To serve or not to serve, to stock or not to stock – by Supply Chain Detective

If you asked any CEO, Sales Executive or Marketing head what is the customer service level they desire in the organization they’d invariably say 100%. And hearing that answer the Supply Chain VP will invariably shake their heads and flee the room before you could ask them the same question.

But why, you might ask, such an expectation is unreasonable for any organization in any industry? Intuitively, it seems alright to want to sell to anyone who is willing to pay you in crispy greens. In fact, primary purpose of existence of organization is shareholder value creation? Which in simple words mean that organizations solely exist to earn profit by selling their stuff.

Before we delve deep – keep this thought at the back of your mind –

Organizations aim to maximize their profit

Let us try to understand this problem and define our problem statements more clearly.

1.Why it is unreasonable to have customer service level at 100%? And if it is, indeed, unreasonable then,

2.What is the optimum service level?

Qualitative Approach

Let us suppose you are the store manager in the said organization that sells consumer goods. You are responsible for managing stock on the shelves and ordering them before they go out of stock. Customer Service Level is your primary KPI and it is defined as percentage of times customer gets on the shelf whatever he is looking for.

Let us also imagine that one fine morning you get a memo from the CEO, the Sales VP and the marketing head (who must truly hate the supply chain guy) have decided to set this Customer Service Level as 100% as the new target.

Just yesterday you had to turn a guy back who wanted to buy five dozen television sets. With this new policy you’d have to stock everything that the next customer might need.

Oh heck, you realize that you need to stock your party supplies section for the next customer who accidentally invited 21,000 guests on her birthday. Even though the probability of this happening is very small, it is not zero. And the customer service target of 100% nudges you to be stocked for this small probability. Even if this means tons of overstocking and surely lot of wastage later, you have to be ready for all the extreme cases of demand.

You let out a muffled scream and consider quitting your job before sending a polite reply to your boss asking for permission to stock infinite inventory.

Quantitative Approach

We now intuitively understand why the customer service level can not be 100%. It would mean keeping infinite inventory for any possible customer demand that may or may not come. Keeping high inventory is almost sure to lead to excess inventory and write-offs ultimately making it a loss making proposition. But how much then should we “serve” before it starts becoming a loss making proposition.

Let us first take an example to understand the underlying logic before we go on to make complex models.

Imagine that you are that poor store manager responsible for customer service as well as inventory cost. The product that you sell costs $8 and you sell it at $20 for a net profit of $12. However, if you are unable to sell it, you’d incur a loss of $8 that was product cost.

The trade-off here is the profit that you’d earn if the customer walks in and you have it in your inventory


The loss that you’d incur if you stock and he doesn’t turn up.

So, should you buy the next unit  of inventory (it is very important to note that we are only talking about a single incremental unit) if there is only 25% chance that you’ll be able to sell it? What if this probability is 50%? 75%?

If the probability is 100%, that is you are sure to sell that next unit (I repeat, only one incremental unit) of product, then it’s a no-brainer that you’d want to stock it for a sure-shot profit of $12.

Now let’s take the next case where there is only 25% chance that you’ll sell it and make a profit of $12 but there is 75% chance that you won’t be able to sell it thereby incurring a loss of $8.

Your expected payoff from this extra inventory is = (25% x $12) + (75% x – $8)

= – $3

Since your expected payoff is negative when the probability is 25% , you’d not want to store this next unit of stock.

Similarly, the payoffs at 50% selling probability (Let’s call it P50 ) is  +$2 and at P75 is +$7

Let us summarize these results:

P25 = – $3

P50 = +$2

P75 = +$7

So, somewhere between 25% and 50% selling probability, keeping that extra unit in inventory became a profit making proposition. With little bit of maths we can find that probability is 40%

So, as long as probability of selling the next unit exceeds 40%, you’ll keep stocking the inventory.

40% looks like a pretty high number. In real life, you’ll find that organizations are willing to stock that extra unit, for far lower selling probabilities. There is a logical quantifiable reason behind this behavior even though a vast majority don’t know about it. The reason is that profit on immediate sale ($12 in our case) is not the only gain you make from that customer. When a customer walks-in into your store and finds what he/she is looking for, he will continue coming to your store and give you all that future business. This value of all future goods that the customer would buy is called Customer Lifetime Value.

