their view - When potatoes are on fire - B Y A SHOK G ULATI & S UNIPA D AS G UPTA ···························

In the week ending 5 December, food price inflation, measured in terms of wholesale prices, has surged to almost 20% higher than the
corresponding week a year ago. Cereal prices are up by 14%, pulses and vegetables by 41%. Usually, when prices of cereals and pulses
shoot up, households fall back on potatoes as the last resort. But this time, even potato prices have skyrocketed by an
unprecedented 136%. Call it potatoes on fire! But why have potato prices suddenly shot through the roof?
There seem two plausible reasons for this.

The first explanation lies in supply shocks. Much of the potato crop is harvested during the January-March quarter of the year in
most parts of the country and stored in at least 5,000 cold storages (which help smoothen supplies throughout the year). In the
2007-08 crop year, India harvested a bumper crop of 30.5 million tonnes (mt) of potatoes.
Large stocks were put in the cold storages, which then had to be emptied by November-December 2008 to accommodate the new crop
arrivals. So in late November-early December 2008, potato prices were exceptionally low. But in the 2008-09 crop year, potato
production dropped to 26 mt due to a late blight infestation in March--leading to large crop loss in West Bengal, the second largest
potato producing state. This led to smaller stocks in cold storages that, by November-December of this year, seem to have almost
depleted while new crop arrivals are yet to pick up any momentum. No wonder, then, that there is a lot of pressure on potato prices
--compared with the low base price in December 2008, the price rise this month seems especially exorbitant. This pressure, however,
is likely to ease in a month or so as new crop arrivals increase.
The indication so far is that the new crop is likely to be better than last year, though still below the 2007-08 level.

However, the production shock in itself cannot fully explain potato price inflation. Roughly twothirds of the potato price formation
takes place after the harvest--and that's where the second explanation lies. The postharvest value chain is fragmented with many
middlemen. Such a marketing chain enables intermediaries to exploit production-induced scarcity. Farmers do not receive very high
prices, while consumers pay through their nose.

During the last two weeks of December, potato farmers in north India have sold their early produce at Rs6-7 per kg on average; while
potato prices paid by Delhi consumers to retail vendors varied from Rs15-20 per kg. This happens because intermediaries in the value
chain operate with high margins. For example, the potato wholesale markets are characterized by high rates of commissions determined
by the Agricultural Produce Marketing Committee. These vary across states: In Punjab this is 4%, in Delhi 6%. Though these are the
officially notified rates, they move upwards frequently during produce auctions. In some parts of north-east India, these rates are
found to be even as high as 12%.

A forthcoming study by the International Food Policy Research Institute (IFPRI) in Uttar Pradesh, the largest producer of potatoes,
across 45 commission agents and wholesale traders and 31 cold storages has come up with interesting insights. The study shows that
commission agents at the Agra mandi operate with 4-5% margins, while wholesale traders' margins hover around 30%. Add to that
transport costs and the margins of retail vendors, which typically range between 20% and 40% in Delhi, and you get the price of
potato going up from Rs5 per kg at the farm to at least Rs15 per kg at the retail end in Delhi.

In another 2009 IFPRI study of urban retail in Delhi, it was found that potato prices charged by organized retailers such as Safal
or Reliance Fresh are lower than the prices charged by most push-cart vendors.

All this begs the question: What is the way to douse the fires of potato prices?
The general expectation is that with larger arrivals of the new crop, prices will automatically come down. But with that, the price
for the farmer, too, will go below Rs5 per kg, which is not very attractive to raise production or undertake any investments on the
farm. So, if we want that the farmer gets, say, Rs6-7 per kg, and the consumer pays within Rs10 per kg, we will have to reform the
potato market.

This can be done by encouraging direct buying of major retailers from farmer groups; providing incentives for the formation of
farmer commodity groups, so they can bargain better with organized retailers; providing incentives for farmer groups to sort, grade
and even package their produce in rural areas in line with the needs of organized retailers; giving incentives for investments in
cold storages in the major potato growing rural areas; and compressing value chains. This alone can ensure that the system operates
with low margins and high volumes, and producers and consumers both gain from this system, while making the value chains much more
efficient.
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India's Premiere Warehouse & Logistics

Can India's Logistics Industry Deliver a Better Model for Transporting Goods?

Published: September 10, 2009 in India Knowledge@Wharton

In October, G.R. Gopinath, who revolutionized air travel in India by starting Air Deccan, the country's first low-cost airline, will take to the skies once more. This time around, though, he'll be transporting cargo, not passengers. With his new express transportation and logistics venture, Deccan 360, Gopinath is looking to redefine the industry.

