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The Bharti-Walmart Breakup: Where Does FDI in India Go Next?

No v 01, 2013 Law and Public Po licy Strategic Management Asia-Pacific India

Finance

Af ter a seven-year partnership, Walmart and Indian retail partner Bharti Enterprises last month issued a terse joint message saying they were ending the 50/50 joint venture launched by the two f irms in 2006 and had reached an agreement to independently own their business interests in India. T he move wasnt entirely unexpected. Days bef ore the statement was released, Walmart Asia CEO Scott Price told the media during an Asia-Pacif ic Economic Cooperation meeting in Bali that the existing f ranchise to Bharti is not tenable as the base f or Walmart in India. Both sides were looking at the best way to move f orward, he added. Under the agreement reached by the two f irms, Bharti will acquire Walmarts indirect stake in the Easyday chain of retail stores through acquisition of compulsory convertible debentures of Cedar Support Services, a Bharti group company. In turn, Walmart will acquire Bhartis stake in the 50/50 Bharti Walmart joint venture, which is a cash-and-carry business-to-business operation under the Best Price marquee. India has allowed 100% f oreign direct investment (FDI) in the cash-and-carry segment since 2006. Given the circumstances, our decision to operate independently will be benef icial to both parties, said Price. Even though the split was no big surprise, it didnt make much sense to many observers. Walmart has been leading the campaign to get government permission f or 51% f oreign holding in multi-brand retail. In singlebrand retail, 100% FDI has been allowed since September 2012. T he FDI policy in retail has been extremely controversial and the Manmohan Singh government had to stake its survival on the issue. T he Walmart withdrawal is a victory f or small traders, says Praveen Khandelwal, secretary general of the Conf ederation of All India Traders, an anti-FDI organization.

But according to Wharton lecturer Edwin Keh, India may actually have little to do with Walmart rethinking its strategy in the country. I suspect the current moves in India are part of a larger shif t by Walmart to put f ocus back on its domestic business, says Keh, who was f ormerly chief operating of f icer and senior vice president of global procurement f or the retail giant. In the current environment of a recovering U.S. economy, the opportunities may be back at home.

Even though the divorce was no big surprise, it didnt make sense to many. Walmart has been leading the campaign for 51% foreign holding in multi-brand retail.

Keh cites other recent Walmart moves to support this theory. India, China and Mexico have been the countries where Walmart is rebalancing its stores, he notes. However, he sees Walmarts total business in China as poised f or growth with its investment in online grocery retailer Yihaodian. Walmart has a 51% interest in Yihaodian and plans to integrate its logistics operations with that of the latter. Yet everything is not black and white. T he retail giant has recently run into problems with the U.S. authorities over allegations that Walmart de Mexico had bribed its way to market dominance in that country. Even as this investigation was proceeding, f urther accusations were made about similar transgressions in India, China and Brazil. Probe in India Unlike in the U.S., lobbying is illegal in India, and there was signif icant outcry when Walmart disclosed to the U.S. Senate and the House of Representatives that it had been indulging in India-specif ic lobbying. Opposition lawmakers in India f orced the government to take action, and a retired judge was appointed to probe the issue. While initial indications are that the f indings have been inconclusive, a new controversy has arisen. T he prime ministers of f ice has declined to give sought-f or details of meetings of the prime minister and his of f icials with Walmart lobbyists. While this exemption can be claimed under Indias Right to Inf ormation Act, it has strengthened the arguments coming f rom the anti-Walmart contingent. T he Walmart-Bharti separation was orchestrated with unnecessary controversy on another f ront. In early July, the head of Walmarts operations in India, Raj Jain, was let go. T he announcement was made by Price at a town-hall meeting and came as a big surprise to the employees, who assembled on short notice af ter a summons via e-mail. Jain had been a trusted general of the company f or seven years, and his departure was read as action against those accused in the bribery allegations. The New York Times had earlier reported that the joint venture had suspended several senior executives and delayed the opening of some stores in the country as part of an internal bribery investigation. Now, many were sure that the kingpin had been identif ied. Af ter the break-up, however, Jain was given a vote of conf idence f rom Bharti via a post as advisor to the f irms retail division. When Rajan Mittal, vice chairman of Bharti Enterprises, made the announcement at yet another town-hall meeting, the employees who had heard Price in stunned silence broke out in applause. Jain was unavailable f or comment. Walmarts discomf iture with its Indian partners is f amiliar territory f or multinationals, according to Keh. Some countries may prove to be too dif f icult f or multinationals, he notes. Multinationals are of ten held to higher standards and so are of ten handicapped when competing with national operators. Anand Sharma, Indias commerce minister, says that Walmart has already been given plenty of opportunities in the Indian market. Walmart got enough space, he notes. T here will be no f urther steps to woo the company. With its cash-and-carry venture, Walmart has retained a toehold in India, and observers f eel it will make a comeback in multi-brand retail when the regulations are relaxed f urther. (T he company also has the option, of course, of divesting Best Price and getting out of India altogether.)