Continuing with the previous example, suppose Customer Lifetime Value at the above store is $100. i.e. if the customer keeps on coming to your store then you stand to profit $100 from that customer. However, if he doesn’t find the product he is looking for, he’ll take this business to your competitors. What is that selling probability at which you’ll keep that unit of inventory? Let’s call it S:

PS = (S x $100) + ((1-S) x -$8)

At the cut-off probability, payoff would be zero.

0 = 108S -100

S = 7%!

Surprising. 93% of the times you are not expecting to sell that one unit and yet you’ll keep it in store because in long run that one customer is going to pay-off by becoming your loyal customer.

So, in a nutshell, keeping extra inventory is determined by probability of us selling it for acquiring a customer lifetime value vs having to write-off the extra inventory.

Some of you might be wondering why we did this analysis for only one unit (and kept on harping upon the point repeatedly). This is because the probability of selling keeps on changing as you add more stock. The probability of selling the 1st unit is very different from probability of selling nth unit.

I’ll be bet my arm that a liquor store in the middle of alcoholic town will sell its first bottle during the first hour of the day. 50th bottle – maybe. 1000th bottle – all bets are off (because I love my arm way too much).

So, coming back to the original point, how do we do this analysis for all of stock and not just one unit? It is the next level of analysis of service level that deserves its own article. Keep tuned in – it’ll be releasing soon.


Calculating Distributor or Dealer ROI

This is a post that is written on and the link to the original article is here. I just cannot emphasize enough about how well this article has been written and hence I’ve included even some of the comments. Thanks to gyaanokplease for this post.

So probably the first thing that your distributor/dealer/stockist is going to tell you when you go to him for the first time is “Sirjee, ROI nahin baith raha hai”. What this simply means is that he is challenging you to calculate his return on investment.

This is sort of a monthly exercise – he knows that he is getting an ROI, else he would not be in the business. What he simply needs is some ego massage so that he gets an ILLUSION that he is in control of something when he is not – your rates are fixed, your schemes are fixed, and so are your claims. While ROI is something that they teach us in first day of B-School, calculating dealer ROI might be a different ball game altogether as he is a weasel who is going to try different permutations and combinations to get the better of you. Do this properly with him, and he (and you BDE/TSO who is twice your age but earns half as much) will respect you forever.

The equation is simple – Return/Investment, Return = (Earnings – Expenses).

The trick lies in realizing what earnings, expenses and investment involve & it is here where the dealer uses his tricks.

Let’s put down the formulae first:

  1. RoI or Return on Investment = Returns/ Net Investment
  1. Returns = Earnings – Expenses
  1. Earnings = Gross Margin that the dealer enjoys (Usually 6% – 8% in FMCG companies)
  1. Expenses = Direct Expenses + Indirect Expenses
  1. Here is where the first trick lies, Calculating Expenses:

This arises from the fact that the dealer in question is not dealing with just 1 company, he instead has 4-5 or even more number of companies that he is dealing with. Hence there are some resources that he is exclusively using for a particular company for eg. Sales Man and similarly many resources that he is sharing among the companies eg. His godown space, accountant, supply units etc.

Please note there is no thumb rule to it as there might be (and more often than not, will be) cases where even salesmen are being shared among 2 or more companies, and there will be one guy who would be the accountant-cum-manager-cum-supply wala etc. This is where the concept of direct and indirect expenses comes in.

Hence his expenses are split in to 2 parts i.e. Direct & Indirect Expenses

Direct Expenses are those that the dealer incurs exclusively for the company concerned.

And Indirect Expenses are those that the dealer incurs in totality for the companies for whom the resource/s is/are being shared.

The only rule in calculating expenses is that you need to take into account the part of expenses that he is incurring for your company alone. We will see how we do it below.

  1. Similarly the second trick lies in properly calculating the denominator, i.e Net Investment.

A dealer’s investment comprises of 3 parts : Average Stock that lies in his godown, Average Market Credit that he extends & Average Claims Outstanding,


Investment = Avg Closing Stock + Avg Market Credit + Avg. Claims Outstanding

Here the usual suspect where one may go wrong in calculating Investment is the first variable i.e. Average Closing Stock of the dealer.

A layman would take the month-end closing stock as the average closing stock for the dealer, or worse if you do the mistake of asking the dealer what his closing stock is, the beast would tell you a figure which will be his all time high closing stock in a month.

