In 1602 when Sir James Lancaster arrived in India, commanding the first trading expedition of the East India Company, the economy of the Indian subcontinent dwarfed that of the British Isles. What many people in the West don't realize is that, except for the last 500 years, this has always been the case. What even fewer realize is it likely will be true again. A huge, educated, and motivated population with access to capital—such as India's—will demand a strong economy, and India is reclaiming its traditional role as an economic power.
Considering the bright future that lies ahead for India, now is a good time for companies to develop their supply chain strategies for serving the country. India's 7-percent growth rate for its gross domestic product (GDP) may not be as attention-grabbing as China's. But India is the second fastest-growing economy in the world, and it is more diversified. Its burgeoning middle class is employed in a wide variety of business services, leading some experts to believe that India will be more resilient in the current economic downturn than China.
India's government has begun implementing tax-law changes that will make delivering goods to consumers and businesses much more efficient, making products more affordable and spurring demand. The government also is gradually lowering barriers to foreign direct investment, and soon retailers will be able to operate in India by taking majority positions in Indian subsidiaries.
Although India offers a huge growing market for outside products, setting up a distribution network there presents a host of challenges in areas ranging from infrastructure to human resources, from warehouse site selection to hiring a trustworthy trucker. These challenges shouldn't discourage companies from expanding into the country. Rather, they should simply motivate firms to start their planning now. Based on our experiences in India, we believe that if a company starts to navigate the obstacles now, it will be well-positioned to reap the benefits when government regulation and economic reforms finally align behind this very large consumer economy.
Breaking down barriers to investment
India has not always offered as attractive an investment opportunity as it does now. When India established its republic in 1950, the government tightly controlled the economy. The country began moving to a freemarket economy in the 1990s, and in 1991, the government began instituting a series of economic reforms designed to open its markets and eliminate some restrictions on foreign trade and investment. Those reforms have fostered the development of a growing middle class with an interest in Western-style consumer goods. This young, highly educated segment of the population will continue to drive India's economic boom. In fact, in a 2005 A.T. Kearney survey, global executives rated India as the greatest consumer market opportunity, placing it second highest on the consulting firm's Foreign Direct Investment (FDI) Confidence Index.
India's state tax system historically has hindered the establishment of regional distribution networks. Many of the 28 states and seven Union Territories that make up the federal state of India have levied a local sales tax, known as a CST (for Central Sales Tax), on manufactured goods. The CST is the primary source of revenue for some of these state governments, so enforcement is strict; guard towers at state borders are a common sight, and vehicles are required to stop and pay a tax to secure admission into many regions or municipalities.
The CST applies when merchandise moves between states as well as when goods change owners. (Stock transfers among a company's internal warehouses, however, are not subject to the CST.) This has motivated most of the big companies in India to have warehouses in every major state. As a result, consumer goods companies cannot easily centralize their inventory. Instead, they typically use a number of smaller warehouses to get the products into the various markets, and then turn the goods over to local distributors or small retail stores. This practice, of course, adds more inventory, handling, and transportation costs to products.
Fortunately, this situation is about to change. The government plans to end CSTs completely by March 31, 2010, in preparation for a national Goods and Services Tax (GST). The national GST is intended to integrate taxes and duties on services and goods at both the state and the federal levels. As a result of this change in the tax structure, it will become more economical for a company to set up a distribution network with central or regional warehouses.
With the promise of a more cost-efficient distribution network and a large base of consumers clamoring for goods, more and more companies may be enticed to enter the Indian market. Before they plunge into this complex environment, however, they need to clearly understand and plan for the distribution challenges that they will face.
The warehouse scene
While regional distribution centers promise greater efficiency and effectiveness, few facilities in India today could fit the bill. Called "godowns," most Indian warehouses owned by multinational companies are small in size—between 5,000 and 25,000 square feet—compared to the 250,000- to 1-million-square-foot structures found in the United States or Western Europe. Existing Indian warehouses tend to be located close to a customer base and carry only enough inventory to serve those customers. Large warehouses are rare because there has been little demand for storage of huge volumes of product to date.
Most Indian warehouses have few racks for shelving product and are likely to have dirt rather than cement floors. This means that they use space inefficiently, and managing them is actually quite complex because there is little in the way of technology or material handling equipment. The "warehouse management system" at these small sites is a bookcase filled with three-ring binder notebooks. Each notebook holds the receiving documents for one or more products.
When an order is received, someone looks up the locations of the required items in these notebooks. The loading and receiving docks at these small sites are alive with activity. Without forklifts, flex conveyors, and/or dock levelers, everything is passed from hand to hand for stacking inside the trucks. These types of warehouses employ three to five times the number of people one would expect at a Western facility of similar size.
This does not mean that the warehouses have no information technology. They often do, but it usually is employed for the customer's benefit and not for management of the facility. For example, one of the authors visited a third-party logistics (3PL) warehouse that was exactly as described above. The warehouse had a computer terminal that was connected directly to the local automobile plant's manufacturing resource planning (MRP) system. Warehouse employees would print out the order and then go to the bookcase, look up the location of the required inventory, and then go and pick it. Three other people would update the records.