Finance Minister P. Chidambaram says more relaxations are unlikely. We have a policy, he told business channel CNBC-T V18. A genuine investor must work within that policy. It may not be the ideal policy f rom [the company's] point of view. But this is the policy that we have today. You have to take it as it is. Policy Pains What is it about the FDI rules that Walmart is f inding dif f icult to accept? T he trouble in India is that every policy is accompanied by subsequent clarif ications, some of which are dif f icult to digest. Swedish f urniture maker IKEAs $2 billion proposal to set up single-brand stores in India was stalled because it wanted to operate caf es and restaurants in its stores. According to the government, this would make it multi-brand retail, logic of f icials f irst used while rejecting a Marks & Spencer application. IKEA ultimately received the approval move f orward; the chain is allowed to sell cof f ee but only f or consumption on store premises. T he f irst IKEA store in India is expected to open in 2017-2018. Walmart is f acing a dif f erent obstacle. A contentious clause says that multi-brand f oreign retailers must source at least 30% of their products f rom small industries. T his may be possible in textiles and handicraf ts, but what about electronics? T he second problematic clause relates to investment. T he policy states that 50% of investment must be in back-end inf rastructure. T he clarif ications issued by the Department of Industrial Policy and Promotion state that this must be entirely f or green-f ield assets, meaning Walmarts investments in India thus f ar do not count toward meeting that mandate.

With its cash-and-carry venture, Walmart has retained a toehold in India, and observers feel it will make a comeback in multi-brand retail when the regulations are relaxed further.

It is now clear that f oreign players will have to create capacities f rom scratch. T his means that they will need to go back to the drawing board, assess their appetite f or investment and rethink their strategies, Ankur Bisen, vice president f or retail at New Delhi-based research and consultancy f irm Technopak Advisors, told Knowledge@Wharton in an earlier interview. Bisen noted that the new set of clarif ications has added more rigidity and disincentives and will result in f urther delay in investment decisions. And according to a KPMG study: T hese clarif ications may pose additional road blocks f or global retail players. Not Just Walmart T he Walmart-Bharti breakup is not the only recent severing of ties between multinationals and local partners. Fast-f ood giant McDonalds, which has a 50/50 joint venture called Connaught Plaza Restaurants, has accused Indian partner Vikram Bakshi of looking af ter his own business interests in pref erence to those of the joint venture. On August 30, McDonalds issued a public notice that deposed Bakshi as managing director. T he company would hencef orth be run by the board, it said. T he af f air has ended up with the Company Law Board. Meanwhile, a year-old 30/70 partnership between Australian cof f ee chain Di Bella Cof f ee and Indian entrepreneur Sachin Sabharwal is now embroiled in legal suits and def amation charges. T he 26-year-old joint venture between the Munjals and Honda of Japan broke up in 2010, albeit with much less acrimony. Other joint ventures said to be on the rocks include Gillette India (with key shareholder and chairman Saroj Poddar) and German stationery maker Faber-Castell (with partner and managing director Anup Bhaskaran Rana).

