Indonesia's dynamic consumer base means there are numerous opportunities for investors in the retail sector

Now comprising a mix of old-world markets and modern retail outlets, Indonesia’s retail sector has been swiftly evolving since the late 1990s, when the country’s economic development began to accelerate. Gross national income per capita at current prices grew from $570 1999 to $3440 in 2015, more than a 500% increase over 15-year period, according to World Bank data. Fuelled by this economic explosion, a large domestic consumer base, second to none in South-east Asia, and a burgeoning middle class, the country’s retail sector has emerged over the same time as a force in its own right and as a result has attracted substantial investment from domestic and international sources over the past decade and a half.

Retail sales reached $329bn in 2011 and have continued their upwards trajectory to $335bn by 2013, although they receded slightly in 2014 to $328bn in the face of an economic downturn, according to consultancy PwC’s “2015-16 Outlook for the Retail and Consumer Products Sector in Asia”. A combination of slower GDP growth and lower purchasing power as a result of the ongoing slide of the rupiah have kept retail sales relatively flat throughout 2015 and 2016.

Latent Demand 

These short-term hiccups aside, Indonesia still possesses vast potential with much of its latent retail demand being untapped, particularly outside of primary markets. The country’s large population, coupled with strong projected economic growth and political stability, make the country an attractive target for foreign and local players. Although regional economic growth has slowed in recent years, Asia remains easily the world’s largest retail market, accounting for nearly $7trn in sales in 2014, according to PwC. Over the past two decades China has accounted for much of this total, but with decelerating growth continuing in China, weakness in Japan and mixed signals from India, large players are showing increasing interest in switching their focus to relatively smaller and less saturated Asian markets such as Indonesia which are supported by comparatively strong demographic and income growth. As the sector continues to expand, it is also becoming an increasingly important component of the labour force in Indonesia, which when combined with the restaurant and hotel sector accounted for one-fifth of the employment, or approximately 25m jobs.

This sustained expansion has attracted the attention of foreign investors due largely to the fact that annual growth rates for retail sales in Indonesia have exceeded those of other countries in the region. From 2011 to 2014 retail sales growth averaged 4.9% each year, more than other emerging economies, including India (3.5%), the Philippines (4.3%) and Thailand (0.8%), according to PwC. With total retail sales estimated at nearly $376.9bn in 2015, Indonesia’s market outpaces Malaysia ($106.8bn), the Philippines ($138.8bn), Thailand ($119.8bn), Vietnam ($85.4bn) and even South Korea ($331.3bn).

Changing Dynamics 

As a result of this growing interest from abroad, as well as an increasingly international urban base, the dynamics of the retail market as a whole continue to evolve, as evidenced in the dramatic reshuffling of how consumers purchase goods. Traditional vendors in the form of “mom and pop” shops and wet markets selling all manner of traditional foodstuffs dominated the marketplace until very recently, and it has only been over the past decade or so that modern retail establishments have been making significant inroads in urban areas.

Market Value 

The market size of modern retail outlets consisting of supermarkets and mini-marts surpassed that of traditional venues for the first time in 2015, with the former estimated by research firm Frost & Sullivan at Rp189.5trn ($13.8bn) compared with Rp181.4trn ($13.2bn) for the latter. This marks a trend that started in 2008, when the modern retail market was valued at just Rp70bn ($5.1m) compared to Rp119.7trn ($8.7bn) for the traditional segment. This transition is due almost exclusively to the rise of chain convenience stores, which have expanded from 8.8% of trade in 2008 to 18.6% by 2015, while the share of trade held by traditional markets has declined from 79.8% to 73.8% in the same period.

Caught between a ubiquitous mini-market segment and larger hypermarket retailers, which began arriving in the early 2000s, the supermarket sector continues to be squeezed on both sides. Hypermarkets have yet to make a significant impact on the retail landscape, and while they maintain sustained growth in turnover each year, it is substantially less than the mini-market segment. This is due to a number of factors, including a lack of economically viable space in built-up commercial areas, the prevalence of convenience stores around the country offering goods at comparable prices and consumers’ spending habits, which tend to exclude non-essential items due to a lack of large amounts of discretionary funds.

Government Intervention 

After another slow retail start in 2015, the government responded quickly by rolling out assistance payments for lower-income groups to counteract rising food prices. Under the Bantuan Langsung Tunai (BLT) Fund the state distributed Rp300,000 ($22) per month to eligible families starting in April 2015, with each household receiving two more payments in the ensuing months for a total of Rp900,000 ($66) each. First implemented in 2005 to combat price inflation, particularly rising energy prices, the BLT Fund provides direct cash payments to poor households to supplement consumption in the face of unprecedented price increases.

