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India is a land of growing consumerism. With about 14 million retail points serving the end customer, in both urban and rural markets, it is a mammoth task for manufacturers – especially those of FMCG and consumer durables – to address the demand. What makes this even more challenging is the fact that as on today, 92% of the retail sector is unorganized – making it practically impossible for a manufacturer to cater to the last mile, solely on the strength of direct distribution channels.
The inevitable saviour? The Indian wholesale market.
Before we delve further on the impact of GST on the wholesale market, it is probably useful to understand the position of a wholesaler in the supply chain, vis-à-vis a distributor, who too, is a middleman between the manufacturer and the retailer. While the nature of business is pretty much the same, the behaviours are different.
A distributor, for instance, has a commercial relationship with the manufacturer. As a result, while he may deal in multiple product lines, he ensures that they are non-competing in nature. While he mostly services retailers who are his regular buyers, he occasionally services the wholesaler as well. A distributor often is a part of the principal manufacturer’s promotional efforts, providing manpower and cash support to roll out schemes across their chain of retailers. He also provides a range of services such as product information, estimates, technical support, after-sales services, and most importantly credit to their retail customers. In a bid to safeguard his business, he will often have agreements with the principal manufacturer, which limit the number of distributor entities in a particular territory. All in all, a distributor is quite organised, maintains a healthy margin, and has almost the same equation with retailers, as manufacturers have with him.
A wholesaler, on the other hand, largely operates without any commercial or business obligations. He buys in bulk – mostly from the manufacturer, occasionally from the distributor – and resells it, again in bulk – mostly to retailers and occasionally to distributors and other wholesalers. His bulk-buying nature allows him to bargain for lower prices from the manufacturer. Also, he often deals in a huge range of contrasting products, as long as it results in overall profit for him. Retailers - especially small ones in urban and most rural ones – flock to him, because they can get products at lower costs (thus the term, wholesale rates) and, they are not subjected to any terms and conditions, like distributors are. However, the flip side is, the wholesaler does not offer any credit, as he himself works on thin margins, and mostly does not take back unsold inventory/stock. This retailer-wholesaler dynamics allows manufacturers to achieve sales from those markets, where they are not able to handle direct retail sales and shipments.
Having discussed how wholesalers operate, we can now start to appreciate that not only distributors but wholesalers too, are extremely crucial cogs in the supply chain wheel, which manufacturers cannot survive without. Thus, while manufacturers may have started preparing to brace the impact of GST on themselves and their direct channels – distributors and outlets, they will also be fairly concerned about the wholesalers that they work with. With the wholesale market on its way to recovery after being hit by the demonetization wave last year, it remains to be seen how it will negotiate the bigger wave of GST about to hit the shores of the Indian economy, come July 1st.
Here are 4 ways in which, we believe, GST will transform the Indian wholesale market –
Wholesalers, as discussed above, are mostly into bulk transactions of a wide range of products, and immediate payments in cash. Also, they may buy both from manufacturers as well as distributors – which entail different tax liabilities for them. Since most wholesalers do not have an excise registration, they cannot pass on the excise tax liability to the next buyer in the chain, and the tax credit chain is broken, pretty early on. Coupled with the fact that the tax jurisdiction in the existing taxation regime is not transaction based – the need to maintain a neat record of invoices, that too for compliance, goes down and more focus is given to the prime business activity of buying and selling. This has led to a scenario, wherein most wholesalers are unable to stay compliant due to the associated complexities, leading to reduced tax liabilities. This allows them to undercut market prices, and generate volume sales. While this still translates into wafer-thin profits - as low as 1 percent – life is good for the typical Indian wholesaler, as he follows a largely credit-free policy.
Under the GST regime however, every invoice pertaining to taxable supply has to be uploaded on the GSTN’s common portal and has to be accepted by the buyer. On top, GST subsumes most of the indirect taxes, which leads to seamless tax credit flow across the chain, irrespective of whom the wholesaler is buying from and selling to. Also, it no longer entails multiple registrations for multiple taxes – making it much easier for a wholesaler to stay compliant in the coming times. Yes, there may still be those few truant wholesalers or retailers who may choose not to abide by the compliance norms. However, the only possibility for tax evasion will arise if every single entity in the supply chain is non-compliant – which is highly unlikely. The rest of the compliant wholesale channel is bound to boycott business with such entities after a while – practically forcing them to start filing proper returns in order to sustain business relations and definitely, their business. In short, the GST era will see the large segment of wholesalers being brought into the tax bracket.
