Winning the Indian consumer - McKinsey article

Winning the Indian consumer
Multinationals that successfully adapt their products to India's largely untapped market will have the advantage.
V. T. Bharadwaj, Gautam M. Swaroop, and Ireena Vittal
2005 Special Edition: Fulfilling India's promise

India's growing market for consumer goods, already in the top ten (Exhibit 1), could reach $400 billion by 2010—making it one of the five largest in the world. Add the fact that during the next few decades India will likely surpass China as the world's most populous country, and it is clear that multinational consumer goods companies seeking faster growth must begin to focus on the subcontinent.

Multinationals in the grocery, durable-goods, and packaged-goods sectors have been entering India since 1991, when restrictions on foreign investment were relaxed. Some companies have adopted a specialty-player strategy, catering to a small segment of "global Indians" and marketing products much as they would be marketed to any such customer around the world. These companies concentrate on a few big cities. Their business model is low risk and easily rolled out, can often be sustained initially through imports, and requires a limited distribution network. Although businesses of this kind can be profitable, their sales volumes are typically modest and will grow only as fast as the segment does. In many ways, this strategy misses the point of entering a market as large as India.

By contrast, other multinationals have targeted "aspiring India"—the much bigger and faster-growing middle-income segment—with an eye to making the country a core market. In some cases, these companies have won substantial shares in product segments ranging from breakfast cereals to washing machines to cars (Exhibit 2). With this market-shaping strategy, a company can achieve scale and create a strong position that should allow it to reap even bigger benefits in the future. But it is also a challenging route, and some companies have stumbled, confounded by attempts to make money in a geographically immense market of consumers who demand high value at low prices.
In our work with multinationals, we have found two keys to serving India's giant middle segment successfully. First, the winners have worked hard to understand its needs and the country's rapidly changing consumer goods landscape. That knowledge was critical to informing the next step: tailoring products and pricing to the budgets and tastes of these consumers.

A new consumer generation
Since 1990 India's economy has grown, on average, by 5.7 percent a year. Its per capita income has nearly doubled in real terms since liberalization, reaching $543 in 2004. But these numbers don't tell the whole story of the Indian consumer goods market. In fact, there are several Indias, each moving at a different pace.

Looking at the pyramid
An estimated 1.2 million affluent households sit atop the Indian income and consumption pyramid. This is "global India"—only a third as large as the comparable segment in China but expanding by more than 20 percent a year. These households buy branded products, vacation abroad, own a number of cars and television sets, and generally behave like their counterparts in developed markets. Moreover, they are largely concentrated in the top eight cities. This segment may be worthwhile for manufacturers of high-end products such as perfume, haute-couture apparel, and luxury cars, but it is far too small for most consumer goods companies to make India a key market.
At the bottom of the pyramid are the large but poor segments. "Struggling India" comprises more than 110 million households earning $1,500 to $4,000 a year—$7,500 to $20,000, adjusted for purchasing-power parity (PPP)—and "destitute India" comprises 40 million households that are poorer still. For the most part, people in these segments will be able to afford only basic necessities for some time to come.
The real drivers of the growing consumer goods market occupy the center section of the pyramid, among India's 40 million middle-income households, which purchase more than just the basics (Exhibit 3). In this "aspiring India," a typical family comprises five people, lives in a city, and has an educated head of household who is an employee or a small-business owner earning $4,000 to $10,000 ($20,000 to $45,000, adjusted for PPP). Such a family often lives in a small apartment, has a bank account, and owns a television, a refrigerator, and a motorcycle or small car. This new consumer group, growing by about 10 percent a year, is expected to comprise 65 million households by 2010. Its emergence is signaled, for example, by passenger car sales of $5 billion in 2004, more than twice the level of sales five years earlier. The growth in mobile telephony has been even more extraordinary: in excess of 55,000,000 Indians are subscribers, up from 300,000 in 1996.