The typical trend in FMCG is that majority of Pushing, also known colloquially as “thokna” (Primary) and Pulling (Secondary) happens in the last week and therefore the last week is not a true indicator of the entire month’s activity then why consider last week’s closing stock as his month’s closing stock. (To clarify, primary is what your company bills to the dealer and secondary is what your dealer bills to the retailer)

Confused?, we will deal with it with simplicity. Consider this as the trend of Primary & Secondary for a dealer in a 4-week cycle of a month

    1 5, 00,000 50,000 1,00,000 4,50,000
    2 4,50,000 1,00,000 2,00,000 3,50,000
    3 3,50,000 2,50,000 2,50,000 3,50,000
    4 3,50,000 5,50,000 4,00,000 5,00,000

The above table is how a dealer’s inventory in a typical FMCG set-up would behave like, i.e. majority of activity happening in the last week and hence one would be wrong in taking 5,00,000 (Week-4 Closing Stock) as the average closing stock for that dealer in that month.

The better way to do it is to take an average of all 4 weeks’ closing stocks. In this case it would come out to be as : ( 4,50,000 + 3,50,000 + 3,50,000 + 5,00,000) / 4 which equals to 4,12,500 which is lesser than the previous  result and hence his investment goes down and RoI goes up.

Enough of this gyaan now, let us get straight down to calculating a sample ROI


Mr. Atul Mittal is the proud owner of his distribution firm M/S Bhagat Ram Jwala Prasad. His firm deals with distributing 4 companies in total of which ABC Pvt. Ltd. Is one for which we need to calculate the RoI. The firm has 1 dedicated (exclusive) salesmen working for ABC Pvt. LTd. with a monthly salary of INR 6,000/- per month per salesman. Apart from this, the firm also has an accountant-cum-manager with a monthly salary of INR 5,000/- per month, pays a monthly rent for the godown which comes to INR 5,000/- per month, incurs electricity & miscellaneous costs (supply units, chai-paani etc.) to the tune of INR 5,000/- per month. Other expenses such as his son’s education and his daughters marriage which your dealer would want to include are not to be included.

All figures are assumptions

Monthly Business (Turnover) inclusive of all 4 companies: 20,00,000/-;

Monthly Business (Turnover) of ABC Pvt. Ltd. : 8,00,000/-

ABC Pvt. Ltd.’s Company Margin: 8%

Average Market Credit for ABC Pvt Ltd. Is 10,000/- INR

Average Closing Stock for ABC Pvt. Ltd is worth 2,50,000/- INR

Average Claims Outstanding in ABC Pvt. Ltd. Is worth 10,000/- INR.

Hence going by the formula:

RoI or Return on Investment = Returns/ Net Investment

Returns = Earnings – Expenses

Earnings = Gross Margin that the dealer enjoys (Usually 6% – 8% in FMCG companies)

Expenses = Direct Expenses + Indirect Expenses

Let’s calculate each element one by one:

Earnings = Gross Margin = 8% of monthly turnover of ABC Pvt. Ltd. which is = 64,000/-

Expenses = Direct Expenses + Indirect Expenses

Direct Expenses = Salary of Exclusive Salesmen = 1*6000 = 6000 per month

Indirect Expenses  for ABC Pvt. Ltd.=( Contribution of ABC Pvt. Ltd’s Turnover to Total Turnover) * Total Indirect Expenses

Total Indirect Expenses = Godown Rent + Manager’s Salary + Miscellaneous Expenses = 5,000 + 5,000 + 5,000 = 15,000/-

Contribution of ABC Pvt. Ltd’s Turnover to Total Turnover = 8,00,000/20,00,000=40%

Hence, Indirect Expenses for ABC Pvt. Ltd. = 40% of 15,000/- = 6,000/-

Therefore Total Expenses = 6,000 + 6,000 = 12,000

Hence Returns = Earnings – Expenses = 64,000 – 12,000 = 52,000

Net Investment = Avg. Closing Stock + Avg. Market Credit + Avg. Claims Outstanding = 2,50,000 + 10,000 + 10,000 = 2,70,000

Therefore RoI = Returns/Net Investment = 52,000/2,70,000  = .1925 or 19.25%

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    1. AnupriyaJune 14, 2012 at 8:50 PMReply
    2. Just a point here….when you look at his investment in stock – one should always check whether he has taken bank loan. if he has then his actual capital investment is actually only to the extent of his own money. rest is interest which is part of expenses. a lot of dsitributors conveniently miss out this part of the equation. and for big distributors this makes a big difference in ROI.Similarly, if the distributor has a good overdraft facility then he actually pays for the stocks to the company from that and not his actual investment. here again interest should be added into his expenses and the investment reduced by the overdraft amount.



