This article explores the key elements that drive the business of organized retail companies. By the end, investors will gain insights into the critical factors influencing retail performance and learn how to distinguish fundamentally strong retailers from weaker ones.
Critical Drivers Impacting the Performance of Organized Retail Businesses
1) Retail Segments Operate Like Distinct Industries
While all retailers essentially act as intermediaries—purchasing goods from wholesalers and selling them to end consumers without adding value—the dynamics of their businesses vary significantly depending on the segment in which they operate.
For instance, a value retailer focused on food and groceries will face entirely different operational challenges and market behavior compared to a lifestyle retailer dealing in apparel or consumer durables. Similarly, a discount store will operate under different business pressures than a premium electronics outlet.
Essential goods like food and groceries exhibit stable demand across economic cycles, making value retailing relatively immune to macroeconomic fluctuations. In contrast, lifestyle products—such as branded fashion items and consumer electronics—are more discretionary in nature. Consumers tend to defer such purchases during economic downturns, making these segments more vulnerable to cyclicality. Additionally, some product categories experience seasonal demand—for example, cooling devices in summer and heating equipment in winter—leading to irregular cash flows.
As noted in ICRA’s Retail Rating Methodology (July 2021), a value retailer dealing in essentials is more likely to exhibit operational stability compared to a lifestyle retail outlet, which, despite offering higher gross margins, is more exposed to economic cycles. Seasonal demand in segments like consumer durables also contributes to fluctuating revenue patterns.
Therefore, when analyzing a retail business, it is essential first to identify the segment it operates in. Only then can one meaningfully assess its performance across varying economic and seasonal conditions.
2) Intense Competition Within the Retail Industry
The retail industry is inherently competitive and highly fragmented, largely due to low entry barriers and the significant presence of unorganised, small-scale players such as local kirana or mom-and-pop stores. In India, this fragmentation is further supported by political and regulatory efforts aimed at protecting these small retailers.
According to CRISIL’s Rating Criteria for Organised Brick-and-Mortar Retail (Feb 2021), the industry is characterised by intense competition not only among organised retailers but also from unorganised players and the rapidly expanding e-commerce segment.
This high level of competition is not unique to India—it is a global phenomenon. As highlighted in Standard & Poor’s report on Key Credit Factors for the Retail and Restaurants Industry (Nov 2013), the global retail industry is “highly competitive and fragmented with few barriers to entry.”
One of the primary reasons for this intense competition is the ease of market entry. The retail sector does not demand specialised technical skills, advanced technology, or regulatory clearances, making it accessible to a wide range of new entrants. Scope Ratings’ Retail and Wholesale Methodology (April 2022) affirms that the sector faces few legal or technical restrictions, and thus entrance barriers remain low.
This is evident in India, where organised retail still forms only a small portion of the overall retail market—around 16%, with brick-and-mortar retail accounting for ~12% and e-commerce ~4%, as per ICRA’s Retail Rating Methodology (July 2021). The rest of the market remains dominated by unorganised players.
Furthermore, competitive dynamics vary across retail segments. Value retailers—focusing on essential commodities like food and groceries—face intense price-based competition, as these products are commoditised and easily interchangeable. Consumers have little brand loyalty in this segment, and pricing plays a dominant role in purchasing decisions.
In contrast, lifestyle retailing—which includes branded apparel, consumer durables, and electronics—requires significant investment in brand-building, marketing, and customer experience. These factors act as higher entry barriers and help build a more loyal customer base. However, even within lifestyle retail, competition remains intense due to the abundance of suppliers offering similar products.
As noted again by CRISIL (Feb 2021), value retailing faces greater competitive pressures due to its focus on price-based propositions, whereas lifestyle retailing benefits from brand strength and customer loyalty, which take longer to establish.
Despite these differences, most retail formats—aside from exclusive brand outlets—sell products from multiple manufacturers. This means that the same goods are often available through various retailers, reducing customer stickiness and loyalty. According to Pefindo’s Retail Industry – Key Success Factors (Nov 2022), customer continuity and retention remain relatively low across the sector.
As a result, retailers continuously compete for customer attention and wallet share. This often leads to aggressive pricing strategies, which in turn squeeze profit margins and limit the financial flexibility of retail businesses across segments.
3) Low Profit Margins in the Retail Industry
As discussed earlier, the retail industry primarily operates as a trading business—buying goods from wholesalers and selling them to end consumers with minimal or no value addition. This basic business model, when combined with the intense competitive landscape, results in consistently low profit margins for most retailers.
One of the key factors contributing to this is the high price sensitivity of consumers. With widespread internet access, customers can effortlessly compare prices across different retailers—both online and offline—and choose the seller offering the lowest price. Moreover, online platforms make it easy for consumers to compare features across similar products from various manufacturers, further influencing their purchasing decisions based on price.
This transparency puts significant downward pressure on prices, compelling retailers to match or beat competitors’ pricing in order to attract and retain customers. As a result, profit margins are squeezed across the industry.
According to Scope Ratings’ Retail and Wholesale Methodology (April 2022), “due to fierce competition between retailers and the ease with which customers can compare prices nowadays, the profitability of retailers is lower than in most other industries.” Since retailers do not transform or enhance the products they sell, they are unable to command premium prices, leading to slim margins and constrained cash flows.