The programme had an immediate impact on sales in 2015, particularly in the food products sector, as purchases spiked in the second quarter and continued growing into the third quarter. The sector’s strong performance then carried on through the end of 2015, even with government spending slackening, as a stronger rupiah and dropping energy prices boosted consumer confidence. In 2015 Bank Indonesia’s (BI) Real Sales Index (RSI) increased from 172.6 in January to 197.3 in December with a holiday-influenced spike of 204.2 in July. However, this confidence levelled off in early 2016, with the RSI only exceeding its year-end level in April, when it hit 198.1.

Counter to efforts to stimulate demand through cash injections, the government has also implemented measures which some observers believe are having a chilling effect on the sector. As retail sales remained flat through the end of 2015 and early 2016, in spite of favourable economic indicators, some of this stagnation has been partly attributed to more aggressive tax collection as the state looked to hit its tax revenue target of Rp1294trn ($94.5bn) for 2015. Yongky Susilo, executive-director of retailer measurement services at Nielsen Indonesia, told OBG, “People began carrying out fewer transactions and holding off on purchases for fear of being monitored, and this in turn created distribution problems in the supply chain as wholesalers limited the stock available in order to avoid suspicion.”

Reprieve 

Another related issue that could have a significant but positive impact is the 2016 government decision to grant a period of tax amnesty for undeclared funds, including income tax, value-added tax and luxury goods tax. It is being offered in three stages: July 1 to September 30, 2016; October 1 to December 31, 2016; and January 1 to March 31, 2017. The law offers special tax rates from 2-10%, depending on how quickly an individual declares their assets and whether the assets are repatriated to Indonesia. Offshore assets that are repatriated to the country during the first phase will enjoy a 2% tax rate. The rate will subsequently be increased to 3% for those who repatriate assets between October 1 and December 31 of 2016, and to 5% by March 31, 2017.

Those declaring offshore assets but not repatriating them will face a tax of 4% in the first phase, increasing to 6% and then 10% thereafter, although a lower rate is applicable for small and medium-sized enterprises (SMEs). Taxpayers who choose to repatriate their assets to Indonesia are also required to put their funds in several designated investment instruments, such as government bonds, corporate bonds of state-owned enterprises and other government-approved instruments, provided the parties retain these investments in Indonesia for at least three years. BI estimates inflows into the country at Rp560trn ($40.9bn), as a similar programme in 2008 helped increase tax revenue by about a third to Rp566trn ($41.3bn), according to the bank.

In addition, in May 2016 President Joko Widodo signed a decree allowing foreign investors to own up to a 67% stake in department stores with a sales floor area of 400-2000 sq metres, provided that the properties are located in a mall. Previously, foreigners could only invest in a department store with a sales floor larger than 2000 sq metres.

Teetotaling 

Following the conclusion of presidential elections in 2014 and as politicians sought to shore up support across the spectrum of Indonesian society, a social policy measure was introduced by the Ministry of Trade that has had a significant impact across the mini-market segment. The banning of alcohol sales by smaller vendors – which essentially means the entire mini-market and kiosk segment, which dominates the retail sector – has sent ripples through the industry and left conveniences stores scrambling to recalibrate to the new environment. The move has had an effect on the bottom line across the industry, and not just for beer sales alone, but the accompanying purchases which are generally paired with beer sales, such as snacks and other non-alcoholic beverages. Taken as a whole, these transactions accounted for between 20% and 40% of total sales, depending on the specific store.

Online Purchases 

Easily the fastest-growing retail segment in the country, online shopping is rapidly gaining popularity, primarily among the middle and upper classes. “The size of the e-commerce market in Indonesia is currently estimated at 1% of total retail. This percentage is expected to grow to 5-6% by 2020,” Kusumo Martanto, president director of Blibli. com, told OBG. Although starting from a small base, online purchases represent strong growth opportunities for the future as the usage of smartphones continues to climb. According to PwC, nearly 90% of city-dwelling Indonesians owned smartphones in 2015, compared to 20% in 2012, prompting retailers to utilise social network sites to promote products and tap into prolific social networks. Sales remain narrow in focus with fashion, travel and novel gadgetry products generating the most interest, as consumers have largely stuck to brick-and-mortar stores for groceries and fast-moving consumer goods.

However, in spite of this vast potential for delivered goods, uptake remains hampered by a number of issues such as cultural attitudes, poor transport infrastructure and inefficient payment methods. As a result, Indonesian firm DataStatistik estimates that e-commerce transactions accounted for only $1bn-2bn in 2013, out of a total retail sales pool of approximately $330bn. Carmelito Regalado, director and deputy CEO of retailer Matahari Putra Prima, told OBG, “Going to malls and shopping centres is a very important recreational and social activity. This is something that will not be replaced by e-commerce.”

However, e-commerce did receive a fresh jolt of optimism in 2016 when it was included in President Widodo’s “Big Bang” plan to loosen restrictions on foreign investment in nearly 50 sectors in a bid to encourage competition. New regulations were issued in May 2016 that removed e-commerce from the negative investment list, resulting in a partial opening of the sector and allowing foreign investors to own up to 49% of e-commerce businesses.