    1. KaushikJune 14, 2012 at 8:53 PMReply
    2. Thanks Anupriya! Duly noted 🙂
    3. KiranJune 14, 2012 at 11:19 PMReply
    4. Alternatively, if a distributor rotates his investment say, 10 times a year, multiply that by net profit percentage per rotation.
      For eg:The company gives a margin of 5% on its products to a distributor. After all his distribution expenses, the net profit % is 2.1, and his investment is 20L with an annual turnover of 200L, ROI is easily calculated as under.
      No:of rotations = annual turnover/investment = 200/20 = 10 rotations/year
      Investment = 20 Lakhs
      This means he rotates his investment of 20lakhs, 10 times a year, each time making say 2.1%. So his ROI is 10*2.1 = 21%
    5. KaushikJune 14, 2012 at 11:33 PMReply
    6. Thanks Kiran! Duly noted. Please feel free to contribute in the further posts also!
    7. Sambhav JainJune 14, 2012 at 11:48 PMReply
    8. Very Well Explained.!Thanks
    9. Ashish ShahJune 15, 2012 at 12:05 AMReply
    10. Very helpful. A much needed initiative. Thanks Kaushik! 🙂
    11. Tirthadeep DharJune 15, 2012 at 7:02 AMReply
    12. Brilliantly explained – Subbu and Nishit! I remember looking for somebody or something to teach me this, about a year back. That my dist. ridiculed me abt not knowing my ROI calculation was the ‘push comes to shove’ part.However, lets not forget a very important parameter of credit given by the company to the distributor which can range from 0 to anything.So if Credit = 7 days, 7 days of closing stock is deducted from the distributor’s investment. Also a distributor gives a cash discount to wholesale or even retail, so that too has to be accounted for. I would urge you to simplify this and put it up as ur article is crisp and clear and this could prove useful too.


      1) Teach them how to calculate a Super Stockist ROI as well. Far simpler than direct.

      2) Also, in your next article you could explain how to get back an uninterested distributor on track based on key parameters. (Kaushik you had aced that, Nishit you could share too… btw sup with you?)

      3)All distributors are swines with hair coming out of all their holes.. jusayin….they might not squeal but they do grunt a lot. Somebody has got to tell these kids that… Nishit you could elaborate I guess (this inference from ur fb statuses)

      And excellent explanation Kiran… was thinking abt that while reading the article.


    13. Capt.KrunchJune 15, 2012 at 8:52 AMReply
    14. hey TiTo,hw u doing man….points noted dude….the upcoming posts will only highlight the point number 3 that u ve mentioned.

      may be we could come up with a post about how to tinker RoI to get back distributor’s interest provided he is sitting on a lesser RoI…

      would urge you also to contribute…and about explaining credit, wholesale discount, we intentionally didn’t go into the detail to avoid it from getting complicated…

      nevertheless thanks for the feedback.


    15. Tirthadeep DharJune 15, 2012 at 10:47 AMReply
    16. Sure would love to contribute… but I would rather start by trying and provide some comic relief between intense FMCG sessions 😛
    17. Amber VermaSeptember 26, 2012 at 7:15 PMReply
    18. Thanks All of,
      amber verma
    19. Kapil GuptaFebruary 8, 2013 at 4:26 AMReply
    20. Realy good explained ….Thanxxxx
    21. Robin Godara BishnoiFebruary 21, 2013 at 9:46 AMReply
    22. thanks dear
    23. vibhor srivastavMarch 4, 2013 at 12:06 AMReply
    24. very helpful…..thanks….for explanation of ROI insuch a way….
    25. avik dasMarch 20, 2013 at 10:51 AMReply
    26. Can anybody exactly explain following-
      per month
      Sales: 10 Lac
      Margin: 3%
      Inventory: 2.5 lac
      Market credit: 2.5 lacCase 1: No credit from company to distributor
      Case 2: 7 days credit from company to distributor
      Case 3: 30 days credit from company to distributorPls explain the concept also


    27. Ankit DwivediApril 12, 2013 at 6:14 AMReply
    28. GOOD explanation……… but one doubt is there in example. ROI is 19.25%, as per calculation this is monthly ROI but monthly ROI would be 1.5-2.5%



    1. Ankit DwivediApril 12, 2013 at 6:27 AMReply
    2. avik das……
      if no expenses are there then
      case 1: roi is 6%
      case 2: roi is 7.2%
      case 3: roi can’t calculate……. because there are no investment.