One of the biggest challenges for the wholesale market has always been, that their business hinges on low margins. In the wake of demonetization last year, it went through a major cash crunch, and the most natural response to the same was to de-stock to improve their liquidity. FMCG players such as Dabur and Tata Global Beverages have predicted a repeat of the same once GST comes in, primarily because of the last mile i.e., the retailers fearing about the availability of input tax credit on the existing stock.
To begin with, retailers who are currently registered under state VAT laws would have paid VAT on all the stock held on the transition date. Although provisions have been incorporated in the GST Law, wherein VAT paid under the current regime will be allowed as input credit under the GST regime - the government has imposed certain conditions for availing input tax credit on closing stock; not all retailers may make the cut.
Further, for goods lying with the retailers on which excise duty is paid – 100% tax credit will be available only if the excise value is ascertainable by means of invoices, and if not, only 40% tax credit will be available. In most of the cases, the excise tax chain stops with the first stage dealers – wholesalers and distributors. Tax is passed on to the retailers as additional cost, which means that most retailers will never be able to claim the full excise tax credit, as it does not appear in their invoices at all. Ultimately post GST, they will be forced to pass on this cost to their customers, making their prices much less competitive to other players. This is bound to trigger most retailers across the chain to de-stock the inventory during the transition phase and eventually re-stock again under the new GST regime. And once that happens, demand to the wholesaler will fizzle out, leading wholesalers to de-stock as well. However, once the GST era dawns, this could also translate into a steep rise in demand for goods as a result of a widespread re-stocking of goods by wholesalers.
As GST inches closer, more and more FMCG and consumer durable players are becoming wary of their wholesale businesses. Sanjiv Mehta, CEO and MD of HUL recently opined that post GST, the wholesale sector will take at least a quarter or more to stabilise – which could lead to the overall contribution of wholesale coming down significantly, compared to direct coverage.
This is because GST will cause disruptions in the core behaviour of a wholesaler – bulk transactions; selling purely on cash basis; not giving credits and using the same to maintain liquidity in the business; operating on thin margins, and so on. As discussed earlier, GST will see more wholesalers stepping into the tax bracket – which will entail not only efforts but costs as well. With their already thin margins becoming thinner still, their sheer survival will be in question. At the same time, their survival is of extreme importance to the principal manufacturers, who need them to service the long tail of retailers and kirana shops in both urban and rural areas.
However, if that needs to happen, manufacturers will need to support the sinking wholesaler by pumping business benefits – in terms of further reduced pricing, increased commissions etc. However, the effort required on the direct distribution channel will be much less – as most distributors, would have already started working with the respective manufacturers and invested in the right technology to become GST compliant – for their own sake. All this, could gradually make wholesaling a more expensive deal compared to direct distribution, and thus most manufacturers - especially of FMCG and consumer durables – are sure to extend their direct reach, wherever feasible, in a bid to become more cost-effective.
In short, while wholesale is still important, the post-GST period could see a major spike in company owned direct outlets and more penetration of distribution channels. This will also be good news for the more organised modern wholesale players such as e-commerce and cash & carry outlets – who will easily trump the unorganized supply chain, cracking under the pressure of GST compliance.
Typically, the current indirect taxation regime in India has driven supply chain decisions of businesses. More often than not, supply chain models have been designed keeping in mind the tax liabilities, multiplicity of taxes and costs involved with inter-state supplies. As a result, wholesalers tend to do business with manufacturers within the state, and end up serving the last mile of retailers with a limited product portfolio.
GST is set to change that picture. To begin with, the movement of goods, in the absence of multiple taxes like entry and octroi – will open up business at an all India level. The seamless availability of input tax credit across state boundaries will bring forth increased efficiencies in the supply chain, and allow manufacturers to remain competitive outside their home states as well. While the manufacturer will gets access to a wider base of distributors and wholesalers across the country; for the wholesaler too, it is an advantage – he can now align with manufacturers outside his home state, expand his product portfolio, and make the most of the additional opportunity - to not only generate more sales from existing retailers, but serve more retailers in the same geography.
GST will definitely transform the Indian wholesale market like never before. While there is a fair chance that it could hit them initially in the same way as demonetization did, the benefits of GST in the long run - coupled with their own willingness to become tax compliant, will allow them to not only survive but also garner more benefits in terms of revenue and overall growth.
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