Discusses the distribution network within the country from how products enter to final destination, including reliability and condition of distribution mechanisms, major distribution centers, ports, etc.
There has been a significant expansion in distribution channels in recent years. According to the India Brand Equity Foundation (IBEF), Indian retail market, which stood at $672 billion in 2017, is projected to grow to $1.1 trillion by 2021. The total number of retail distribution outlets in the country is approximately 12 million mostly family owned businesses. An annual growth rate for the fast-moving consumer goods (FMCG) sector is predicted to be 10-12 percent during the next 10 years. According to Boston Consulting Group, India is expected to become the world’s third-largest consumer economy by 2025. India’s Business to Business (B2B) e-commerce market is expected to reach $700 billion by 2020. India is expected to become the world’s fastest growing e-commerce market, driven by robust investment in the sector and rapid increase in the number of internet users. Online retail sales are expected to double from $32 billion in 2018 to $60 billion by 2020.
Most Indian manufacturers use a three-tier selling and distribution structure that has evolved over the years. This structure involves redistribution stockists, wholesalers, and retailers. As an example, an FMCG company operating on an all-India basis could have between 40 and 80 redistribution stockists (RS). The RS will sell the product to between 100 and 450 wholesalers. Finally, both the RS and wholesalers will service between 250,000-750,000 retailers throughout the country. The RS will sell to both large and small retailers in the cities as well as interior parts of India. Depending on how a company chooses to manage and supervise these relations, its sales staff may vary from 75 to 500 employees. Wholesaling is profitable by maintaining low costs with high turnover, with typical FMCG product margins anywhere from four to five percent. In urban areas, the more enterprising retailers provide credit and home-delivery. Now, with the advent of shopping malls, companies talk of direct delivery and discounts for large retail outlets.
In recent years, there has been increased interest from companies to improve their distribution logistics to address a fiercely competitive market. This in turn has led to the emergence of independent distribution and logistics agencies to handle this important function. Marketers are increasingly outsourcing some of the key functions in the distribution and logistics areas to courier and logistics companies and searching for more efficient ways to reach the consumer. The courier network in India now spreads to smaller Class IV towns (defined as a town with a population of less than 50,000).
Most FMCG and pharmaceutical companies use clearing and forwarding (C&F) agents for distribution, with each C&F agent servicing stocks in an area, typically a state. Taxes used to vary between states until the introduction in 2017 of a national value added tax, known in India as the General Service Tax (GST). Now, at every stage from producer to end consumer, retail prices are the same throughout India. With the cost of establishing warehouses extremely high, C&F agents are fast becoming the norm.
India has 12 major (national government control) and 205 minor (local state/private control) ports, but in terms of gross weight tonnage conveyed annually, Mumbai and Marmagao on the west coast, and Vishakhapatnam and Chennai along the east coast are the most important ports in India. Mumbai, the financial capital of the country, is very important for international cargo trade.
To assist companies entering the Indian market, the GOI uses free trade and warehousing zones (FTWZ) as a special category of special economic zone with a focus on trading and warehousing. The objective of the FTWZ is to create trade-related infrastructure to facilitate the import and export of goods and services with greater flexibility. These zones are established in areas close to seaports, airports, or dry ports. FDI up to 100 percent is allowed in the development and establishment of the zones and in their infrastructure facilities. The program allows duty free import of all goods for warehousing (except prohibited items such as arms and ammunition, hazardous waste, special chemicals, organisms, materials, equipment, and technology items). The maximum period that goods may be warehoused within the FTWZ is two years, after which the goods must be re-exported or sold. After the two-year period expires, custom duties are applied and automatically become due unless the goods are re-exported with a grace period of three months.
Using an Agent or Distributor
A local presence in India is strongly advised, but if your company is not ready to establish a branch office or a subsidiary, you can appoint an agent, representative, or distributor. India is a huge and diverse country, with over 30 regional languages and different rules and regulations in each state. A regional approach (north, south, east, and west) ensures broader market presence and greater flexibility in addressing region-specific needs and issues. Within each region, states differ widely in citizen income, purchasing power, educational, and other socio-economic aspects. Furthermore, there are a certain product where the appointment of an authorized agent or distributor in India is legally required, such as for pharmaceutical drugs or select medical devices, diagnostic kits, cosmetics, food products and for some technical products where stringent quality testing and standardization certifications are mandatory. Thus, there is always an advantage to work with an agent, representative or a distributor, who understands your target market and has a good grasp of local laws and policies to help increase your reach and, ultimately, determine your success.