    1. Davidraja J E SamJune 15, 2013 at 10:32 PMReply
    2. hi Ankit could you please explain the second case..David
    3. Rhishabh SuritJune 28, 2013 at 11:32 PMReply
    4. davidraja….if market credit is given for 7 days.. then average market credit would be 75% of inventory, thus total invenstment wud turn out to be 4.2lac.. hence ROI wud turn out to be 7.1% (guys plz correct if im wrong .. not from fmcg background)
    5. jjkljljJuly 23, 2013 at 1:45 PMReply
    6. This comment has been removed by the author.
    7. Munish KaulJuly 23, 2013 at 1:52 PMReply
    8. aa you are very close to being right if market credit = 2.5 lacfor 7 days market credit = 75% of inventory
      = 75/100*2,50000 = 1,87500total investment would be = 2,50000+1,87500 =4,37500

      margin is 3% of sale of 10,0000 = 30000

      so, Return on investment is = returns/total investment

      ie : 30000/437500 which comes out to be 6.8 % or you can say 7%

      but how come you came to conclusion that average market credit for 7 days = 75% of inventory cost ???


  • MadhavAugust 11, 2013 at 2:46 PM
  • I believe, he has not taken it as 75%..but..for 30 days..stock is 2.5 for 7 days it’s 2.5 lacs* 7/30~=58300….So net investment in inventory=2,50000-58300=191700…..So,
    roi comes to be 6.7%..I think so…
  • chandan kumar balSeptember 10, 2013 at 1:24 AM
  • Hi what is the healthy ROI for FMCG Distributors(as u told margin is between 6%-8%)? Is it between 14%-24%?
  • AyushNovember 19, 2013 at 8:08 AM
  • 30 days inventory is 2.5 Lakhs
    so we can calculate inventory for 23 days which comes out to be (250,000/30)*23=191,667
    then final investment= 191,667+250,000= 441,667
    ROI= Earning/Net Investment


  1. vickyNovember 13, 2013 at 2:39 AMReply
  2. HI can any one confirm the standard norms for the ROI & Investment.If some one having please share @
  3. Bipin BhanushaliFebruary 7, 2014 at 9:14 AMReply
  4. can anyone clear my following doubt
    Investment include Avg Closing Stock + Avg Market Credit + Avg. Claims Outstanding OK…. but what about deposit given for taking godown on rent and down payment done for purchasing vehicle do these investments are consider for calculation of net investment and if not then what would be consideration for them
  5. pranoy paulApril 10, 2014 at 12:05 AMReply
  6. thanks dear
  7. KapsMay 11, 2014 at 2:51 AMReply
  8. This comment has been removed by the author.
  9. KapsMay 18, 2014 at 11:42 PMReply
  10. Hi..Can someone help me crack this..
    Distributor does a 20Lac business per month. Earns Gross Margin of 10%, Exp per months comes to around 2%. Avg Inventory: One month, Avg Market Outstanding of 45 days. No claims outstanding. No company outstanding. Funding purely from internal resources. Doesn’t have any other co’s distributorship.
    I get two different ROIs with different approaches. Turnover/Inv method and Standard Method of Net Earnings/Investment.
  11. himanshuOctober 14, 2014 at 1:24 AMReply
  12. In both case it will be 38.4 % annual Roi1st method 160000 *100/ 500000 = 3.2 monthly Roi or 38.4 annual Roi2nd method 2400000/5000000 = 4.8 rotations , Earning per rotation 8 % hence annual Roi will be (8*4.8) = 38.4% only
  13. himanshuOctober 14, 2014 at 1:25 AMReply
  14. in first case read denominator as 50 lac and not 5 lac
  15. Ramaswamy VenkataramanApril 18, 2015 at 1:20 AMReply
  16. in the second case shouldn’t the numerator be the annual turnover ?
  17. qamar khanJune 7, 2015 at 1:36 PMReply
  18. thanks
  19. AdarshSeptember 12, 2015 at 12:40 AMReply
  20. Was going through the comment section and found someone mentioning interest charges on CC or OD being part of the expenses. This is a valid point of discussion and I have personally faced such scenarios.
    Humbly request the author to give a verdict on this. My understanding and opinion from many with whom I have shared is…Is a dealer who continuously needs CC or OD to fulfill his billing commitment, a sound dealer/distributor?
  21. UnknownMarch 14, 2016 at 9:43 AMReply
  22. Can anybody explain the followingAbc is a fmcg companyxxx is the product name

    Margin of the product for stockist is 10%
    Margin of the product for retailer is 20%

    Mrp of the product is 25000

    cost of stockist is 19120
    Retail cost is 20830

    What is the method of calculating the margin

  23. biswa nayakApril 12, 2016 at 10:24 AMReply
  24. ANYONE KNOW THE Healthy ROI for the FMCG channel partner??

