet in the Marathahalli area of Bengaluru, where the discount offered was in the range of 20-25%. “Given that our products were anyway so affordable, consumers came back and told us they were willing to pay ₹100 more to buy something new,” says a slightly bemused Vasanth Kumar, executive director, Max Retail. The product mix in the store is equally split between old and new apparels and over the next one year, this will transform into a normal Max store.

Be it discounted clothes or a value-fashion offering such as the ₹1,400-crore Max Retail, the trick lies in stringent cost control. Kumar says this is true at all levels, starting from advertising and promotion, which is never more than 2% of revenue, to rentals. Max stores are never present on the ground floor of a mall, resulting in savings of not less than 30%.

“When you are working on a net margin of 4-5%, the way to do business is by working backwards,” he says. The thumb rule to run a profitable business in retail, according to Kumar, is to generate revenue of at least ₹1,000 per sq ft each month. “It is very difficult to make money at anything less than that. In our case, the operating break-even for each store takes about a year, while the capex recovery takes about four years,” adds Kumar.    

Changing tack

When the Sanjay Lalbhai-owned Megamart realised that the discount format was not working, it decided to reposition itself on the value-fashion platform. While its first outlet opened in 1995, it was not until this year that the repositioning exercise was complete. This process meant small changes such as reducing the size of the stores from at least 50,000 sq ft to 10,000-12,000 sq ft. Today, there are 83 stores on the value platform, with another 55 discount stores still around.

“The plan is to scale down the discount stores over the next one or two years,” says Suresh J, managing director and CEO of Arvind’s brands and retail business. Now, the plan is to open 20 new stores of the ₹600-crore Megamart, which is profitable at an Ebitda level, each year. The value proposition will be quite different from the discount stores that Megamart customers have got used to seeing. “The value we bring to the table today is, for instance, selling a Geoffrey Beene shirt at ₹1,100, when other shirt brands will be priced at over ₹2,200. As we go forward, Megamart will make the transition to becoming an omnichannel retailer,” says Suresh. Today, under the new format, only 40% of what is sold are Arvind brands, as compared with at least 80% under the earlier format. 

Of course, there is also Future Group’s ₹1,000-crore Brand Factory, a company that entered the discount store story in 2006 and has chosen to expand slowly. Its 41 outlets are largely present in Hyderabad and Bengaluru. Future Group honcho Kishore Biyani concedes that a big advantage has been the presence of Central, his fashion retail business, which moves its unsold stock to Brand Factory.

“Maybe that is an advantage that other players do not have. We see an opportunity in every segment and brands sold at a discount is a big one,” he says. The expansion has been cautious and Biyani speaks of adding 10-12 stores each year.

“In about five years, we should be at around 120 stores,” he says. He has been working towards ensuring that there is not too much dependence on Central. “Today, only 40% comes from that route, with the rest coming directly from brand-owners. We think it is important to have independent relationships with them,” says Biyani.

At an Ebitda level, Brand Factory has a margin of 9-11%. Wazir Advisors’ Sahni says this entire business is often driven by logic that is not easy to comprehend. “If someone like a Brand Factory gets it right, you will have five more guys wanting to come in. What is not understood is that if supply is limited, there is space only for those many players,” he adds.

In 2013, Biyani bought over Coupon, a south-based discount chain, then owned by Bengaluru-based Prateek Apparels, gaining 14 stores across Hyderabad, Bengaluru and smaller locations such as Raipur and Faridabad. Sanjay Dalmia, president, Prateek Apparels, says the chain was then a ₹100-crore business and was making profits.

“We were looking for funding. With the collapse of many discount store formats, it was clear that private equity money would not come easily,” he points out. In retrospect, he thinks Coupon should have taken a state-wise approach. “Being in one state means you can take tactical steps and get more for each rupee spent on marketing,” he insists. To his mind, there is money to be made in this business and he cites international examples such as TK Maxx, Bob’s and Marshalls, which operate as large discount stores without any frills.

“They sell off-season merchandise, not seconds,” says Dalmia. He thinks that if a discount store can get it right on rentals and location, there is serious money to be made. “You must have a good combination of national and regional brands in addition to private labels, which will greatly improve profitability. Little things like this can go a long way,” he sums up. A learning that has come in too late in the day for the players.