Defining the Terms
An agent is an intermediary appointed to represent your company and can have authority to the extent specified in the terms of contract. An agent procures a potential buyer, negotiates the price, and concludes deals with customers on your behalf. An agent works independently and gets a commission on each sale. A representative works directly for the company whose compensation may include a salary plus commission on the sales generated. A distributor acts as an importer and typically purchases and stocks the products before selling to the end user. The distributor’s compensation is higher than that of an agent or a representative due to higher inventory management costs.
Use Caution when Establishing Critical Relationships
The U.S-India relationship is strong, and Indian firms are eager to buy U.S. products and services. As a result, U.S. exporters can expect generally positive interest from potential representatives and distributors for a broad range of products. However, the enthusiasm of potential partners must be weighed against several factors before a relationship is considered. Carrying out appropriate due diligence procedures is critical in evaluating whether the partner will truly add value.
When evaluating a distributor or agent, the Indian firm’s business reputation, financial resources, willingness, and ability to invest, marketing strength, regional coverage, industry expertise, and credit worthiness should be considered. An ideal distributor will have an extremely good banking relationship to enable the extension of credit and have the capacity to market a full range of products and services. It is important that the agent or distributor maintains a solid infrastructure and facilities such as warehouses, service workshops, showrooms, and competent staff.
U.S. companies should be careful not to be influenced by the eagerness and persistence of a distributor or his representative. Sometimes, Indian firms represent so many companies that they have little time or interest in developing new markets. The Indian firm may not have the vision to go beyond the existing list of contacts that it has nurtured over time. While in the short run, this can still provide positive returns, a more sustainable value-add will be in developing new or under-developed markets. Therefore, it is critical to measure objectively the ability, willingness, and aggressiveness of the firm in developing new networks, contacts, and areas of business. By checking multiple professional references, a U.S. company can gain broad insight into an Indian counterpart.
Be Mindful of these Pitfalls
U.S. companies should exercise pragmatic skepticism when the potential partner offers a long list of foreign clients. These lists may be outdated, and the relationships may no longer exist. On the other hand, if all these relationships do exist, the distributor or agent may not be able to fulfill all obligations and commitments to promoting and selling your product.
Other Issues to Consider
Advantages of a small distributor
A small distributorship with a regional presence and local knowledge may prove to be a competitive advantage over larger ones. Though India is slowly moving towards more modern distribution channels in some sectors, most companies face a fragmented and multi-layered distribution network. In some cases, appointing distributors by product is a plausible consideration for companies.
Online marketplace and eCommerce
India is witnessing a surge in eCommerce business in metropolitan areas along with an increasing trend of digital payments services adoption in tier II & Tier III cities. Thus, having a distributor with an online presence through a dedicated website or through an online marketplace listing will be a huge added advantage. However, eCommerce is subject to Competition Acts released time to time by the Indian Government to enforce pricing and distribution policies. U.S. Companies should be wary of such provisos and incorporate relevant clauses in the distribution partner agreement to avoid violations of competition law.
Due diligence checks
Traditional methods of validating a potential partner’s credentials are less reliable or not possible, especially in case of privately-owned companies, due to a lack of public access databases. For example, while checking a proposed partner’s credit - a crucial first step, the U.S. firm should check with the potential partner’s bank to determine financial health, reputation, and credit worthiness. Further details can be sought from accountants, lawyers, industrial associations, and other entities currently working with the firm. For technical products, U.S. companies should confirm the technical expertise of the company’s staff, without sole reliance on documentation.
To identify agents and distributors, U.S. companies can take advantage of the Initial Market Check (IMC), International Partner Search, Business Facilitation Service (BFS), Gold Key Service (GKS) and Single Company Promotion (SCP), services offered by the U.S. Commercial Service through its seven offices in India. To assist with due diligence background checks on local agents and distributors, U.S. companies can take advantage of the International Company Profile (ICP) service. Virtual services are now offered to address travel restrictions due to the pandemic. For more details, go to: https://www.trade.gov/our-services/
Establishing an Office
The most important factors in choosing a location in India are: (1) physical infrastructure; (2) state government support and flexibility; (3) cost and availability of power; and (4) the law and order situation. Other factors to consider include labor availability and cost, labor relations and work culture, and proximity to resources and/or markets. Under labor law, an employer with more than 100 workers cannot fire them without permission from a government labor commissioner — something usually impossible to obtain.