The more modern warehouse buildings are generally prefabricated structures made from steel, with steep sloped roofs to divert water away during monsoon season. In addition, many distribution facilities are housed in structures that were designed for other purposes. For example, one of the largest pharmaceutical distributors in Mumbai runs a warehouse out of the third floor of an apartment building.
While constructing new facilities may be the only viable approach for developing large regional distribution centers, finding land for those two, three, or five facilities will be difficult. Land can be expensive in parts of India. For example, land on the outskirts of Mumbai is more expensive than acreage on the outskirts of Atlanta, Georgia, USA. Additionally, there are few large landowners in India. As a result, purchasing a parcel of land big enough for a large distribution center is likely to require negotiating with hundreds of individual plot holders.
Even the influential domestic automaker Tata Motors had trouble getting land for a planned factory in West Bengal. To obtain the 997 acres required, the company had to work with the state government to consult with 13,000 farmers and pay them either for their land or the rights to use their land. But that wasn't the end of Tata's real estate troubles. The farmers protested that their compensation was too low and that some of them were being forced to sell their land. In response, the automobile company shifted construction to another, less hostile region of the country. Big domestic retailers, such as Reliance Retail Ltd., have had similar problems.
Because of the issues involved in land acquisition, most companies entering India and adopting a regional network model should consider a partnership with a third-party logistics company that already has a warehouse or land on which it can build a facility. An important consideration, of course, will be the quality of the service provided by this operation. Few international 3PLs operate warehouses in India, and some local logistics service providers are only now becoming familiar with the service expectations of multinational companies. Still, for some firms, partnering with a 3PL will be easier than going it alone.
Once land has been found, the actual construction and design of a new warehouse brings another set of challenges. A company wanting to put up a Westernstyle building with cement walls and floor would have to work very closely with local contractors (supplemented by Western experts) to accomplish such a project. Just pouring a concrete floor that meets accepted Western construction standards requires very close supervision. As a result, it is not uncommon to find high-throughput facilities with recently poured floors that are riddled with cracks. One person queried for this article described a retail warehouse that was less than six months old and already had cracks so large that a lift truck had become stuck in one of them.
When it comes to facility design, foreign companies in India tend to adopt one of two extremes—neither of which is advisable. Some want to replicate their Western buildings. But a regional distribution center should look different in India than in Western Europe or the United States, as India has its own, unique set of constraints and strengths.
At the other extreme, some companies think that because labor in India is so inexpensive, they can forgo automation and technology. The danger of this viewpoint is illustrated by a meeting we had with Mukesh Ambani, head of Reliance Industries and India's wealthiest man. When we revealed our plans for distribution centers that would serve his new retail business, there was hardly any automation in the solution. Ambani expressed his concern. "You Western experts always tell me that automation isn't justified here because people are so cheap," he said. "After you tell me this and you fly home, two years later I have to rip everything out and automate for quality."
When the facility is very small and not overly complicated to manage, it is acceptable to rely on manual labor and assume that local managers and warehousing employees can figure out how to store and forward the product. This is unlikely to work, however, when a firm attempts to put together a large operation. Operations management experience is not nearly as well-developed among Indian warehouse managers and employees as it is in the West. The dearth of warehouse management expertise combined with the great complexity of a manual but high-volume operation seems destined to lead to service failures.
Based on our experience, we find it best to adopt a "middle of the road" approach for high-volume facility design, using some warehouse automation but still relying on workers for a majority of the less complicated tasks. Software can help to ensure the quality of the operation because it can impose discipline and provide data for measuring productivity. Warehouse management software, for example, can influence and improve workers' performance. When warehouse workers get instructions from a computer—the computer, not a human being, directs the pace of instruction and tracks the pace of completion—it minimizes cultural issues that may arise because of differing expectations and priorities.
This same approach should be used with material handling equipment. For example, in high-volume facilities, conveyors are necessary to get products and cartons where they need to be on time. But companies do not need to use an expensive motorized conveyor with complex controls and automatic diverts at the chutes. Instead they might consider employing a simpler, domestically manufactured, motorized conveyor and having workers manually divert the products or cartons.
This strategy helps to keep costs down in other ways. At the present time, it is very expensive to bring material handling equipment into India from overseas. Any imported forklift, conveyor, rack, or other piece of equipment is subject to at least a 30-percent import duty. (See Figure 1 for a sample accounting of import taxes and fees.) This, of course, encourages companies to source equipment from Indian suppliers. Sometimes it is also feasible to bring in less complex equipment (such as racking) from China. Chinese products generally cost a little less than domestically produced equipment, even with the duty added, and they cost much less than U.S. and European equipment.
The challenges do not end once the facility has been designed, built, and fully equipped. Indeed, it is noteworthy that the largest market for logistics consulting services in India is not for designing warehouses and distribution centers but for helping to teach people how to operate them.
