Rent! - The Biggest Flaw of the Retail Industry in India?

The increasing rent for commercial spaces is becoming a major challenge for companies to get a positive ROI for their Retail Stores.

Original Story by Prashant Sachdev

Recently, an old friend of mine started his own restaurant in New Delhi. He chose an amazing catchment for the same which is helping him to get a decent footfall and most of the items offered by him are having a good profit margin as well. But even after doing that, the contribution margins are still very low. Surprised? Guess who the culprit is?

You guessed it right! It is the high rent cost that he is bearing which is becoming a major challenge for him day by day.

Most retail chain companies in India opt for large commercial spaces in highly populated areas, preferably malls or shopping centers. Such properties do get them a good footfall with the least amount of BTL (Below the Line) advertising, but sooner or later, they realize that the bigger issue for them is not the footfall, but the Rent Expenses that puts a dent on their Income Statement every month.

Many companies have faced losses due to this one issue. One of the examples of the same is Aditya Birla Retail Ltd. which faced losses from most of its stores across India especially due to major rent expenses. Eventually, ABG divested in this business.

Let's consider a case to understand the problem:

Assume that a furniture startup is planning to start a retail store in Delhi for showcasing and selling furniture items. They are expecting a monthly revenue of Rs. 30 to 40 Lacs.

The average monthly rent for leasing a good commercial space in Delhi NCR is more than 10 Lacs per month for a 5000 Sq. Ft. sized area. It would be even higher for spaces that are close to the Mall Entrance, or the ones that have a larger area. The payroll cost for employing people would be more or less Rs. 15 lacs annually ~ Rs. 1.25 Lacs per month. The overheads would also cost more than Rs. 3 Lacs every month considering the cost of water & electricity, security, telephone & internet, maintenance etc. Considering a better than average profit margin of 5%, the Cost of Goods Sold would be Rs. 33.25 Lacs (considering a monthly revenue of 35 Lacs). It’s clear that none other than the Rent Cost is a major controllable factor.

The total costs already add up to Rs. 47.5 Lac and we can observe losses of 12.5 Lac!

Going by this calculation, the company would need a monthly revenue of Rs. 47.5 Lacs, just to break even. This would require a sales growth of 35.7%.

Is it possible for a Startup to get an annual revenue of Rs. 5.7 Crores FROM A SINGLE STORE just to break even?

I won't answer that for you...

So, should companies stop renting such commercial spaces?

Companies can choose to lease such commercial spaces if:

1. hey can earn very high revenues that would not just help them to break even, but also become profitable.

2. The per-unit contribution is very high, i.e. higher than 25-30% leading to very low COGS.

3. They can, and want to bear losses. (Launder Money maybe!)

However, it is very unlikely that any business would opt for the latter two.

As far as higher revenues are concerned, that might require more space, leading to even higher rent expenses.

That would lead us to only one final solution – Own Brick and Mortar Stores.

This would require an even higher one time fixed cost but there would be no recurring cost. Don’t get me wrong… the risks are even higher here. In case of a failure, there might be major write off costs for the company.

It is very critical for any organization to make sure that the success of an upcoming brick and mortar store is guaranteed as any bad decision related to the catchment or strategy would lead to a catastrophic failure for a small or mid-sized business.

A typical D Mart Brick and Mortar Store in Bangalore

One fantastic example of the Brick and Mortar strategy is of D-Mart. They always preferred a built from scratch store which helped them to eliminate the huge dent of rent expenses on their P&L Statement. Guess what? The company as well as their stores, both are profitable!

Do remember that this company is also following the Economies of Scale concept. Even a brick and mortar store with a low revenue would still face losses and ROCE (Return on Capital Expenditure) won’t be good.

And then there is the best of both worlds methodology:

Another smart way to manage the same is to purchase the property in installments. The installment value can be more or less similar to the rent cost. This would help the organisation to build a fixed asset and the installments would end eventually.

To conclude, there are a lot of factors to consider in case of a rented commercial space while investing in any kind of retail format. Companies and their executives do consider these factors, but they might not be forecasting the right revenue.

Large companies with an assured high revenue generation capacity can easily survive, but small and medium sized companies face the challenges.

Talking about start-ups, almost none of the these in India have been able to break even their consolidated businesses. Making a rented space retail store profitable is an even bigger challenge for them.