Given the shortage of good commercial office space at reasonable prices in major Indian cities, business centers are a viable option for new companies wanting to establish a physical presence. Business centers are facilities that are ready to move in, wired for communications, and air-conditioned. Billing is normally done monthly. For long-term use, discounts are generally available. Many state governments are creating special technology parks for selected industry sectors like software, biotechnology, and automotive.
Type of Office
A foreign company or individual planning to set up business operations in India – but choosing not to establish a subsidiary or to form a joint venture with an Indian partner – can do so by establishing liaison, project, or branch offices in India. Approval from the Reserve Bank of India (RBI) is required and can be obtained by submitting form ‘FNC’. Such companies also must register themselves with the Registrar of Companies (ROC) within 30 days of setting up a place of business in India.
Liaison or Representative Office
Many foreign companies initially establish a presence in India with a liaison or representative office that is not directly engaged in commercial transactions in India. The purpose of these offices is to oversee their networking efforts, promote awareness of products, and to explore further opportunities for business and investment. A liaison office is not allowed to undertake any commercial activity and cannot earn any revenue in India. As no revenue is generated, there are no tax implications to the office in India. Such offices are not allowed to charge any commission or receive other income from Indian customers for providing liaison services. All expenses are to be borne by inward remittances. A foreign company establishing a liaison office cannot repatriate money out of India. All in-country activities conducted by the liaison office should be non-revenue generating.
A branch office is not an incorporated company but an extension of the foreign company in India. A branch of a foreign company is limited to the following activities by the RBI: representing the parent company and acting as its buying/selling agent, conducting research for the parent company, carrying out import and export trading activities, promoting technical and financial collaborations between Indian and foreign companies, rendering professional or consulting services, rendering services in information technology and development of software in India, and rendering technical support to the products supplied by the parent/group companies.
A branch office does business in India and is subject to taxation in India. The branch office may repatriate profits generated from their Indian operations to the parent company after paying taxes. However, a branch office is not allowed to carry out manufacturing and processing activities directly (though it can sub-contract such activities to an Indian manufacturer).
Foreign companies sometimes set up a temporary project office to undertake projects in India awarded to the parent company. It is essentially a branch office set up for the limited purpose of executing a specific project. Approval for project offices is generally accorded for executing government-supported construction projects or where the projects are financed by Indian and/or international financial institutions and multilateral organizations. In exceptional cases, approval is also given for private projects. Upon completion of the project, project offices may remit profits outside India after meeting tax liabilities.
None of these entities is permitted to acquire real estate without prior RBI approval. However, project offices can lease property in India for a maximum period of five years.
Under the current Foreign Direct Investment policy and the Foreign Exchange Management Law, foreign investment into Indian partnership firms requires permission from the RBI. A partnership is an association of two or more persons to carry on as co-owners of a business for profit.
A limited liability partnership (LLP) is a hybrid of an existing partnership and a full-fledged company. It is a separate legal entity, liable to the full extent of its assets, with the liability of the partners being limited to their agreed contribution in the LLP. Foreign direct investment in LLP’s is allowed in activities where 100 percent foreign direct investment is allowed under the automatic route. Under the automatic route, the non-resident investor or the Indian company does not require any approval from Government of India for the investment.
A limited company is an incorporated entity, which is a separate legal entity distinct from its members or shareholders. Foreign investment in India is governed by the FDI policy of the government as well as the Foreign Exchange Management Law. As per the current policy, all companies in India must be incorporated under the provisions of the Companies Act, 2013.
The Indian franchise industry is a rapidly growing business model. U.S. franchisors, especially in retail apparel retail and food services, have contributed to this growth. Demand for U.S. brands is strong in food & beverage, hospitality, retail, education, apparel, healthcare, fitness, and personal grooming clinics. According to a KPMG and Franchise Association of India (FAI) report, the current estimated market size of the Indian franchise industry is $50.4 billion, an increase from $13.4 billion in 2012.