Traditionally, JVs break up mainly because of incompatibility issues or big egos. But in India, it may be more the external environment than the internal environment that is causing separations. In the Bharti-Walmart case, I suspect it is more the FDI policy and possibly the U.S. Foreign Corrupt Practices Act (FCPA) investigation which led to their decision, says Pradeep Mukherjee, India head and CEO of global HR consultancy f irm Mercer. U.S. companies entering into a JV are required to have a clear understanding of their duties and responsibilities under the FCPA, adds S. Raghunath, prof essor of corporate strategy and policy, and dean of administration at the Indian Institute of Management, Bangalore. We also know that compliance issues af f ect U.S. company executives and heighten corruption risk. T hey are, theref ore, extremely concerned about the potential impact of corruption on their business. T his is the reason why when Raj Jain was shown the door, speculation immediately started that the change was evidence of Walmart trying to clean up its act in India. In recent times, several CEOs of multinational subsidiaries in India have been let go. Reebok Indias managing director Subhinder Singh Prem was even arrested f or f raud. T he Bharti-Walmart case is completely dif f erent, says Raveendra Chittoor, prof essor of strategy at the Hyderabad-based Indian School of Business. Pointing out that the partners in the joint venture came together based on certain assumptions on the regulatory f ront, Chittoor notes: For Walmart, their proposed business model does not f it in with the new regulations.

Traditionally, JVs break up mainly because of incompatibility issues or big egos. But in India, it may be more the external environment.

A joint venture is a partnership between two companies, each bringing its own strengths local market knowledge f rom one and international best practices f rom the other, says Bundeep Singh Rangar, chairman of Indusview, a London-based advisory specializing in business opportunities in India f or multinational f irms. Like all relationships, however, one party might f ail to f ulf ill its share of responsibilities, which leads to a breakup. Chittoor observes that the breaking up of alliances is very common, both globally and in India. According to various studies, almost 60% to 70% of joint ventures f ail. Failure can be due to many f actors. For instance, the objectives of the partnership may not have been thought through or articulated clearly; lack of planning and lack of articulation leading to misunderstandings; dif f erent leadership styles; inf ormation asymmetry leading to ideological and cultural dif f erences [or] HR issues. He makes a distinction between partnerships that spin out of control and those that are designed f rom the very beginning to break up. Pepsi started in India with the Tatas (Voltas). T he moment the laws were changed, the two abandoned the venture. Procter & Gamble-Godrej and Tata-IBM came to an amicable end because the objectives set out at the beginning of the relationship were achieved. T here is no clear evidence as to how many of the partnerships that break up are by design or because of actual f ailure, Chittoor notes. So even if there are more partnerships breaking up today in India, it is important to see how many of them are a natural progression because the objectives have been met. Rangar adds that it would be unf air to cast most of the joint ventures being dissolved as acrimonious breakups. T he reason f or having a JV is that the overseas company needs handholding as it understands the nuances of doing business in India, and the Indian company needs to learn the best practices in product development and adopt manuf acturing technology f rom the overseas entity, Rangar says. When the purpose of the JV is achieved, the partners dont f eel the need to piggyback on each other.

Raghunath sees a dif f erent set of reasons f or incompatibility issues between multinationals and Indian partners. Foreign investors of ten have deep pockets, a longer-term view of a joint ventures f inancial returns and a willingness to reinvest prof its and increase capital, while the Indian partner of ten has a more short-term view and relatively shallow pockets, Raghunath notes. T he result can be dif f erent priorities f or investments and a lack of cooperation, both between the JV partners and within the joint management team. T he bigger issue today f or India, which is currently being crippled by a huge current account def icit, is the impact on FDI inf lows. Walmart will be a speck in Indias retail market, says Chidambaram. Its absence wont make any dif f erence to the country. Rangar is also optimistic. As long as the broader investment case f or an India entry is compelling and overseas companies are patient enough to commit to India f or f ive-to-seven years to see stability in their Indian operations, FDI will keep f lowing in, he predicts. Whats more, the Indian companies that have deep domestic execution skills will f ind themselves being courted by overseas companies, not necessarily f or a joint venture but on a project-by-project basis. But Chittoor sees Walmart as a key player. Since the FDI rules were amended more than a year ago, India has not received a single application f or multi-brand retail. T he impact of the Bharti-Walmart breakup on FDI depends on what Walmart plans to do now, he says. If it decides to continue in India on its own, it means that it is conf ident of the potential of the Indian market. T hat is very positive f or FDI. However, if it decides to pull out of India completely, it could have a negative impact.