In a country where the average worker makes US $500 a year, it's tempting to follow the U.S. practice of recruiting warehouse personnel from the less educated tiers of society to save money. We strongly recommend against it. The skill gap between educated and uneducated people is much greater in India than it is in the West. Some concepts and equipment that Western businesses take for granted, like computers, are totally alien to the uneducated segment of the Indian population.
That is why it makes more sense to hire college-educated personnel to handle standard warehousing tasks, even though they may demand more compensation. College-educated workers will possess the basic knowledge needed to operate a computer or a lift truck.
Another reason to hire young, college-educated workers is that it minimizes cultural clashes. Indian culture historically has emphasized hierarchies and social status. These cultural beliefs can be inhibiting to Western companies that are used to a more open style of decision making, in which employees discuss work problems with upper management. Young workers, however, are more willing to adapt to this style of management.
Looking beyond the four walls of the distribution center, companies will need to design a distribution network that takes into account the realities of India's transportation infrastructure. India's supply chains must contend with slow transit networks and insufficient infrastructure. For example, 70 percent of India's seaborne trade is handled by just two of the country's 12 major ports. The rail system is also constrained when it comes to freight movements. Historically, the country's rail capacity was restricted to passenger traffic, and people protested the use of rail for freight haulage. Only recently has the Indian government begun efforts to promote rail shipments.
Most commercial shipments in India make their journey aboard a truck (although it's not uncommon to see goods being hauled through a city on a handcart). Hiring a motor carrier means working with a small trucking company, as the country has no large, national transportation companies and only a handful of medium-sized carriers. A recent study of the Indian trucking industry conducted by the consulting firm Orkash Services Pvt. Ltd. found that the majority of carriers had fewer than five trucks in their fleets. The fact that the largest trucking association in India, the All India Motor Transport Congress, says that it represents 4.8 million truck owners is further evidence of the preponderance of very small operators. These carriers do not have specialized equipment like refrigerated trailers. A company that plans to enter the Indian market and needs specialized services may therefore want to consider working with a large carrier that can partner with local trucking firms.
The trucks themselves typically are 24-foot-long vehicles that can transport 12 standard Grocery Manufacturers of America (GMA) pallets, which are 48 inches long by 40 inches wide. The 53-foot trailers that are common in the United States are unheard of in India and wouldn't be able to make it through the crowded, narrow city streets to pick up or drop off goods.
Scheduling deliveries and pickups also can be tricky. At present, most warehouses are located in the heart of Indian cities, and many municipalities prohibit large truck movements during daytime hours. It is possible to negotiate special exemptions in some places, but generally shippers must plan on nighttime movements. Another option is to unload large shipments at a cross dock outside the city and transfer orders to smaller vehicles for delivery.
Transit times are slow and unpredictable compared to those in Western countries. A 1,000-mile trip from Kolkata (formerly Calcutta) to Mumbai could possibly take as long as seven to 10 days because of delays at state borders and poor road conditions. In fact, the Orkash study reported that a typical truck in India covers an average of just 300 kilometers (approximately 186 miles) a day. The average truck in a country with a better road system can travel 800 kilometers (approximately 497 miles) in a day, the researchers found. Furthermore, technology that often is used in the West to mitigate transit variability is not yet common in India. Indian trucking companies are just beginning to issue drivers cell phones that they can use to call in shipment status, and global positioning systems (GPS) are virtually nonexistent.
To reduce the impact of variability caused by poor logistics infrastructure, suggests Abraham Joseph of the consulting firm Chainalytics, companies should adopt inventory strategies similar to those used in small-parts service industries. Service-parts industries use inventory to buffer against demand variability rather than against transportation variability, but the resulting network structure is the same. Companies will need to stage inventory throughout multiple levels, or echelons, of the network to reduce the impact of transportation variability and high transportation costs. Thus, instead of shipping from a regional distribution center in one state to wholesalers in several states and cities, a company might still need to maintain a small amount of inventory in each state to maintain service levels.
Plan to act now
Clearly, one of the biggest challenges facing any company that wants to develop a supply chain in India is learning to serve customers well despite the challenges and roadblocks to efficiency discussed in this article. That said, the government has started to invest heavily in such areas as transportation infrastructure and regulatory reform, and these future improvements will bolster companies' efforts to run an efficient supply chain in India.
In our experience, a company can reasonably expect to spend at least five years setting up a distribution network in India because of the complexity of navigating those challenges and complying with India's laws and regulations. But as we noted earlier, the opportunity to serve the world's second fastest-growing economy and a rapidly expanding, educated middle class is not to be missed. If companies act now and begin drawing up their supply chain plans, they will be well-positioned to participate in India's prosperity.
Author's Note: The authors would like to thank Abraham Joseph for his contributions to this article.
Editor's Note: This article included a statement that India has no large, national transportation companies. According to Mr. Chander Agarwal, Executive Director of Transport Corporation of India (TCI), his company provides nationwide transportation service to all 611 of the country's administrative districts. We regret the error.
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