Because retailers have limited pricing power over their customers, they often turn to their suppliers to negotiate better terms. Those with stronger supplier relationships or better bargaining capabilities can secure goods at lower costs, giving them a competitive advantage in terms of gross margins.
As noted in Scope’s methodology (April 2022), when pricing power over customers is limited, sourcing capabilities become a key differentiator among retail businesses. The ability to procure goods at favorable terms can significantly affect profitability, even among similar players.
Retailers with larger scale and market share are generally in a better position to negotiate with suppliers and obtain volume-based discounts. This scale advantage enhances their pricing flexibility and margin sustainability.
Consequently, retailers strive for growth—either organically through expanding their footprint or inorganically through mergers and acquisitions—to improve their bargaining power and overall profitability.
4) Large Size and Market Share: The Key Competitive Advantage in Retail
In the retail industry, size matters. As retailers grow in scale and market presence, they gain significant advantages across multiple dimensions—procurement, real estate, cost efficiency, and customer value proposition.
Greater Bargaining Power
Larger retailers command stronger bargaining power with suppliers. As they become significant buyers, suppliers are more willing to offer better pricing and favorable terms. This directly improves the retailer’s gross margins. Beyond suppliers, even real estate owners often provide preferential rental terms to large-format retailers, viewing them as anchor tenants that drive footfall and visibility in commercial spaces.
As noted by CARE Ratings (Organised Retail Methodology, Dec 2022):
“Size not only boosts the bargaining power of a retailer while accessing quality real estate or ‘anchor tenant’ status but also provides it with better bargaining power with its suppliers.”
Additionally, large retailers are often able to source directly from manufacturers, bypassing middlemen. This eliminates intermediary margins and lowers procurement costs, thereby improving profitability and allowing for more competitive pricing.
CRISIL Ratings (Organised Brick-and-Mortar Retail Criteria, Feb 2018) highlights:
“A retailer’s ability to approach producers directly enables cost reduction by eliminating middlemen and associated costs.”
Cost Efficiency Through Scale
Large size also facilitates supply chain efficiencies, such as reduced wastage and lower logistics costs. Bulk procurement and distribution bring down per-unit costs, allowing large retailers to offer competitive pricing while maintaining profitability.
According to CRISIL (Feb 2021):
“Shortening of the supply chain enables procurement efficiency, reduces wastage, improves margins, and supports low prices for end consumers.”
Rental costs, a major overhead for retailers, are another area where size plays a crucial role. Premium retail locations often come with high rent. A larger retailer with stronger financials and higher sales per square foot is better positioned to absorb or negotiate such costs.
As ICRA (Retail Rating Methodology, July 2021) states:
“Despite higher sales per square foot, stores with high rental levels take longer to break even. Rising rental costs in key locations can render retail operations unviable.”
Economies of Scale
Operational scale brings economies of scale in areas like procurement, logistics, marketing, and administration. Fixed costs are spread over a larger volume of sales, improving overall profitability.
As per Pefindo (Retail Industry – Key Success Factors, Nov 2022):
“Larger players benefit from stronger bargaining power and economies of scale in transportation, logistics, purchasing, and advertising.”
ICRA (July 2021) adds:
“A large revenue base supports operating margins through procurement and administrative efficiencies.”
Focus on Market Share
Given these benefits, retailers often prioritize expanding market share—sometimes by focusing on specific product categories to dominate niche segments. This strategy enhances their negotiating power and reinforces their value proposition to customers.
Scope Ratings (Retail & Wholesale Methodology, April 2022) notes:
“Most retailers focus on a single product category to build high market share within that niche.”
Sustainable Business Model
The ability of large retailers to offer lower prices while remaining profitable makes their business models more resilient to competitive pressures and economic downturns. By passing cost benefits to consumers, they ensure long-term sustainability.
According to CRISIL (Feb 2021):
“Sustainability in models such as supermarkets depends on the ability to price competitively and still maintain profitability.”
However, this scale advantage comes at a cost to smaller retailers. Large-format and “category killer” stores exert intense pressure on smaller players, making it increasingly difficult for them to maintain reasonable profit margins.
As S&P (Key Credit Factors – Retail and Restaurants, Nov 2013) states:
“Big-box retailers with high volume sales per store put intense pressure on smaller players.”
However, beyond scale, several other factors also influence a retail store’s profit margins.”
5) Key Factors Influencing a Retailer’s Profit Margins
5.1) Value vs. Lifestyle Retail Segments
One of the most critical determinants of a retailer’s profit margin is the segment in which it operates. Specifically, value retailing—which includes categories such as food, groceries, and discount stores—tends to generate significantly lower margins than lifestyle retailing, which focuses on fashion, branded apparel, electronics, and consumer durables.
As per ICRA’s Retail Rating Methodology (July 2021):
“The type of retail format operated by an entity is typically the most important determinant of gross margins, while scale brings operational efficiencies. For instance, supermarkets have a much lower gross margin as compared to lifestyle retailers.”
This contrast stems largely from the nature of the products sold in each segment. Value retail primarily deals with commoditized goods, where consumers are highly price-sensitive. Even a small difference in price can lead to a switch in customer preference, forcing value retailers to maintain the lowest possible prices to attract footfall and drive volume.
