In the past two decades, warehousing has steadily evolved from being carried out in run-down ‘Godowns’ to modern structures which are compliant with global standards. This shift has been aided by the implementation of the GST reform — benefits of scale offered by larger warehouses (funded by significant institutional capital flows) — and increased outsourcing by end-user industries (EUIs) to specialised Logistics Service Providers (LSPs). The aforementioned events accelerated outsourcing of the logistics function to specialised LSPs, a trend which had begun after the Global Financial Crisis as EUIs focussed on their core business and adopted stringent compliance requirements. A multidecadal analysis of the warehousing sector brings out 3 clear trends:
- Growing penetration of Grade A and B warehouses – Penetration of Grade A and B warehouses as % of total warehousing area has grown from ~5% pre-2000 to ~23% in 2019. Grade A and B addition of ~36 mn sq ft in 2019 alone was the same as the total addition during 2001-2010. From 2011-2020, India has added nearly 5x Grade A and B capacity compared to the previous decade.
- Steadily changing tenant profile from EUIs to LSPs – In the early 2000s, EUIs (non e-commerce, brick-and-mortar businesses) commanded 85% share in the total Grade A and B warehousing pie, which has since steadily declined to 33% in 2019. The remaining share (~67%) has now been taken up by LSPs and e-commerce companies.
- Emergence of reliable and specialised contract logistics players – With increasing penetration of Grade A and B warehousing and change in the tenant profile, India has seen the emergence of reliable and specialised Contract Logistics (warehousing operations and secondary distribution) players. The growing maturity in the Contract Logistics market is facilitating the shift of EUIs towards a service-led, variable pricing model provided by LSPs from the inefficient, do-as-directed cost-plus model.
Below is an overview of four periods of 5 years each to observe the evolution of warehousing more closely:
2001-2005: Local Labour Supply Services (LSS), with limited capital and capabilities on a ‘cost+plus’ model were availed of by EUIs to undertake warehousing operation services in ‘Godowns’ (Grade C/D) owned/leased by the EUIs themselves. The supply of Grade A and B warehouses stood at less than 5% of the total warehousing space of 350 mn sq ft by the end of 2005.
2006-10: The foundation for modern warehousing and Contract Logistics was laid in a slow and steady manner. This was driven by the growing needs of EUIs, foreign LSPs such as DPDHL, DB Schenker, etc. entering India and a few Indian LSPs kicking off operations. Most of these new Indian players were supply chain entities of large end-user companies such as M&M, Future Group and TVS Motors respectively. Initially, these large end-users provided their supply chain entities with adequate anchor volumes, which the supply chain entities used to gain expertise and scale in Contract Logistics. Thereafter, these LSPs leveraged this experience to offer Contract Logistics services to other large customers. By 2010, India had ~400 mn sq ft of warehousing of which the penetration of Grade A was a mere 12% (~44+mn sq ft).
2011-15: India witnessed an e-commerce boom led by home grown e-tailer Flipkart as well as the entry of Amazon in 2013. The likes of Snapdeal, Jabong, Myntra and Firstcry followed suit. E-commerce introduced challenging service-level agreements (SLAs) for LSPs, which in turn created the need for higher efficiencies in logistics, with having quality warehousing at the core of the desired solution. Two approaches emerged to address the complex logistics needs of e-commerce– specialised e-commerce logistics players and e-tailers themselves developing a logistics function in-house to cater to captive volumes. This indicated the limited capabilities of existing LSPs at that time. Eventually, larger LSPs did enter the domain but a lion’s share continued to be with e-com logistics players and e-tailers themselves. On the back of this traction in warehousing and capital flows into the sector, modern warehousing added 30% more capacity in these 5 years than in the decade from 2001 to 2010.
2016-2020: With all the above enablers growing in scale and the impending policy reform of GST and E-Way Bill, organised warehousing started to gain traction. With the onset of GST in 2017, compliance and re-organisation of the supply chain gained focus and a hub-and-spoke model with larger warehouses in fewer strategic locations (such as Delhi NCR, Bangalore, Chennai, Mumbai) came to the fore. EUI accelerated migration from unorganised, non-compliant and local LSPs towards organised, compliant and pan-India present LSPs. India added nearly 3x capacity in this period compared to the 2010-15 period.
