Is Ikea right to fret about local sourcing?

Ikea fans in India, here’s something that will disappoint you: the Swedish furniture retailer won’t be coming to India any time soon.

According to various media reports, the company has been put off by the local sourcing requirements and decided to enter India only when conditions are better.

Earlier this month, the government gave the go-ahead to single-brand international retailers to set up 100 percent-owned ventures, but added a clause that required any company investing more than 51 percent to source 30 percent of the value of its products sold from Indian small and medium-scale enterprises (SMEs).

Reports suggest that it’s not just Ikea that is taking a dim view of this particular clause.

But, is the 30 percent local sourcing requirement such a bad idea?

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Not really. It’s just that given the diversity of single-brand retailers, not every company will find it easy to source that much from small Indian vendors.

While a fast-food company like McDonald’s might find it easy to adhere to local sourcing requirements, companies on the higher end of the customer value chain, like tech giant Apple Inc, might not necessarily find the quality, expertise or technology that they need in small Indian vendors.

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Global brands build their reputation by delivering consistent product quality and uniform brand experiences around the world. “This has been achieved through a very strong process orientation and total control across all aspects of the business - store design, all operating processes and most importantly, in the manufacturing and/or sourcing of their merchandise,” notes Saloni Nangia, president of Technopak, a management consultancy, in Business Standard.

Those manufacturing operations involve highly integrated, global supply chains. As Nangia notes, “It takes years to develop this manufacturing and sourcing capability, and once it is in place, this supply chain is very closely integrated with the overall business.”

A mandatory 30 percent sourcing requirement from small Indian suppliers could upset that supply chain’s dynamics. “Anyone having even a very elementary understanding of this business dynamic would see the infeasibility for Apple, Ikea, Aldi, Uniqlo, H&M, M&S, or even Gap to meet the government’s condition on mandatory 30 percent sourcing from small-scale (and cottage industry) vendors,” she adds.

In addition, asking multinationals that operate on a global scale to depend on small Indian vendors requires not just splitting production across several suppliers, but also frequent changes in those suppliers. For instance, when a vendor, because of the growing number of orders, outgrows the definition of SMEs (enterprises with a total investment in plant and machinery of Rs 5 crore ($1 million)), it will have to be replaced by another one by the foreign retailer.

“With the same revenue, the company has to go to more suppliers so that they are less than $1 million. It will create huge supply chain problems,” Debashish Mukherjee, a partner and vice-president at consultancy firm AT Kearney told Reuters.

Clearly, the 30 percent local sourcing requirement, while good on intentions, holds the potential of creating more problems than intended for foreign retailers.

While it’s important to ensure that multinational retail giants do not view India just as a market to sell their goods in, unrealistic caveats might not promote a gush of foreign investments into the country, which is what the government is aiming for by raising the cap on foreign investments for single-brand retail companies.

Of course, there’s also no denying the fact that several foreign retailers have nasty reputations for destroying local industries in other countries and paying exploitative wages to workers in developing countries so that they themselves earn above-average profits. So, it’s important that at least in India, they should be urged to take a lead role in promoting healthy job creation and manufacturing.

But perhaps there needs to be a more flexible solution to the sourcing issues. A more gradual approach could help. Maybe to start off, companies could start with sourcing 15 percent of their requirement from India, not 30 percent. On its part, the government has said it is flexible to adjusting this clause, according to The Economic Times.

Nevertheless, it remains to be seen whether these local sourcing requirements eventually help or hamper Indian industry.