ICRA (May 2017) notes:
“This is especially so in the case of commoditised products, where a meaningful price difference between players can result in switching of customer loyalties.”
In contrast, lifestyle retail relies heavily on branding, customer experience, and perceived product value. These retailers often build strong customer franchises and are able to command premium pricing, resulting in higher profit margins.
As highlighted by CARE Ratings (December 2022):
“Value retailing is a high-volume but low-margin business. In contrast, lifestyle retailing is a high-margin and low-volume business and also fosters higher customer loyalty with relatively low substitutes and high entry barriers.”
In summary, while value retailers depend on scale and price competitiveness to drive profitability, lifestyle retailers leverage brand strength and customer loyalty to maintain healthier margins.
5.2) Sale of Private Labels
The introduction and promotion of private labels—store-owned brands—provide retailers with a valuable opportunity to enhance their profit margins. When customers visit physical stores, they are exposed to these in-house products, which are typically manufactured at lower costs compared to those offered by large branded players, particularly multinational companies in the FMCG sector.
Unlike MNCs, which invest heavily in brand-building and advertising—thereby increasing the cost of their goods—private labels benefit from in-store visibility and price competitiveness. Their lower production and marketing costs allow retailers to earn a higher gross margin on each sale.
As noted by ICRA (July 2021):
“Retailers with a high proportion of private label sales enjoy higher gross profit margins owing to better control over costs and inventory.”
However, despite their margin benefits, private labels generally contribute only moderately to overall sales volumes. This is primarily because most retailers refrain from spending extensively on advertising their private brands—doing so would erode the price advantage these products hold over established branded goods.
According to ICRA (May 2017):
“While private label sales do offer retailers higher gross margins, sales volumes are generally limited on account of the low marketing/promotion.”
Moreover, it is often the well-known third-party branded products that draw customers to retail stores in the first place. Private labels typically serve as alternatives for value-conscious shoppers once they are already inside the store. If retailers disproportionately stock private labels at the expense of popular branded items, they risk alienating customers and weakening their store’s overall appeal.
As highlighted by CARE Ratings (December 2022):
“Lifestyle retailers need to have a judicious mix of private labels so as not to dilute the offerings as regards other brands.”
5.3) Inventory Management
Efficient inventory management is a critical success factor in the retail business. Since retailers operate by purchasing goods from wholesalers and reselling them to end consumers, they must maintain a diverse inventory to meet customer demand in real time. However, this introduces a delicate balancing act.
If a retailer stocks an excessively broad range of items, significant capital is tied up in inventory, increasing the risk of unsold goods and potential inventory losses. Conversely, stocking only essential or fast-moving products may result in stock-outs, disappointing customers and leading to lost sales opportunities and damage to the store’s reputation.
As noted in ICRA’s July 2021 report:
“Maintaining optimal levels of the right kind of product inventory is critical… Too much inventory can strain a retailer’s working capital position and increase the risk of obsolescence, while too little of it increases the risk of stock-outs, thereby risking loss of customers.”
The inventory risk is higher in certain product categories. Items with a short shelf life, such as dairy and seafood, or those subject to rapid changes in trends, like fashion apparel or electronics, are especially vulnerable. These goods face risks from perishability, technological shifts, seasonal variation, or changing consumer preferences.
According to ICRA (July 2021):
“Inventory risk further increases for product categories which have high fashion, technological and obsolescence risks. In addition, there are certain product categories like dairy and seafood products, which are exposed to perishability risk.”
In sectors where raw materials or products are seasonally available, inventory must often be purchased in bulk, which can lead to uneven cash flows and greater vulnerability to inventory write-downs—direct hits to the retailer’s bottom line.
ICRA (May 2017) highlights:
“In such industries, large inventory holding accentuates the risk of inventory write-downs.”
Given these challenges, successful retailers must closely monitor and optimize their inventory levels, ensuring product availability without overstocking.
As per CRISIL (February 2021):
“Players need to optimise their inventories to minimise working capital levels, while ensuring the ready availability of stocks at all times; this is a critical factor as it can significantly impact the profitability of the retailing entities.”
5.3.1) Return and Liquidation Arrangements for Unsold Inventory
Some retailers are able to negotiate agreements with suppliers that allow for the return or liquidation of unsold inventory. These arrangements help reduce inventory risk by shifting the burden of unsold goods back to the supplier.
As highlighted in ICRA’s July 2021 report:
“[Assessment includes] arrangements with brand owners for inventory liquidation and return policies, among others.”
However, such favorable terms are typically available only to large retailers with significant market presence and bargaining power. Smaller retailers often lack the leverage needed to secure similar agreements.
Even when available, these return arrangements come at a cost. Suppliers often charge a premium for offering such flexibility, which can eat into the retailer’s profit margins. In contrast, retailers that operate under an outright purchase model—where inventory is bought upfront without the option of returns—usually receive products at a discounted rate, enabling them to achieve higher margins.
According to CARE Ratings (December 2022):
“Although the ‘Private label portfolio’ and ‘outright model’ have higher margins vis-à-vis other business models, they entail higher working capital requirements and carry inventory obsolescence risk.”
In essence, retailers must weigh the trade-off between inventory risk and profit margin when choosing between flexible return arrangements and outright purchase models. Larger retailers may be in a better position to absorb the associated costs or negotiate favorable terms, while smaller players must manage their inventory with greater caution to avoid financial strain.