With a growing middle class, Indians look for quality goods and services, which can opportunity for U.S. franchisors. Simultaneously, India is witnessing significant growth in entrepreneurship. These new entrepreneurs are very receptive to American franchises, paving the way for strong American brands in India. This has been the preferred method for starting operations in India for the hospitality and food service industries.
Major U.S. restaurant brands that operate in India through franchisees include Krispy Kreme, Dunkin’ Donuts, Wendy’s, Chili’s, Burger King, Johnny Rocket’s, Hard Rock Café, Cinnabon, McDonalds, Kentucky Fried Chicken (KFC), Pizza Hut, Taco Bell, Domino’s Pizza, Subway, and Baskin Robbins. Hotels include Marriott, Hilton, Westin, Hyatt, and Radisson.
Some of the key challenges that U.S. Franchisors should be aware of are:
Lack of Legal Framework:
Unlike the United States and other western countries, India does not have any specific laws on franchising. Franchising is covered within the broad definition of transfer of technology. Thus, the legal framework for new franchisors interested in setting up master franchises in India exists in terms of brand protection and rules regarding payment of franchise fees.
When franchisors enter India, they are governed by several different national and regional statutes and codes rather than a single comprehensive statute. These regional variations should be considered before engaging in any franchising venture in India. A thorough understanding of laws related to the business of franchising is crucial for the U.S. franchisor. In addition, hiring a good local tax consultant is recommended. It is also wise to conduct a market feasibility study followed by thorough financial and legal due diligence.
Understanding local culture and tastes and innovative strategies like “Indianization” of products is vital to a franchise brand’s success. For example, a large percentage of Indians is vegetarian. A classic example of successful “Indianization” is in the fast food sector. Several American companies such as McDonald’s, Pizza Hut and Domino’s have developed special India menus to cater to the Indian palate. Companies often prefer to appoint master franchisees on a zonal basis, as India is a large geographical mass with a diverse mix of populations.
Expensive Real Estate:
In large Indian cities, retail space continues to be expensive and the quality is relatively poor. Antiquated rent control laws make finding a suitable and affordable location difficult.
Resistance to Fees & Cap on Royalty Payments:
U.S. franchisors should also be prepared to face stiff negotiation from prospective Indian franchisees toward the franchise fees/royalty payments as they are generally considered high in this market.
Despite such challenges, numerous U.S franchisors have been extremely successful. Most of them have adapted their products/services to local market preferences and have pursued effective market entry and expansion strategies.
According to a report by World Federation of Direct Selling Associations, the Indian direct marketing sector recorded sales of $2.7 billion in 2019. The growing Indian market has attracted many Indian and foreign direct selling companies. Globally, the direct selling industry is a labor - intensive industry that has a positive socio - economic impact in terms of higher employment, women empowerment, skill development, financial independence, flexible timings, and an improved ability to take care of the families. These factors, combined with favorable demographics, will lead to the direct selling industry witnessing an unprecedented opportunity for growth in the coming years.
According to a 2018 report (latest available) issued by The Federation of Indian Chambers of Commerce and Industry (FICCI) and KPMG India the industry will grow at a Compounded Annual Growth Rate (CAGR) of 16 and is estimated to reach $8 billion in India by 2025.
The Indian Direct Selling Association (IDSA) reported a growth rate of 13 in 2018-19. The wellness industry that included weight management supplements, energy bars and drinks contributed to more than half of the total volume of the industry. Wellness and healthcare products account for over 50 of direct sales revenue, with cosmetics and personal care products contributing 34, homecare products 11 and consumer and household durables 5. Direct selling companies are importing fewer goods as they develop local sources of supply.
According to IDSA, Government of India’s Ministry of Consumer Affairs, Food & Public Distribution issued a “Model Framework for Guidelines on Direct Selling” in Fall 2016. However, the direct marketing industry faces some challenges faced with misconceptions of illegal direct selling of products by e-commerce majors and Indian States have been slow to adopt these guidelines. FICCI organizes an annual conference on the industry to focus on the guidelines released by the Ministry of Consumer Affairs and highlight the benefits for the state governments in adopting these guidelines.
For more information about export opportunities in this sector, contact the U.S. Commercial Service: Ruma Chatterjee