Mumbai: Dual disruptions caused by demonetization and the implementation of the Goods and Services Tax (GST) have permanently changed the way India’s largely unorganized and fragmented consumer goods distribution network operates.

Distributors are struggling with a higher compliance burden and associated costs and have trimmed inventory levels, according to industry executives and distributors.

While discontinuation of high-value bank notes in November 2016 plagued cash-dependent distributors through the first half of 2017, they have been struggling to function under a higher compliance burden since GST was implemented on 1 July.

Almost all packaged consumer goods firms say that while effects of demonetization were short-lived, the higher compliance burden under GST has led to a longer-term disruption and more permanent changes in the distribution network.

“Our business did not suffer much right after demonetization because we largely serve the South Mumbai region," a distributor of products from Amul, Colgate and other companies in Mumbai said, requesting anonymity. “We were back on track soon after the Rs2,000 note was in circulation," he added.

GST has mostly affected small retailers and wholesalers–driving them out of business–while it has prompted everyone to work with smaller inventories. “After GST, it is the small retailers, the small stockists who have been unable to bear the brunt of compliance," the distributor said.

“Where will a shopkeeper with a 100 sq ft shop install a computer and how will he get a CA (chartered accountant) to do his taxes? Most of them don’t even understand business beyond the flow of goods into theirs shop and out of their shop. It would be a challenge to find even a small shop in Mumbai that is doing business under the GST limit of ₹ 20 lakhs," he said, adding that it takes his firm nearly 10 days every month to finish getting the paperwork for GST returns in order.

“People used to take a lot more inventory in the past, but now everyone has reduced what they’re carrying," said a second distributor in Kolkata, who sells biscuits from Britannia and Parle among others, also requesting anonymity. “For others in the business, it has come down as much as from Rs10 lakh a month down to Rs2-2.5 lakh a month. Many manufacturers have reduced their monthly sales targets," he said.

Many distributors first began de-stocking in June 2017, in the weeks leading up to GST’s formal implementation date of 1 July because they were still holding on to stocks taxed at the previous VAT regime. Now, packaged consumer goods manufacturers say leaner pipelines have worked well because they allowed trade partners to continue functioning smoothly, but with less working capital.

“There has been a long-term reset," Lalit Malik, chief financial officer at Dabur Ltd, said in an interview. “Inventory pipelines in the long term have become permanently thinner, although it varies from product to product. It has led to loss of sales but it has also made trade pipelines healthier in terms of working capital," he said. “This was in line with our plans because we wanted to work on a healthier replenishment model," Malik said, adding that Dabur was already working on making trade partners reduce pipelines.

However, healthier pipelines have not ensured everyone remains in the business. Wholesalers who have a higher penetration in rural areas and in the less developed North and East India were the worst affected by GST as well as demonetization.

“GST was very different from demonetization because the wholesale component of business was badly affected by GST," Mayank Shah, category head at Parle Products, said in an interview. “Only in the last 1-2 months are we seeing recovery. Many wholesalers are going out of business because they did not want to migrate to the GST regime. These people do business at very low margins so it is more about high, fast moving volumes for them. So...companies are falling back on traditional channels and are relying on their own distributors as trade pipelines have reduced."

Wholesalers serve nearly 70-80% of India’s rural markets, Mint reported on 3 November, while modern trade generally makes up on average about 10% of sales for large, listed packaged consumer goods makers.

The South and West regions have recovered faster than the North and East because they rely less on unorganized wholesalers.

“The northern and eastern parts of India were worst hit with pipeline reduction across channels, leading to a decline in the stock holding in trade," Vivek Karve, chief financial officer of Marico Ltd, said about the impact of demonetization and GST. “However, business started recovering in the quarter following each of these events with some pipeline refilling seen across channels while the pace of recovery in wholesale trade in the northern and eastern parts of India was relatively slower," he said, adding that wholesalers remained under pressure because the GST bill was passed in April, just as effects of demonetization were fading.

“We foresee from a medium to long-term perspective, there will be a gradual shift in this channel towards more compliant way of doing business and the additional cost of compliance will be shared by the entire value chain," Karve said. Packaged consumer goods companies “on the other hand, have also renewed their focus on expanding direct reach, thereby investing towards reducing the dependence on the wholesale channel," he said., adding that Marico’s exposure to wholesale channels was relatively low at 35%.

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