5.3.2) Investment in Technology-Enabled Supply Chain to Minimize Inventory and Wastage
Retailers are increasingly investing in technology solutions to streamline their supply chain management. These technologies enable real-time communication between the store and suppliers, allowing for better control over stock levels. Software systems track inventory within the store, automatically notifying suppliers when stock reaches critical levels, prompting them to replenish it as needed.
This real-time flow of inventory data reduces the need for excessive stock at the store and minimizes the goods in transit, which not only helps optimize inventory but also frees up working capital for both the retailer and the supplier.
As noted in the ICRA (July 2021) report:
“The use of technology aids in optimising order cycles and quantities, enhancing inventory management, and reducing delivery times.”
However, investing in such technology is costly. It requires significant upfront investment as well as ongoing costs for software upgrades and maintenance.
According to ICRA (May 2017):
“Although the substantial upfront investments in technology and subsequent upgrades may impact profitability, the cost savings derived from the efficiencies enabled by technology are essential.”
Despite its advantages, not all retailers can afford to make such significant investments. Larger retailers, with their greater resources, have a competitive edge in this area, as they can more easily implement and benefit from these technological solutions.
As mentioned in ICRA (July 2021):
“A large retailer is better positioned to leverage technology due to its larger scale of operations.”
Better inventory management through technology is a key competitive advantage, as it enables retailers to maintain optimal stock levels, improve operational efficiency, and ultimately generate better profit margins.
As emphasized in ICRA (July 2021):
“Retailers that manage their supply chain to maintain optimum inventory levels in a cost-effective manner are better positioned to face competition and generate better margins.”
5.4) Shop-in-Shop, Subleasing to Specialty Retailers, and Revenue Sharing with Property Owners
As previously mentioned, rental and employee costs are significant expenses for retail companies. To mitigate high rental expenses, many retailers adopt strategies like subleasing portions of their store space to specialty retailers, such as food outlets or small boutiques, often at higher lease rents.
Additionally, some retailers opt to forgo paying fixed monthly rent and instead enter into revenue-sharing agreements with property owners. This approach enables retailers to lower their fixed costs, making it easier for them to navigate economic downturns and other challenging business conditions.
As noted in the ICRA (July 2021) report:
“Retail is a high fixed cost business, with two major expenses being employee costs and rentals. As a result, several retailers are exploring strategies such as subletting space to specialty retailers at higher rentals, entering into revenue-sharing agreements with shopping centre owners, and acting as anchor tenants in malls at lower rentals to reduce overall costs.”
6) Capital-Intensive Nature of Organized Retail Business
While the retail industry is largely dominated by small, neighborhood kirana (mom-and-pop) stores that require minimal capital to operate, organized retail stores demand substantial investment.
Opening new stores requires significant capital, and retailers also need to regularly invest in the refurbishment of existing locations. This capital-intensive nature of the business is seen globally, including in markets like India and beyond.
As noted in the Standard & Poor’s (S&P) report (November 2013, page 3):
“Retailers must consistently invest in new stores, renovate existing properties to maintain sales, and expand geographically to drive growth. This makes the business highly capital- and borrowing-intensive.”
In addition, according to the CARE report (December 2022), retailers need substantial funds for both expansion and refurbishment. If stores are not updated to align with changing consumer preferences, they lose their appeal and, ultimately, their competitive advantage.
S&P (November 2013, page 3) also emphasizes:
“Outdated or poorly maintained stores risk a significant erosion in sales.”
Beyond the initial investment required to establish new stores, retailers also need to allocate considerable funds to cover working capital for day-to-day operations, primarily due to the high inventory levels required to ensure product availability. Lifestyle retailers in particular, dealing with big-ticket items, need even more capital for inventory.
Moreover, as discussed earlier, investing in technology to streamline operations and improve supply chain management is another capital-heavy decision. The S&P report (November 2013, page 4) notes:
“Technology to support online operations and an efficient supply chain also requires sizable capital investment.”
Even after investing in new stores, inventory, and technology, it can take years for these locations to become cash flow positive. During the long-gestation period of a new store, continuous infusions of funds are necessary to keep the operations running smoothly. This lengthy startup phase significantly contributes to the capital-intensive nature of retail.
As per the ICRA report (May 2017, page 5):
“The long-gestation nature of the business leads to negative cash flows in the initial years of operations, necessitating regular fund infusions.”
The capital-intensive nature of organized retail also creates a barrier to entry for new players. Any new entrant must invest heavily to establish their store network, supply chain, marketing, promotions, and technology infrastructure to compete with existing players.
The CRISIL report (February 2021, page 15) states:
“New entrants to the retail industry face very high capital outlays to compete with established players, which limits the number of newcomers.”
Retailers must constantly monitor the performance of their stores. If a location loses its competitive edge or becomes unprofitable, it is crucial to shut it down quickly to avoid draining the company’s scarce capital.
The R&I report (August 2022, page 7) emphasizes:
“Slow closure of underperforming stores can weaken a company’s ability to invest in new openings or expansions, diminishing its competitiveness.”
7) Diversification Provides a Competitive Advantage to Retailers
Organized retail companies gain a competitive edge through diversification across both their store operations and product offerings.