– See more at:

How the visibility budgets are used for price undercutting in FMCG?

If you speak to any Territory Sales In-charge or Manager (TSM) of a large FMCG company, they are going to mention one huge problem called price undercutting that affects their daily work. In an earlier post, I have written about how the wholesale trade leads to price undercutting. In this post, I am going to write about how the Territory Sales Persons use the so called ‘visibility budgets’ for undercutting practices.

Wikipedia defines price undercutting as: ‘Price cutting, or undercutting, is a sales technique that reduces the retail prices to a level low enough to eliminate competition‘. In most cases (more than 95%) the competition is not with a competitor’s product, but it is the competition between a company salesman and a wholesaler selling the same branded product at different prices.

Let’s understand this with an example. Let’s say there is a brand X of soap which the TSM is supposed to sell at Rs.32 per piece to the retailer. Let’s say, the area allocated to this TSM is adjacent to a big wholesale market called Bhindi Bazaar. There are twenty retailers distributed across his area and some of the retailers are at a stone’s throw distance from the wholesale market.

So, when the TSM goes to the retailer, the TSM realizes that the nearby wholesaler is selling at a very reduced price. Typically, the conversation between the retailer and the TSM goes like the below:

TSM: Naya scheme aaya he, aap bees pete (20 cartons) lelo… itne price mein milega aapko

Retailer: Kitna padega? Rs.32?

Retailer: Saab, Bhindi Bazaar mein Rs.26 per piece mein mein mil raha he (single carton mein bhi)

So, the TSM thinks that he cannot compete with the wholesaler’s undercutted price. The TSM calls the Area Sales Manager (ASM) or his supervisor and tells him the problem.

TSM: Rate ka problem he Sir

ASM or Supervisor:  Mein samajhsakta  hoon… per manage karlo

ASM or Supervisor: Aapka monthly target se shortfall hora hein

So, the TSM realizes that he is not going to get much help and he has to reach his monthly target by any means.

The TSM uses the visibility budget to get out of the problem

Generally, FMCG companies put up some display material or place their product very attractively in the shelves or as separate displays in the retail stores. The company pays a certain amount of money to the retailer for doing so. The TSM gets a certain budget to pay the retailers to place or stick the brand display material. Typically, the price for a shelf in a retail shop may range from Rs.300 to Rs.1000 per month. Generally, companies buy 1-4 shelves and pay the respective money per month to the retailer.

The TSM uses this money to reach his sales targets instead of giving it to the retailers. In our example, as the wholesaler is selling at Rs.26 per piece, the TSM will sell the stock at Rs.25 per piece (Re.1 less than the wholesaler’s price), but tells the retailer to give the bill at Rs.32 so that the company cannot find out about his undercutting practice. The TSM reaches his monthly target through price undercutting.

So, what happens to the display material of the company?

All the display material provided by the company will be placed in the TSM’s house and will probably be used by his son for making paper rockets.

What happens during the visibility audits?

FMCG companies also do some visibility audits or sometimes the brand guys would like to visit the field for some reason. Suddenly, the TSM will come to know that tomorrow morning there is going to be an audit of the display material. Within a few hours, the TSM and his salespersons will place or stick the display material in all the stores or a subset of stores where the audit is going to happen. They tell the retailer that they are going to remove it tomorrow and it is only for one day. Most retailers don’t mind it.

On the next day, when the auditors come and check, they find everything to be fine and they go back and send appreciation mails that this area is 100% compliant and that the TSM is doing a brilliant job. On the next evening, the TSM tells his salesperson to remove all the display material.

This is how the TSM achieves his sales target through undercutting practices. It is important not to blame the TSM completely but to understand that the origin of the problem is mainly due to large wholesalers. The sales teams do talk to the wholesalers and fix their prices or sometimes they solve the problem by re-allocating the markets.

The big danger in all this process is that the retailer is getting used to this practice, and it will impact have a negative impact on the brand in the long term. Nevertheless, price undercutting is a harsh reality of sales in the FMCG world.

How Price Undercutting happens via Wholesale Trade?