In light of the ongoing COVID-19 pandemic, it is also important to re-examine some of the above trends and assess the pandemic’s implications for some of them:
- Shift towards a variable pricing model – As EUIs grapple with liquidity challenges and attempt to make their cost structure variable to the extent possible, the shift towards a ‘variable pricing’/‘pay-per-piece’ model from the inefficient, cost-plus model is expected to accelerate. From a tenancy perspective too, this would translate to an accelerated shift towards outsourcing by EUIs to LSPs, who in turn are likely to operate multi-user facilities (MUFs) (shared by multiple EUIs vs single user) and underwrite volume risk to benefit from a larger share of gains from efficiency and scale, that come from higher utilisation. We expect LSPs from all sub-segments like full truck load (FTL), e-com and express logistics to diversify into Contract Logistics for the EUIs they cater to.
- Shift from unorganised to organised LSPs – As EUIs seek reliable and resilient logistics partners in challenging times, organised players with professional management teams, IT systems and processes, pan-India network, higher level of automation, mechanisation and superior operational capabilities are expected to replace and gain market share from unorganised service providers incapable of operating in challenging environments like present days.
- Outsourcing and partnership approach –The relationship between EUIs and LSPs is expected to undergo an upgrade from the current ‘Purchase Order’ based model to a more contractual one with higher level of outsourcing and LSP involvement. The contractual scope is likely to be more integrated, under a variable pricing model (pay-per-use), extending from the factory till the end consumer (irrespective of the sales channel). In comparison, the previous model involved leasing of warehouses by EUI themselves, cost-plus pricing model for manpower supply by LSPs, in-house inventory and demand planning by the EUIs and collaboration with multiple LSPs for various legs of the supply chain.
2021-2030: Trends for the decade ahead
- Warehouses designed to enhance supply chain efficiencies to gain focus as LSPs become main tenants and users: Currently, a large portion of the Grade A and other modern facilities are designed to maximise storage area and thus rentals, without adequate number of docks, poor road connectivity, and insufficient area for truck movement within premises. This result in inefficiencies like higher detention times for trucks and low throughput. This is expected to undergo a change as the tenant profile is shifting to LSPs. We expect addition of ~400 mn sq ft of modern warehousing space in this decade. Of this, the share of LSPs is likely to exceed 90% by 2030 from current levels of 45%. Cumulatively, we expect LSPs to have ~75% market share, up from the current ~35%.
- Pay-per-piece pricing methodology: The adoption of a variable pricing methodology is expected to be widespread with EUIs opting for flexibility to optimise their supply chain spend and focus on core business. LSPs with larger warehouses are likely to improve their cost structure owing to inventory optimisation via a throughput-driven model and increasing value-added services (VAS) such as inventory and demand planning along with integrated services. This shift from the previously followed storage-led model to a high-churn one to increase the tonnage handled/sq ft is expected to translate into higher realisations for LSPs.
- Shared warehousing in multi-user facilities: Built-to-Suit (BTS) warehouses are designed under instructions from a EUI customer for long-term use. Currently, BTS warehouses enjoy 70% share in the total Grade A and B space. However, shared warehousing in MUFs operated by LSPs offers benefits such as shared administrative costs, flexibility to meet fluctuation in demand as well as pay-per-piece pricing model.
To summarise, the increasing share of organised LSPs shall help reduce inefficiencies in supply chain, enhance pricing power of efficient LSPs, leading to the emergence of Contract Logistics as a critical business support service. Market leaders could command >50% share of the industry going forward, thereby presenting the ecosystem (consisting of existing LSPs, capital providers like Private Equity funds, Foreign Strategic investors, and EUIs) with an unprecedented opportunity. Simply put, growth in Contract Logistics is expected to have three major drivers:
i) Grade A warehousing footprint growth at a CAGR of 13%+ (vs historical 10-yr CAGR of 16%+)
ii) Market share gains for LSPs of 6%+ annually in new leasing vs EUIs
iii) Conversion of ‘cost-plus’ contracts to ‘pay-per-use’ model leading to pricing gains of ~5% inlieu of reduced obligations and lower fixed costs for EUI.
The above three factors are likely to drive growth at 25%+ CAGR in the organised Contract Logistics market. In the 2020-30 decade, fresh real estate (RE) capital required (at current prices) to fund modern warehousing and its sustained growth would be in excess of $10 bn and additional capital for secondary deals sponsored by sovereign wealth funds (SWFs) and pension funds is likely to be $5bn+.
The author is Divyanshu Tambe, Executive Director – Transport & Logistics, Private Equity, M&A Transactions, Ernst & Young LLP