7.1) Mix of Retail Store Segments
As previously discussed, value stores typically offer essential goods (such as food and groceries) with low-profit margins but high volumes, while lifestyle stores focus on discretionary items (like fashion, branded apparel, electronics, and consumer durables) that command higher margins but are sold in smaller volumes. Additionally, value stores are less vulnerable to economic fluctuations, experiencing more stable demand, whereas lifestyle stores tend to see a dip in business during economic downturns.
As per the CARE Ratings (December 2022):
“We analyze the share of revenue from food and grocery products compared to non-food items to assess the stability of cash flows.”
A retailer with a balanced mix of value and lifestyle stores can better manage profitability and maintain revenue stability through various economic cycles.
Moreover, within these segments, retailers that offer a wide range of products and brands in their stores can provide greater value to customers, leading to higher foot traffic and increased sales.
The ICRA (January 2015) notes:
“A retailer with a broad product range across categories is better positioned to meet a customer’s needs more effectively.”
Additionally, such stores are relatively insulated if any single brand fails to perform well.
ICRA (July 2021) further adds:
“A retailer’s revenue potential is closely tied to the range of products offered and their pricing. A diversified brand portfolio helps the retailer remain resilient to the loss of business from any one brand.”
7.2) Geographical Diversification of Stores Brings Stability to the Business
The location of a retail store plays a critical role in determining its success. It is the primary driver of customer footfall, directly impacting revenue generation.
Retail stores situated in densely populated areas or central business districts have a significant competitive edge. These locations typically attract higher foot traffic, boosting sales.
As noted by ICRA (July 2021):
“The location of retail outlets is a key factor influencing footfalls and sales volumes. A store located in a densely populated area is likely to experience higher customer visits than one located on the outskirts or in less populated areas.”
For retailers with stores spread across multiple regions, this geographical diversification helps mitigate risks associated with local disturbances such as natural disasters, socio-political issues, or regional economic downturns.
According to ICRA (July 2021):
“A geographically diversified portfolio of retail outlets ensures greater long-term stability in earnings and cash flows for the business.”
Moreover, retailers operating in diverse socioeconomic regions—including urban, semi-urban, and rural areas—are better protected from demand slowdowns confined to specific customer segments. For instance, a poor monsoon may reduce demand in rural areas, while an economic slump may have a greater effect in urban centers.
As per CRISIL Ratings (February 2021):
“Geographical diversification, including the mix of urban, semi-urban, and rural locations, adds resilience to a retailer’s business model.”
7.3) Diversification Across Sales Channels Brings a Competitive Advantage
Retail companies that operate across various store formats gain a competitive edge by effectively catering to different customer segments.
As noted in CARE Ratings (December 2020):
“Presence across different retail formats (specialty stores, department stores, supermarkets, hypermarkets) allows a retailer to tap into various customer groups, providing a significant competitive advantage.”
Furthermore, retailers with a blend of brick-and-mortar stores and online sales channels are better insulated from economic downturns. By offering goods through both physical stores and e-commerce platforms, they can reach a broader customer base across wider geographies. This flexibility allows them to adapt to changing consumer preferences, whether shoppers prefer in-store or online experiences.
As mentioned by CARE Ratings (December 2022):
“Diversification across sales channels helps mitigate the risks associated with dependence on a single medium, giving the retailer an edge over competitors.”
Moreover, a diverse range of product categories, distribution channels, and geographic reach can cushion retailers from negative macroeconomic fluctuations, ensuring more stable performance.
Scope Ratings (Germany, April 2022) highlights this:
“A broad mix of product categories, distribution channels, and geographic exposures can help retailers offset adverse macroeconomic conditions.”
7.4) Diversification in the Supply Chain is a Competitive Advantage
Retailers that maintain a diversified supplier base are better positioned to avoid disruptions in their operations if any single supplier encounters difficulties.
As stated in CARE Ratings (December 2022):
“A diversified supplier base is preferred to ensure smooth operations in case of any issues at the supplier’s end.”
Thus, retailers with built-in diversification across various aspects of their business have a significant competitive advantage over their peers. Such retailers present a strong barrier to entry for new players, who are typically cautious about competing in markets already served by well-diversified companies.
As mentioned by Scope Ratings (Germany, April 2022):
“A high degree of diversification also protects against the threat of new competitors entering a market (product category or region) that the retailer serves.”
7.5) Diversification in Store Ownership Model
Retailers typically operate their stores through three primary ownership models: outright purchase of the premises, lease/rental arrangements, and revenue-sharing agreements with the property owner.
Each model presents its own set of challenges. Ownership of store locations generally provides lower day-to-day costs, which can be beneficial during economic slowdowns when sales may decrease. This ownership also ensures business continuity and mitigates the uncertainty associated with lease renewals.
However, focusing on store ownership as a core business model requires substantial capital investment. Moreover, if the retailer chooses to shut down a store, it may face significant losses unless the premises can be sold at a favorable price.
As noted in CARE Ratings (December 2022):
“Ownership of stores ensures business continuity, especially in strategic locations, and reduces the uncertainties associated with lease renewals. However, it involves higher initial capital costs and larger exit costs compared to leasing.”
In contrast, leasing allows retailers to expand rapidly without a large upfront investment and provides flexibility to close underperforming stores with relative ease.