Wikipedia defines price undercutting as: ‘Price cutting, or undercutting, is a sales technique that reduces the retail prices to a level low enough to eliminate competition‘. It is obvious that price under-cutting happens mostly to boost volume sales. This article is about how undercutting works in the context of Indian FMCG.

Brief Overview of the supply-chain and the trade schemes

As mentioned in earlier posts, the typical distribution line for an FMCG product in your area looks like: Stockist -> Company Distributor -> Wholesaler -> Retailer  Or  Stockist -> Company Distributor -> RetailerTypically, the distributor gets a margin of about 6-8% and the retailer gets a margin of 10-15%.

Just like the way the FMCG company brings out various promotions to the end consumer, the company also introduces various trade schemes or trade promotions as incentives for all the partners in the supply-chain. Typically, the incentives are based on the quantity of the volume purchased or the value purchased. There are many different types of incentives such as, but the major ones are:

1. Quantity Purchase Schemes (QPS)

A few examples are below:

a).     Buy 25 pieces, get one piece free;  50 pieces, get 5 pieces free;  100 pieces, get 12 pieces free;  200 pieces, get 25 pieces free
b).    Buy 25 pieces, get 1% discount;  Buy 75 pieces, get 3.5% discount;  Buy 150 pieces, Get 7.5% discount

2. Value Purchase Schemes (VPS)

Example: Buy Rs.5000 get 4% discount,  Buy Rs.8000 get 7% discount, etc.

So, the formula seems simple: the more somebody buys a particular product the more the discount. Bargaining Power!

But, this is where the problem starts.

Undercutting by the Wholesaler

We shall walk through a common scenario of how undercutting happens.  For simplicity of math, lets say, a product has an MRP of Rs.15, and the retailer gets it for Rs.13.50 and the distributor gets it for Rs.12.50. Lets say the wholesaler also is getting at Rs.13 as he typically buys more. So, simply just say the distributor margin is Rs.1, the retailer margin is Rs.1.5 and the wholesaler has a margin of Rs.0.50.

Lets say Mr. Lal Babu is a a very big wholesaler who caters to certain number of retailers locally. When the distributor goes to Mr. Lal Babu he says there is a new scheme. Lets say the scheme is:  Buy 75 pieces, get 3.5% discount;  Buy 150 pieces, Get 7.5% discount.

So, Mr. Lal Babu decides to buy 150 pieces. So, apart from his actual cost, he gets a bonus 7.5% discount. So, instead of buying the product at Rs.13, Mr. Lal Babu buys it at Rs.12 (7.5% discount over Rs.13). So, now instead of selling it to the retailer at the usual price of Rs.13.5, assume Mr. Lal Babu sells it to the retailer at Rs.12.50, taking his usual margin.  The company distributor is selling the same product at Rs.13.5 to the retailer. So, you see what the problem is?

The retailer would be attracted to buy from Mr. Lal Babu as he gets more margin compared to the company distributor. One might think it is only Rs.1, but when they buy a couple of cases, it translates into good savings for the retailer.

Is undercutting only relevant to wholesale?

The answer is No. The philosophy of under-cutting is the same, but it can be done by anybody in the supply chain. So, the salesman himself, in order to reach his target, can make this happen. He makes an invoice against one such large wholesaler Mr. Lal Babu and he passes the benefits to his retailer. But, this is going to be a problem in future for the salesman, as the retailer will get used to these benefits and he stops buying in normal situation. In a way, the brand or the particular product starts to become more driven by the wholesalers.

Various channel partners do under-cutting to boost volumes at his/her own level. Territory Sales Officers who will be in-charge of certain stockists too sometimes bill it against a certain stockist ABC, but he actually sells it to a big wholesaler. The distributor too can have his own share of price undercutting to attract the retailer.

Undercutting is a very common phenomena in the field. Though FMCG companies have various strict mechanisms to curb them, new loopholes are invented continuously to take advantage and undercut. After all, price matters to everybody.

E-commerce in India

As per IAMAI, the current number of Internet users in India is around 150 million users (~50 million in Rural) growing at a CAGR (2010-12) of 40%. This number is expected to grow to around 300-350 million by 2015. This means 30% of India is online covering most of the Urban India, which is where 60-70% of the consumption happens in this country.

Youth are increasingly adopting e-commerce

India has the biggest youth market that is adopting technology quickly.  Indian youth are comfortable using technology and are preferring to shop online. From books and apparel  to FMCG goods, everything is being sold online today. The apprehensions of buying online are subtly fading away for the Indian consumers and online retail is showing positive signs for the future.