"Deccan 360 will change the way deliveries are made all over India," Gopinath says. "At present, next-day connectivity is limited to the metros and a few cities. My goal is to connect 75 cities in India to each other on a 24-hour delivery schedule within the next year." If he delivers on his promise, Gopinath could well change how companies big and small look at their supply chains and run their businesses. He began air cargo operations from India to the Middle East and Southeast Asia a few months ago and plans to integrate domestic and international operations over time.

When Gopinath launched Air Deccan in 2003, only 1% of Indians traveled by air. By the time he sold his venture to industrialist Vijay Mallya in 2007, the figure had jumped to 5%. Why is Gopinath, a former army pilot and farmer, venturing into the logistics space now? "Many entrepreneurial decisions are taken at a subterranean level," he says. "The idea of starting a logistics business was both instinctive as well as fueled by my own frustrations."

Gopinath notes that many times in Air Deccan's early days, a flight cancellation could be attributed to the lack of adequate logistics services in India. A spare part would come from somewhere in the world to Mumbai within 24 hours, but then, within India, several days would be needed to complete the journey. More often than not, Gopinath wouldn't know how long it would take for the part to arrive. Once it took seven days to move a spare engine from New Delhi to Kolkata; it was cheaper to transport it via Singapore.

Gopinath's experience largely sums up the state of the logistics industry in India: inefficient and expensive. Industry players and analysts say logistics costs in India are among the world's highest -- accounting for 13% of GDP, according to a report by KPMG. That is far greater than in the United States (estimated at 9%), Europe (10%) and Japan (11%). Outside of the metros and a few cities, the timing of deliveries is uncertain.

Big Hurdles

Logistics is still a nascent and fragmented industry in India. It is estimated that while outsourced logistics accounts for 54% of total logistics spending in India, organized players have only 10% of the pie. In road transportation, which accounts for the biggest portion (36%) of logistics spending, 74% of operators are small-time players owning a single vehicle. In outsourced warehousing, 92% of players are from the unorganized sector. Even among the organized logistics players, few have offerings across multiple modes (air, water, rail and road) and services (transportation, warehousing and value-added services such as packaging, cold chain and customs clearance).

A lack of adequate infrastructure and complex taxation and regulations are big hurdles. For example, most domestic airports don't have adequate cargo terminal facilities. Blue Dart, the leading express logistics player in India, set up in 1983 and now owned by the global player DHL, started cargo airline operations in 1996. In most airports, Blue Dart operates from the same amount of space first given to it by airport authorities. "In this business, turnaround time is critical," notes Anil Khanna, managing director of Blue Dart Express. "If one does not have the right facilities in terms of size and site within an airport, it is a huge challenge." Blue Dart is the only logistics player in India with dedicated cargo aircraft (just seven). Other logistics companies typically turn to the belly space in passenger airlines, something even Blue Dart does occasionally, depending on the load.

Moving cargo by road has its own set of problems. National highways form only 2% of India's road network, but they handle more than 40% of road freight traffic. This naturally leads to traffic jams. Regulatory requirements and cumbersome documentation also compromise speed. "On average, a commercial vehicle in India runs at a speed of 20 miles per hour. In Western Europe and the USA, the average speed is over 60 miles per hour," notes Vineet Kanaujia, general manager at Safexpress, which has a fleet of 3,500 vehicles.

Moreover, India's tax system is complex. To avoid multiple taxation, companies typically have warehousing operations in every state. The result is a large number of small warehouses across the country that lack the latest warehousing processes and technologies and don't offer economies of scale.

According to Narayanan Ramaswamy, executive director at KPMG Advisory Services who follows the industry closely, "Infrastructure constraints and a piecemeal approach have resulted in non-conducive policies and avoidable hurdles. What the country needs is integrated logistics planning." N. Viswanadham, executive director at the Center for Global Logistics and Manufacturing Strategies at the Indian School of Business in Hyderabad, adds: "The planning problem with Indian logistics is the lack of [an] 'ecosystem' outlook in building facilities, attracting investments and building up stakeholder groups."

Betting on Hub-and-spoke

Yet not all is gloom and doom. Despite the limitations, industry players see strong potential. Several initiatives and projects are under way to boost development of roads (including the Golden Quadrilateral, North-South and East-West Corridors), ports (Pipavav, Mundra and Dhamra), and airports (Bangalore, Hyderabad, New Delhi and Mumbai). The complex central sales tax is expected to be phased out in coming years. The emergence of India as a manufacturing hub, growth of the organized retail industry, increased domestic consumption, and multinationals bringing in global best practices are all expected to boost the logistics industry.

"The logistics industry in India is transforming from a conventional storage-transportation concept [to] being perceived as a better way of managing the supply chain and a strategic tool for growth and competitiveness," says Anurag Mathur, managing director of real estate services firm Cushman & Wakefield India. "This presents strong opportunities for logistics players."