As CARE Ratings (December 2022) further explains:
“Retailers with access to low-cost, quality real estate have a competitive advantage, saving on major cost components and enabling faster expansion.”
A leasing-based model also exposes retailers to credit risk. Retailers are required to provide a security deposit to the property owner, which is refundable at the end of the lease term. However, over time, if the property owner faces financial difficulties, they may not be able to return the deposit, leading to potential financial losses for the retailer.
As noted in the Rating Methodology by Sector – Retail, Japan Credit Rating Agency (JCRA), May 2020:
“A large amount of guarantee money is deposited when a store is established under a long-term lease contract… There have been instances where deposits were not returned or were reduced due to the owner’s bankruptcy or insolvency.”
To mitigate this risk, retailers with a diversified mix of both owned and leased stores are better positioned to manage the financial implications of leasing.
Additionally, retailers with in-house real estate operations have a competitive edge. They benefit from easier access to premium retail spaces, as opposed to relying on external real estate developers. This advantage is particularly significant because delays in property handovers by developers can cause setbacks in store openings.
According to Rating Methodology by CARE (November 2019):
“Retail companies with access to real estate through group holdings enjoy a distinct advantage over competitors.”
Furthermore, delays by real estate developers in handing over store premises are a key risk for retailers, as highlighted in the Retail by ICRA (July 2021):
“Delays by developers in delivering properties can significantly hinder retailers’ ability to launch stores on time.”
Many retailers also look to expand quickly through franchise models. However, this approach has limitations, as it caps the potential profitability from franchise stores.
As observed in the Retail and Wholesale Rating Methodology by Scope (Germany, April 2022):
“A high share of franchised stores usually reduces the total addressable profitability, which may signal lower overall profitability for the retailer.”
8) Regulatory Risks:
The retail industry is a major contributor to India’s economy and employment, accounting for approximately 10% of the nation’s GDP and about 8% of overall employment, according to CARE (Nov. 2019).
Rating methodology – organised retail companies by CARE, November 2019, page 1:
“The retail sector contributes roughly 10% of India’s GDP and provides around 8% of employment.”
Given its size and significance, any policy change affecting the retail industry can directly impact a large portion of the population. This makes the sector highly susceptible to political risks, and as a result, successive governments have been cautious about allowing large corporations, including multinational companies (MNCs), to enter the retail space.
While India has relaxed some regulations governing the retail industry, implementation remains challenging. Various conditions, as well as state-level authorities, complicate its execution.
Rating methodology – retail by ICRA, July 2021, page 2:
“Political hurdles continue to impede the retail industry from attracting foreign investments, limiting access to capital, technology transfer, and improved supply chain efficiencies. Additionally, FDI regulations are complex, with compliance remaining a state-level issue, leading to inconsistent enforcement.”
These challenges have led to minimal corporate and institutional investment in India’s retail sector, both from domestic and foreign investors.
Rating methodology – retail by ICRA, July 2021, page 1:
“Despite significant investment requirements, the industry has attracted only limited domestic capital, with foreign direct investment (FDI) remaining marginal. Retail trading accounted for just 0.65% of the total $529.6 billion equity FDI inflows between April 2000 and March 2021.”
Due to this lack of institutional investment, the Indian retail sector faces significant infrastructural challenges, particularly in areas like supply chains, warehouses, and cold storage, which hampers its overall efficiency and growth.
Rating methodology – retail by ICRA, July 2021, page 1:
“Inadequate infrastructure, especially in warehousing, cold storage, and access to quality space, remains a major obstacle for the retail sector.”
In addition to institutional investment controls, the government also regulates other aspects of the retail industry. For instance, in the pharmaceutical sector, the government imposes pricing controls on many drugs listed in the National List of Essential Medicines (NLEM), limiting the profit margins that drug retailers can earn.
Rating methodology – retail by ICRA, July 2021, page 3:
“Certain product prices are heavily regulated, constraining retailers’ ability to expand margins. The Drug (Price Control) Orders and NLEM are key examples of such regulations.”
Another example of regulatory oversight is in the alcohol retail sector. Recently, certain regions have imposed bans on the sale of alcohol, negatively impacting the businesses of retailers involved in alcohol sales.
Rating methodology – retail by ICRA, June 2019, page 1:
“Regulatory restrictions, such as a ban on alcohol marketing, limit industry growth potential. For instance, the Supreme Court’s ban on liquor sales within 500 meters of state and national highways has affected retailers in the alcoholic beverage sector.”
As such, investors analyzing organized retail companies should closely monitor evolving regulations related to the products they sell. Any adverse regulatory changes can significantly affect the retailer’s operations and profitability.
9) Key Ratios to Analyze Retail Companies’ Business:
Retail companies are essentially a network of individual stores, with each store functioning as an independent selling unit. Therefore, evaluating the performance of each store is crucial for understanding the overall business health of a retail company.
Since each store acts as a fully operational unit, analyzing store-level performance helps investors gauge the strength of the company’s business model. To effectively assess this, the following parameters are key:
Same-store Sales Growth:
This metric is essential for understanding a company’s ability to grow profitably across different economic cycles. A decline in same-store sales growth indicates that the company is losing its competitive edge, as both pricing and sales volume tend to shrink. Conversely, a strong market position will reflect positive same-store sales growth, suggesting sustained business momentum.