Young and eager to consume
We can use our recent work in the apparel, durable-goods, financial-services, media, and telecom sectors to paint a profile of this consumer group. For starters, India's consumers are young: 70 percent of the country's citizens are below the age of 36, and half of those are under 18 years of age. These people are deeply rooted in Indian culture and traditions yet connected to and curious about the outside world. Their incomes may be growing, but their budgets are still limited. Together, these characteristics have big implications for the product categories and brands they select.
Such consumers focus on the right housing (that is, housing with access to power and water) and on food, health, and hygiene products. While people in this middle-income segment still spend about half their budgets on the basics, that amount is falling every year, leaving more money for other areas of consumption. This demographic is the new battleground for companies and brands alike.
Beyond basic needs, households make their children's future a clear priority; education is seen as a passport to a better tomorrow. To gain a winning edge, parents spend much money and effort securing the right schools and tutoring for their children and invest in nutrition, computer games, and books. As a result, several categories of products—from protein powders to educational toys—have enjoyed rapid growth.
With basic needs satisfied and the future looked after, these consumers will consider product categories representing the good life—perhaps a new color TV or a new motorcycle after 4 years (compared with the earlier 12 years) or a simple statement such as serving guests Coke instead of the traditional lime juice. Unlike older generations, with their memories of wars with Pakistan and slow economic growth, young Indians have been raised in the postliberalization era of fast growth and underlying optimism and are thus more confident about the future. One way this attitude manifests itself is borrowing to buy big-ticket items; as a group, such consumers are challenging the myth that Indians are averse to credit.
What's on the mind of young Indian consumers as they shop? Price and value for money are certainly important considerations. What of brands? Indians, with more than 200 television channels offering a window to the world, know of and value global brands but are unlikely to pay a premium for them. On the contrary, these consumers increasingly demand brands that are relevant to their own experience and reflect local preferences. One successful effort to fuse local and global tastes is MTV India, where local language and music account for 80 percent of the programming. Not surprisingly, Indian young people love it.

Tailoring the business model to India
Knowing what makes consumers tick is a vital first step. To capture their hearts and wallets—profitably—companies must use that knowledge to tailor the business model to local conditions.
Offer value at the right price
For several years, a leading multinational attempted to sell global brands in India at global prices. The company bet that the country's consumers would move in a premium direction because of their technological sophistication. It also decided to restrict its distribution presence, assuming that the brands were strong enough to attract consumers. These assumption turned out to be wrong. After 15 years, the company had only a marginal 4 percent share of the market and was clearly missing the boat. It then tailored its products and production methods to Indian market conditions and cut its prices by 65 percent. It is now rebuilding its distribution network and in general has begun to adapt its offerings more systematically to the needs (and wallets) of Indian consumers. The results are already visible: 12 months after the change in strategy, sales are increasing by double digits.
Consider also the fortunes of Lifebuoy (Unilever's biggest soap brand in India), whose sales declined by 10 percent a month for 18 months in a row through early 2000. Unilever improved the quality and perfume of the product, stressed its health and hygiene benefits for children, and raised its price by 20 percent. The resulting 15 percent annual growth for such a mature brand has surprised the market by showing that it is possible to charge higher prices if a product offers the right value.
Similarly, Nokia India (Nokia's Indian subsidiary) successfully introduced a customized version of the 1100 model mobile phone. The new version is equipped with features such as a dust-resistant keypad, an antislip grip, and a built-in flashlight (a particular favorite among the country's hundreds of thousands of truck drivers, who use it during stops along India's poorly lit highways). Samsung washing machines include memory backup to compensate for India's frequent power outages and a special rinse cycle for saris to prevent them from becoming twisted and knotted. What's more, the company's microwave ovens can cook Indian menus with a single touch. In addition to offering explicit value, such features help multinationals show Indian consumers that "we understand you and your world; we are the brand for you."
Getting the price right is just as important. Although the incomes of Indian consumers are growing, they still have many competing pulls on their modest budgets. Winning companies thus have learned the importance of affordability. Take the Indian mobile-telecommunications market—the fastest growing in the world—which has 55 million customers. Mobile telephony is also cheaper in India than it is anywhere else; steep and continual price cuts have led to rates of five cents a minute. In only 8 years, the market has reached a level of penetration that took television sets 25 years to achieve.
Successful companies have reduced the consumer's cost of entry into product categories by providing payment options such as financing, pay-per-use, and community ownership. In segments as diverse as motorcycles, durable goods, and apparel, for example, companies have representatives from banks and other financial institutions in stores to process loans in just a few hours. Game console brands are considering pay-per-use formats, including prepaid cards. Along with PC makers, they are also studying ideas for community ownership (at schools, for instance) as a way to drive penetration and consumption.
Affordability also has a bearing on price points for everyday products, sometimes in a paradoxical way. The shampoo market, for example, was revolutionized by ten-milliliter sachets, priced under five cents each. In ten years, the shampoo-buying share of India's population increased to 45 percent, from 18 percent, and such sachets drove almost all of this growth despite their premium price per unit of volume. These products succeeded because consumers who could not afford to spend 20 to 30 times more on a bottle of shampoo can now opt for single-serve portions.