On Location 

While Indonesia’s large population undoubtedly creates an enticing market for retailers, it is well dispersed over large geographic distances, which poses significant challenges for vendors looking to create integrated, nationwide networks. What works in Jakarta in terms of products and promotion, for instance, does not necessarily translate to second-tier markets or in rural areas for both cultural and economic reasons. Susilo told OBG, “With Java, Sumatra and Kalimantan all different from each other, you have to be mindful of the multidimensional aspects of the population.”

The retail sector also has notable demographic splits depending on primary income generators for each region. Areas such as Java – which have been significantly negatively affected by declining demand for the resource exports produced there such as palm oil, coal and precious metals – have seen their spending power decline in recent years. By contrast, business remains brisk in eastern Indonesia, including Sulawesi where the economy relies more on cash crops like coffee, spices and other commodities which have remained strong. Compounding all these factors are the logistical challenges faced by retailers in extending supply chains across the country due to insufficient transportation infrastructure. As a result, retail markets outside of a few primary urban centres remain highly fragmented. For example, in the grocery sector the five largest firms have a combined market share of just 3.8%, according to PwC. Outside urban areas, informal retailing in the form of independent grocers and wet markets dominates. As a result, the proliferation of modern malls and shopping centres are largely limited to Jakarta and the surrounding areas, while other major cities have experienced an influx of trade centres offering discounted prices in order to undercut normal malls.

Franchising 

Indonesia’s long history of protectionist policies has often proved challenging for large international chains. In the retail sector there have historically been limits on foreign ownership in various segments, particularly those related to SMEs. In terms of franchising for smaller businesses such as mini-markets, convenience stores and quick-service restaurants, some of these regulations are set up to prevent the dominance of only a few large players, ostensibly protecting smaller local shops and chains and fostering a level playing field. These measures include a cap on the number of outlets a single company can own at 250 locations.

In practice, however, the law allows for breaking up of ownership among several holding companies all complying with the letter of the law. And some of the largest convenience store franchise owners, such as Indoritel, which owns well over the maximum 250 outlets, were grandfathered in when the law was passed as it and other leading companies already exceeded the limit of locations. From 2010 to 2015, Indoritel further increased the number of Indomaret branches from 1897 to 3889, achieving a compound annual growth rate of 15.4% over the six-year period.

Along with expansion into suburban and rural areas, the format of fast-food outlets is also evolving. Some brands are looking to expand their reach into the much geographically larger secondary markets by adding a greater number of smaller locations. Indoritel, for instance, is seeking to add potentially hundreds of new locations across the country by developing smaller, less expensive kiosks at a reduced franchising fee compared to the full-kitchen outlets present in more populated urban environments.

Alex Wreksoremboko, independent director of Indoritel, which owns stakes in Indonesian franchises of KFC and Indomaret, told OBG, “The market is already there. There are local knock-offs operating in secondary markets offering lower-quality products at lower prices. When per capita income increases, these people will gravitate towards established aspirational brands such as KFC, which will act as a substitute or replacement for the existing market.”

Climbing The Ladder 

The cumulative effects of Indonesia’s economic growth on the retail sector, along with its regulatory policies, have been viewed overall as largely positive in recent years, particularly in relation to other comparable developing economies. According to AT Kearney’s annual Global Retail Development Index, Indonesia has sprinted up the rankings since 2013 to reach fifth out of the 30 different economies included in the index in 2016. The index ranks the top-30 developing countries for retail investment based on relevant macroeconomic and retail-specific variables, deriving a ranking based on the amalgamation of four equally weighted categories of market size, country risk, market saturation and time pressure (measuring the speed at which the retail market is maturing). This score is then compared to other countries within the index to determine the optimum window to invest in organised retail within the respective countries. Indonesia’s ranking in 2016 is the highest yet achieved by the country, placing it behind only market leader China (led by its perfect 100 score in the market size category) along with India, Malaysia and Kazakhstan. This marked a considerable jump from its 2015 ranking of 12th and the middling 2014 ranking of 15th.

Outlook 

Indonesia’s huge domestic population, growing and young middle class, and increasing urbanisation create ample untapped potential for the country’s retail market going forward in spite of the current relatively low level of retail spending per capita. In the short term high levels of poverty and more constricted monetary policy will likely constrain retail growth, although the favourable youthful demographic profile of the population and recent overtures at liberalising the sector bode well for the future. As this market opens up further to foreign investment there will be significant expansion across a wide range of modern outlets led by continued robust growth of convenience stores, as well as larger big box retailers which will continue to displace traditional retail options. As this trend continues going forward, the highly fragmented supply chains which are a by-product of traditional and informal retailing will also become more efficient; a cost-reducing trend that will be further bolstered by the massive infrastructure investments now in the works. Improved transportation infrastructure will also benefit the fledgling e-commerce segment which is poised for a breakout, albeit from admittedly a low level currently.

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The Report: Indonesia 2017

Retail & E-Commerce chapter from The Report: Indonesia 2017

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