Gopinath, for one, is betting big. He is creating India's first hub-and-spoke distribution model for express logistics. A 100-acre state-of-the-art cargo handling facility in Nagpur in central India will serve as the hub for his operations and will connect the metros as well as tier two and tier three cities through an air and surface network. Deccan 360 will begin operations in October with three Airbus aircraft and a network of 30 franchisees (for surface transport, warehouses and collection points). At first, Deccan 360 will offer next-day connectivity to 30 cities in India. Within a year, Gopinath plans to increase the air fleet to five Airbuses and four aircraft from French-Italian manufacturer ATR, ramp up the franchisee network and offer next-day connectivity across 75 cities.

Will this connectivity carry a huge price tag? No, Gopinath says. "No logistics player in India has the hub-and-spoke model that we are setting up. Like in the case of Air Deccan, I am establishing a different model ... that will both increase the reach and bring down the cost for the customer."

It may not be all that simple. The hub-and-spoke model, though new for India, was introduced years ago by the global major FedEx. It is a tried-and-tested model the world over. Yet in India, Blue Dart, which holds 43% of the air express market, does not follow this model. Instead, it flies three different routes: crescent (Chennai to Kolkata via Bangalore, Mumbai and Delhi), zigzag (Hyderabad to Mumbai via Ahmedabad) and direct (Bangalore to Delhi).

Blue Dart studied the hub-and-spoke model closely before starting operations. It even had a sales alliance with FedEx at the time. Despite the close association, Blue Dart chose a different model. According to Blue Dart's Khanna, "We found that that this model works well when you have a large fleet of aircraft. If you have only a few aircraft, you end up losing capacities. We restudied this model once again a few years ago, and again found it to be unfeasible."

Others who tried running cargo airlines gave up. Gati, a multimodal player with more than 4,000 vehicles and six marine vessels, is among them. Mahendra Agarwal, managing director and CEO, attributes the decision to "commercial bottlenecks." Gati, he says, initially wanted to have its own cargo aircraft. However, faced with regulatory issues and a lack of expertise in running cargo aircraft, it chose to outsource two freighters from Air India. "We had a successful operation of these two freighters regularly on the Chennai-Delhi route," he says. "While operating [them], we realized certain commercial bottlenecks and therefore decided to close the operation for the time being."

For now, Agarwal has other priorities. He is expanding his range of value-added services, focusing on small and mid-size enterprises and key retail markets, creating deeper inroads into city and tertiary distribution, and developing industry-specific expertise.

Competing Approaches

Others have made their own moves. In 2007, Blue Dart earmarked a five-year investment of US$250 million for aircraft acquisition and strengthening its air and ground infrastructure. Last year, to mark the company's 25^th anniversary, Khanna announced 25 initiatives to upgrade the product range and improve quality.

At TNT India, managing director Abhik Mitra is working toward expanding the reach and strengthening TNT's network in tier two and tier three cities. "We also want to invest in the infrastructure in our hubs and depots and take them to the next level of efficiency," he says. TNT was the first multinational express distribution company to enter the Indian market with a direct subsidiary. TNT came to India in 1994 for international operations. Over time, it realized that the domestic market was a much bigger part of the pie. In 2004, TNT made its domestic foray, and in 2006 it went a step further, acquiring road express firm Speedage Express.

Safexpress, meanwhile, has zeroed in on warehousing. The company has more than 5 million square feet of warehousing space across the country and is planning to set up 32 state-of-the-art logistics parks and add another 5 million square feet in the next two years. Five of these parks are already operating. Says Kanaujia of Safexpress: "With the phasing out of the central sales tax, we expect to see a huge demand for world-class warehousing in the country."

Redington, a leading distributor of IT products, is also eyeing the logistics space and is setting up a state-of-the-art automated distribution center in Chennai. Spread over 11.6 acres with the latest very-narrow-aisle technology, it is one of the most advanced distribution centers in India. Managing director R. Srinivasan plans to set up similar distribution centers in New Delhi, Kolkata and Mumbai and a network of slightly smaller distribution centers across 10 other cities in India. Srinivasan plans to first approach his own vendors for business. Over the next 12 months, he aims to spin this off as a separate and neutral logistics company and secure other IT distributors as customers. But Srinivasan's ambition is not limited to IT distribution and warehousing. Redington buys products from vendors and sells to a vast network of channel partners. Srinivasan wants to leverage this expertise and become a third-party logistics service provider across industries.

Analysts say industry players' attempts to expand their reach, offer industry-specific solutions and work toward more integrated operations are moves in the right direction. Meanwhile, what role Gopinath plays in transforming Indian logistics remains to be seen, but his entry into the segment will no doubt accelerate the pace.

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