Educate the consumer
Adapting a product and its price to a specific market sometimes does not suffice to create demand, however. Several Indian product markets are in the early stages of development, and winning in them will require patience and investment. The beauty care market, for example, is now worth only an estimated $60 million, and market penetration is below 5 percent, even among urban women. Similarly, less than 2 percent of all homes have air conditioners, and just 1.2 percent of India's people hold credit cards.
The barriers to building these markets are not only the limited awareness and availability of brands and products but also a lack of knowledge about what they do. To educate consumers, in the 1990s a manufacturer advertised the benefits of the washing machine—"It washes, it rinses, it even dries your clothes; in just a few minutes, you are ready for the show"—and used housewives to demonstrate the product in their homes. One multinational is currently advertising air conditioners as a way to purify air and thus to maintain a healthier home environment.
To expand the beauty market, a winning company would not only launch a cosmetics line and build a brand but perhaps also create a "beauty academy" to train hundreds of young women. These students could then set up their own salons, first to teach customers the art of makeup and then, over time, to sell them cosmetics. One implication is that winning companies will need patience, since the market will emerge in stages. The good news is that the market shaper often has big advantages, both in brand recognition and in the insights required to stay ahead of the competition.

Design to cost
In a market where demand exists, selling an appealing product at the right price is not extremely difficult. But how do multinational consumer goods companies in India make a profit at prices consumers can afford? Instead of setting a target profit and adjusting the price accordingly, a winner calculates the price required to create demand, determines the desired profit margin, and then designs a business model in which cost equals price less profit. It then uses several levers to construct a business model with the right cost structure.
A leading multinational, for example, recently changed the formulation of a product to reflect local usage patterns and, as a result, reduced its cost and price by about 40 percent. Similarly, motorcycle companies in India redesign bikes to sacrifice speed for mileage and sell these models, at very low prices, to millions of Indians who otherwise couldn't afford them. Indeed, our work with clients suggests that the design-to-cost approach can shave as much as 30 percent off a product's cost without any deterioration in the consumer experience, since this approach usually reflects the trade-offs local consumers themselves make between performance and price. Both sides ultimately benefit: a better price utility equation for the customer and a better cost margin sweet spot for the company.
Winners also improve their cost position in other ways—for instance, by using Indian contract manufacturers, which typically have lower labor and production costs as well as lower overheads. They then manage their products' quality by placing their own quality teams in these contract units. If companies set up their own plants, they keep capital-spending costs at Indian levels, usually 60 percent of those in developed markets, because of the lower cost of machinery and the more sparing use of automation. They also establish or acquire regional plants, which are better suited to a geographically diffuse market with high freight costs, rather than large-scale world-class plants.

Getting distribution right
Reaching India's consumers cost effectively is a challenge because of the sheer size of the country and its fragmented distribution and retailing networks; some 12 million mom-and-pop stores, for example, have long dominated Indian retailing. Companies that can solve this problem will have a competitive advantage. If, as expected, the government permits foreign direct investment in retailing, consumer goods companies should have greater opportunities to sell products in the modern formats they understand. The traditional network of local retailers, however, will remain important for years, even if modern retailing continues to grow at the current rate of 25 percent a year. With about 5 percent of the total market, modern retailing has a lot of room to expand.
As some companies have demonstrated, the key to distributing products successfully in India is to rely on a third-party network, since building one takes too long and is ultimately more expensive. Unilever, for instance, has achieved national reach through more than 20 distribution centers, run by third-party agents, that transport and store its goods. These centers serve in excess of 7,000 distributors, which use salespeople trained by Unilever to work with more than eight million retailers. Our experience suggests that setting up the right go-to-market strategy (including distribution, rollout, and methods and places for integrating third parties) has a significant—4 to 5 percentage point—impact on net margins, as the costs of direct distribution are 4 to 5 percent higher than those of the third-party approach. Direct distribution also delays the network's rollout, so it takes companies longer to achieve scale and a national footprint.
One company that does well in India, LG Electronics, succeeded thanks to its access to customers in smaller towns (see "Premium marketing to the masses: An interview with LG Electronics India's managing director"). LG created a national sales network of existing small electronics and consumer-durable-goods outlets, built a few flagship stores of its own in large towns, established service centers in several cities, and encouraged local entrepreneurs to set up stores in smaller towns to serve sizable rural populations that had lacked access to such shops.
The modernization of India's retailing sector will complicate life for consumer goods companies, which must not only go on building and leveraging their far-flung small-store networks but also adopt key-account-management skills from the developed world and other countries where modern retailing has moved ahead. To complicate matters further, local retailers are aggressively launching store brands, and Indian consumers don't differentiate between them and brand-name products from big consumer goods companies, according to our research. Clearly, the growth of modern retailing will be a boon for Indian customers. But to maximize the Indian opportunity, big consumer goods companies must learn to manage a widespread distribution network as well as to navigate the modern retailing sector.
India will be a critical growth market for many multinational consumer goods companies. But several distinct Indias now coexist. Global players must define which of them to target—the biggest opportunity is the rapidly growing middle class—and then design the right business model. While the journey will not be easy, the reward will be a share of the world's last big untapped consumer market.

About the Authors
V. T. Bharadwaj is a consultant and Ireena Vittal is a principal in McKinsey's Mumbai office; Gautam Swaroop is a consultant in the Delhi office.