ICRA, July 2021:
“Same-store sales growth reflects a company’s ability to thrive despite economic challenges. If competition intensifies and the company loses its edge, same-store sales will decline.”
This metric is critical because, without it, a retailer might appear to be growing simply by opening new stores, even if the performance of existing stores is weakening. A decline in same-store sales growth can reveal underlying business struggles.
CRISIL, February 2021, page 16:
“While overall revenue may appear strong due to new store additions, low same-store revenue growth highlights risks of stagnation if new store openings slow down.”
Store-Level Profitability Contribution:
This parameter assesses how profitable each store is, helping investors understand the overall financial performance at the individual store level. This data offers insights into whether the business is relying on new store openings for growth or if existing stores are effectively driving profitability.
ICRA, May 2017:
“Store-level profitability is a critical measure to evaluate the retailer’s true operational efficiency.”
Retailers often expand aggressively, but if the profitability of existing stores isn’t addressed, long-term sustainability may be compromised, leading to closures down the line.
Granular Analysis of Store Performance:
To gain deeper insights, store-level performance can be further broken down into specific customer-related metrics:
- Number of customers
- Average spend per customer
- Average price per product sold
- Number of products sold per customer
These parameters help identify the reasons behind changes in sales. For example, declining footfalls could indicate that the company is losing its competitive edge, while changes in pricing or product strategies could be affecting sales volume.
JCRA, May 2020:
“By analyzing customer behavior at the store level, investors can identify whether competition, pricing, or product strategies are influencing sales.”
Additional Key Performance Indicators:
A range of other metrics can provide a comprehensive understanding of a retailer’s business dynamics:
- Rental per square foot vs. sales per square foot
- Capital expenditure per square foot
- Debt per retail outlet
- Percentage of stores achieving breakeven
- Time to breakeven for new stores
- Footfall growth and conversion rates
- Average selling price and transaction size
- Share of private label products
- Proportion of sales under loyalty programs
Working Capital Management:
Effective working capital management, especially inventory management, is vital for maintaining profitability. One key indicator here is the Cash Conversion Cycle (CCC), which reflects how efficiently a retailer manages its working capital. A negative CCC indicates that the retailer can sell goods and receive immediate payment (low debtor days) while benefiting from extended credit terms with suppliers (high payable days). This enables them to fund working capital through supplier credit.
Retail and Wholesale Rating Methodology by Scope, Germany, April 2022, page 11:
“A positive CCC, driven by low days payable outstanding, signals tightening commercial terms, reflecting a loss of confidence in the retailer’s ability to pay its bills. Conversely, a negative trend in CCC implies an improvement in creditworthiness.”
Changes in CCC, such as a shift from negative to positive, may signal concerns about the retailer’s market reputation or creditworthiness.
Gross Margin as a Proxy for Working Capital Efficiency:
A stable or improving gross margin is another indicator of good working capital management. A consistent gross margin suggests the retailer is managing inventory effectively and avoiding costly write-offs or losses.
S&P, November 2013, page 10:
“A steady gross margin reflects strong working capital management, which is crucial for seasonal retailers, where inventory management can directly impact profitability.”
10) Employee Costs:
Employee costs, along with rental expenses, are among the largest expenditures for a retailer. Efficient management of these costs is crucial, as poor handling can delay the store’s break-even point and erode its competitive edge.
JCRA, May 2020:
“Retail is a labor-intensive industry, where personnel expenses typically make up the largest share of selling, general, and administrative costs. Retailers, especially those operating chain stores, require a significant number of employees for tasks such as cash handling, merchandising, and in-store operations.”
Given the retail industry’s narrow profit margins, operational efficiency is essential for sustaining profitability. To ensure this, retailers need to employ skilled staff who can execute these tasks effectively, creating a high demand for talent and thus increasing labor costs.
ICRA, July 2021:
“The retail industry experiences high employee turnover and a shortage of skilled talent, which in turn raises employee costs, as businesses must retain their best employees.”
Larger retailers with a strong market presence and ample resources have an advantage in attracting and retaining top talent, allowing them to maintain operational efficiency and preserve their competitive edge.
ICRA, July 2021:
“Retailers with a solid market position are better positioned to recruit and retain skilled workers, which helps maintain operational efficiency.”
To manage labor costs, many retailers hire temporary or contract-based employees for lower-level tasks. This strategy helps to control costs, but it limits further reductions in employee-related expenses.
JCRA, July 2011:
“While employing low-paid, part-time, and temporary workers can reduce labor costs, the potential for further cost reductions through enhanced productivity is limited compared to other industries.”
As technology advances, many retailers are turning to automated solutions, such as self-checkout systems, to reduce the reliance on human staff and minimize in-store labor costs.
JCRA, May 2020:
“Retailers are increasingly adopting self-checkout and semi-self-checkout registers to reduce in-store labor requirements.”
Summary
The retail industry is vast and diverse, with each segment exhibiting distinct business dynamics. Value retailing operates on a low-margin, high-volume model with stable demand and minimal cyclicity, though it faces low entry barriers. In contrast, lifestyle retailing thrives on high margins and lower volumes but is more sensitive to economic cycles, requiring strong brand-building and facing higher entry barriers.