India online retail is growing at 35% which would take its value of around 3000 crores ($ 600 million) currently to around 7000 crores ($ 1.5 billion) in 2015. Some of the largest retailers in terms of unique visitors are – Amazon, Flipkart, Jabong, Myntra, Indiatimes, Snapdeal, and Homeshop18 (in decreasing order).

Great signs for online retailing:

  • Indian online retail is growing at 35% though the overall size is only 3000 crores.
  • Sites such as Flipkart have their apps loaded in 40-50% of the smart phones in India.
  • As per Assocham, 58% of the online shoppers shop using debit cards inspite of the cash on delivery option.
  • Increase in assortment in online retailing ranging from books, apparel, shoes, electronics, to specialized FMCG, furtniture, etc.
  • Categories such as apparel have witnessed strong acceptance and growth in online buying
  • Increasing time spent on smart phones in browsing online retail websites. In 2012, upto 20% of the traffic for Snapdeal came from smartphones.

Category-wise growth

According to Assocham, apparel and consumer goods are the fastest growing categories in e-commerce.


Source: Assocham and comScore

Browse offline, Buy Online

Consumers who are comfortable and convinced to buy online are popularly using the method of browsing items in the shop and then buying the item online. This is especially observed in books, shoes, electronics, etc. Consumers are reaping the benefits of both the trades (look and feel from the brick and mortar stores, and discount benefits from online) and this is an important clue for the retailers.

Online retail has made a dent in the $ 500 billion Indian retail market. However, there is a long way to go and it is a big task to even reach the modern retail market size of $ 30 billion. Indian consumers are simultaneously witnessing three revolutions – modern retail revolution, smart phone revolution, and e-commerce revolution. With FDI in retail, increasing smart phones and internet penetration there is strong optimism for the growth of all the three and how these three revolutions converge into a giant consumption basket.

The Modern Trade Consumer in India

With increased exposure to global brands, latest internet communications, and desire for better lifestyle, the consumers today are looking to use the global, trendy, life-style oriented products and are demanding more in terms of the shopping experience, simplicity, quality products, and value.

The evolution of Modern Trade is just meeting the demands of these consumers and together causing rapid growth in modern retail. With increased exposure to Modern Trade, the consumer today is becoming more and more comfortable and loyal with Modern Trade.  Nielsen says that a fifth of the Urban India Shoppers now regularly shop at Modern Trade stores. (refer

Technopak forecasts that the penetration of Modern Trade in India will triple to about 15-20% in the nextfive years by 2018.


From the consumer point of view, modern trade results in:

  • Consumers feel that they are smart buyers
  • Increased availability of choice in brands and categories
  • Promises better prices and value to the consumers
  • Better quality products
  • Enjoyable shopping experience with product and brand voyeurism
  • Perceptual benefits of improved standard of living

Consumers feel smart as they have more control in Modern Trade

MT ShopperWith increased brand choice, freedom to browse the products, and the visibility of deals and promotions, the modern trade consumer perceives his buying experience as a smarter way of buying things. It also leads to the consumer willing to experiment more, buying new brands and categories in the modern trade store. It is observed that the modern trade consumers look to buy large packs and aggressively look for promotions, trying to get more value out of every buy.

A family shopping experience with enjoyable product and brand voyeurism

MT Family ShopperThe modern trade consumer is most likely to be accompanied by family and friends, and is not so likely to shop alone. It is increasingly seen that kids sit in the shopping cart, and the mother and father discussing about the product. This increases the fun in the buying experience and provides more opportunity for the retailers to increase the basket size and increase interaction with wide array of brands.

Moreover, the large displays, islands, and the strict arrangement of brands always make the consumers be voyeuristic of the brands and products. This makes them checkout products that were never in their consideration and drop it in the basket.  Modern Trade consumers’ willingness to buy new products and niche variants is making manufacturers add high-end variants to upgrade the consumers.

The rise of mini-modern stores to meet the “modern consumer” needs

Sarvodaya MumbaiThe Sarvodaya supermarket in Mumbai is an example of a growing trend of traditional stores adopting modern practices to meet changing consumer needs. There are about 100 such stores in Mumbai, and this trend is soon catching up in smaller towns too.

The future implications of Modern trade evolution are obvious as more and more consumers flock to the modern trade stores, and as more global retailers look to enter India after the FDI approval.