Papua New Guinea retailers streamline operations to boost efficiency

The retail sector in Papua New Guinea is coming off perhaps the biggest boom cycle in the country’s history after years of sustained investment in capital-intensive infrastructure and a long run of strong “supercycle” commodity prices, which the government depends upon as a foreign currency earner. While an economic slowdown and its ripple effects on the retail segment were expected following the unwinding of the investment period for the PNG Liquefied Natural Gas project and the easing of government spending after the conclusion of the 2015 Pacific Games, which were held in Port Moresby, the added punch of depressed commodity prices came as a surprise. At the confluence of these effects there is cautious optimism for future growth in the retail sector as well as uncertainty as to how consumers will react to the economic downturn. National GDP growth has dropped from sustained double-digit expansion during the boom years to a projected 4.3% in 2016 – a figure that is expected to remain under 4% through to at least 2020, according to estimates from the PNG Department of Treasury.

Spending Cuts

Faced with this decelerating economy, the government has been forced to curtail spending in recent years as projected revenues fall short. In the most recent 2016 budget, for example, the treasury department included cuts of PGK1.4bn ($477.9m) in the accompanying 2015 Supplementary Budget. This resulted in a revised 2015 total expenditure and net lending amounts of PGK15.1bn ($5.2bn) with estimated 2016 expenditures projected to be even lower at PGK14.8bn ($5.1bn). Because much of the retail sector is still heavily reliant on government payouts, this decrease in cash flow translates directly into less spending power, extending across the board as the financial taps slow in the National Capital District (NCD) and throughout the provinces.

Largely as a result of these factors, retail sales declined by 10.7% in the third quarter of 2015 compared to an increase of 6.1% in the second quarter, according to the Bank of PNG’s latest economic bulletin. More specifically, the quarterly decline was attributed to lower demand for heavy equipment from the mineral sector, lower sales of chemical and steel products as well as low fuel sales due to the upgrading of some service stations in the NCD. Slower automobile sales, the conclusion of the 2015 Pacific Games and the destruction of a major retail shop in the NCD by fire also contributed to the decline in retail sales, which were down 17.4% in the year to September 2015. This negative growth marks the third consecutive year of falling retail sales, following declines of 6.4% in 2014 and 13.8% in 2013.

Wholesale sales were similarly affected, falling by 17.8% on the year and 0.9% in the third quarter of 2015. The wholesale sector contraction was attributed primarily to lower demand for chemical and pharmaceutical products along with lower fuel prices.

Consumer Base

The formal retail sector is dominated by the country’s urban centres in the NCD around the Port Moresby area, Lae – the second largest-city in PNG – and Mount Hagen, with other small cities and townships around the country accounting for a much smaller contribution. The demographic dispersion of the country’s population, with roughly three-quarters living outside easily accessible urban centres, also presents an ongoing challenge for retailers. These markets, which are at present economically unviable due to the high logistical costs involved in accessing them and the traditional spending patterns of the inhabitants, present a substantial long-term opportunity for future growth.

At present, rural areas are served by smaller, isolated general stores and are often part of the informal economy. Because of this dispersion of the people, observers estimate the overall consumables market to be just 20-25% of the nationwide population, which currently stands at an estimated 7m.

In urban areas the retail sector is led by a handful of major players – CPL Group, TST Group, Super Value Stores and Rimbunan Hijau – along with a number of smaller operations. The lack of depth in the retail sector is due to several factors creating steep barriers to entry and high operating expenses, but by the same token less competition allows for higher returns.

In spite of the economic slowdown and declining sales exerting increasing pressure on all players in the sector, PNG’s largest retailers continued to roll out new retail centres in 2016 to serve their urban consumer base, primarily in the NCD. For instance, in 2016 CPL Group, the country’s largest retailer, topped off its expansion strategy with two new large Stop N Shop supermarkets located in Koki and Harbour City. These newest additions, which together will employ a 500-strong workforce, follow on the back of the group’s recent opening of the country’s largest supermarket in Waigani Central in 2013. Although the store is currently out of commission as a result of a fire in July 2015, as of mid-2016 repair work was well under way, with CPL Group expecting to resume business by the end of the year.

Overcoming Obstacles

In addition to the economic slowdown affecting the country as a whole, the retail sector is also dealing with several more specific challenges. One of these stems from increased delays in foreign exchange payments made by the financial institutions, which is causing bottlenecks in the retail value chain as producers and wholesalers in the US, Australia, Europe, Asia and other countries cannot be paid on time. As a result of these logistical problems, basic modern cost-efficiency practices, such as just-in-time delivery and production are not being fully utilised and, as a result, PNG retailers are experiencing increasingly frequent periods of extended stock shortages and lost revenue. To avoid having empty shelves, retailers also have the option of pre-ordering goods far in advance of expected demand, although this involves paying for products up-front without recouping the costs until many months later – an equally unpalatable alternative.

In a related currency exchange issue, the depreciation of the kina is also squeezing retail companies, which are forced to absorb at least a portion of the increased price of imports due to competition in the marketplace. Because price sensitivity for goods – in particular basics – is extremely inelastic, even slight price increases in a product could be enough to push customers over to the competition.

Rising income levels due to three increases to the minimum wage since 2014 have also affected the sector, although the rise in wages paid out has so far been largely offset by higher spending power. “Minimum wage is a double-edged sword,” Mahesh Patel, chairman of CPL Group, told OBG. “On the one hand our costs go up, but on the other we have more money being spent in the supermarket so, overall, we are a net gainer. The biggest negative impact is that this pushes our security costs up.”

Franchisement

Over the past two decades franchises have exploded across South-east Asia, with many Western brands establishing a ubiquitous presence in most countries. Starbucks coffee shops now occupy the lobbies of office buildings and retail centres throughout the region, while McDonalds, KFC and other fast food joints continue to compete with local food stalls, and several different convenience store brands are common occupants of major metropolitan real estate. But in Port Moresby, franchises have yet to take hold on a significant scale due to limiting factors and strict corporate criteria governing entry into new markets. The country’s high production costs and relatively low population present substantial challenges for these international companies seeking to make the biggest bang for their buck.

Outlook

Now that PNG’s economy has reached a relatively low point in terms of growth and economic stimulus, much of the rapid retail growth that characterised the boom years up to 2013 has given way to a period of consolidation and operation streamlining as retailers look to raise efficiency to curb the slowdown’s bite. “The positive side of this is the improvement of internal efficiency,” Patel told OBG. “We knew there would be a slowdown after the rampage of expansion in 2012 and 2013, but we didn’t expect it to be this big. We can’t afford any fat in the system.”

This does not mean the market is not without its allure for investors, however. For example, the ubiquitous fried chicken vendor KFC has been in talks with CPL Group to explore a possible partnership to bring the first franchise restaurant chain to PNG, according to Ravi Singh, CEO of CPL Group. Given the popularity of existing similar local restaurants chains, such as Big Rooster and DFC, there appears to be ample demand in the market. The final entry decision could very likely come down to how the government chooses to implement new legislation governing the operation of foreign firms in the country, most notably the proposed small and medium-sized enterprises law.