Despite their differences, all retail segments contend with intense price-based competition, resulting in relatively low-profit margins. To counter this, retailers aim for scale and efficiency—larger players leverage economies of scale, negotiate better supplier terms (including return of unsold stock), and reduce inventory losses.
Efficient inventory management becomes critical, with large retailers investing in advanced technologies to sync real-time stock levels and minimize working capital needs. Additionally, private labels offer higher margins than third-party brands, although excessive reliance on them may dilute customer appeal for globally recognized products.
To control fixed costs like rent and salaries, retailers often collaborate with specialty sellers in-store and adopt flexible formats, balancing self-owned and leased stores. A wide geographic presence and customer base—across urban, semi-urban, and rural markets—strengthens competitiveness. Omnichannel strategies, combining offline and online sales, further enhance resilience, as does diversification in suppliers and product categories.
Retail is labour-intensive, requiring both skilled professionals and low-wage contract workers. With limited scope for further cost-cutting, many retailers are now automating front-end processes like self-checkouts to boost operational efficiency.
Organized retail also demands significant capital investment—both upfront and recurring. However, due to political sensitivities, the sector faces regulatory constraints that limit corporate participation and supply chain modernization.
Regulatory risks remain a concern, and investors must track policy developments affecting the product categories retailers deal in. Beyond financial statements, a deeper analysis of store-level performance, customer spending patterns, and per square foot metrics is essential for a true understanding of a retailer’s health.
FAQs: How to Analyze the Business of Organised Retail Companies
1. What are the key factors to consider when analyzing an organized retail company?
When analyzing an organized retail company, key factors to focus on include:
- Same-store sales growth: Indicates the ability of the company to grow its business profitably without relying solely on new store openings.
- Store-level profitability: Understand how each store contributes to the company’s overall profits.
- Employee efficiency and cost management: Retail is labor-intensive, and efficient labor management can impact profitability.
- Store ownership model: Analyze whether the company owns, leases, or shares its store spaces and how this affects its financial stability and flexibility.
- Supply chain and inventory management: Effective management of inventory and supplier relationships can significantly impact margins and operational efficiency.
2. Why is same-store sales growth important?
Same-store sales growth is crucial because it reflects the performance of existing stores over time, independent of new store openings. A decline in same-store sales could indicate a loss of competitive edge, even if the company is opening new stores. It helps investors understand the underlying health of a retailer’s business beyond its expansion efforts.
3. How do store-level profitability and performance affect overall business analysis?
Store-level profitability provides insights into how well each individual store is performing. It allows analysts to pinpoint strong and weak locations. Analyzing store-level performance helps identify operational inefficiencies or areas of improvement, which is critical in understanding whether overall growth is sustainable or dependent on new stores.
4. How can employee costs impact retail business performance?
Employee costs are one of the largest expenses for retailers. High employee turnover or inefficient labor management can erode profitability and delay the store’s break-even point. Retailers must manage labor costs efficiently, using strategies like hiring temporary workers or investing in automation, to maintain competitiveness.
5. Why is geographical diversification important for retail companies?
Geographical diversification can protect retailers from regional disturbances such as economic downturns, natural disasters, or political issues. By spreading stores across various locations, retailers can stabilize revenue streams, reduce risk exposure, and cater to a broader customer base.
6. How do different sales channels impact a retailer’s competitive advantage?
Retailers with multiple sales channels (such as brick-and-mortar stores, e-commerce, and mobile apps) have a competitive advantage because they can serve a broader customer base across different geographies and adapt to changes in consumer shopping preferences. Diversifying sales channels mitigates risks associated with relying on one mode of business, especially in times of economic uncertainty.
7. How does supply chain diversification benefit a retailer?
A diversified supply chain provides a safety net if any single supplier faces challenges, preventing operational disruptions. Retailers with multiple suppliers across different regions or product categories are more resilient to supply chain bottlenecks and can maintain steady product availability.
8. What role does store ownership play in a retailer’s business model?
Retailers that own their stores benefit from lower day-to-day premises costs, which can help them maintain business continuity during tough economic times. However, owning stores requires significant capital investment and exposes the retailer to potential losses if they need to sell a store. A balanced mix of owned and leased stores can provide flexibility and reduce financial risk.
9. How do regulatory changes affect the retail industry?
Regulatory changes, such as government pricing controls or restrictions on specific products (e.g., medicines or alcohol), can impact profit margins and growth potential for retailers. It’s important to monitor regulatory environments and any upcoming changes that may affect a retailer’s operations or product offerings.
10. How can financial ratios help in analyzing a retail company’s performance?
Key financial ratios like return on equity (ROE), debt-to-equity ratio, and gross margin are essential for assessing profitability, financial stability, and operational efficiency. The cash conversion cycle (CCC) is also a vital indicator for understanding working capital management and liquidity.
11. What is the importance of analyzing the company’s market position?
A strong market position gives a retailer the ability to attract and retain customers, maintain competitive pricing, and secure favorable terms with suppliers. Companies with a strong brand, customer loyalty, and market share are better positioned to weather economic fluctuations and enhance long-term profitability.
12. How does technological investment affect retail companies?
Retailers that invest in technology, such as self-checkout systems or advanced inventory management tools, can improve operational efficiency, reduce costs, and enhance customer experience. Technology also helps retailers adapt to changing consumer behaviors, such as the shift toward online shopping.
