Speak to the executives of India’s largest food companies and they confess a sense of disappointment. For although India is the world’s third largest food producer (Exhibit 1), the combined turnover of its ten largest food companies is only $2 billion—one-tenth the sum turned over by Nestlé’s operations in Europe. In a country of one billion people, it seems that the size of the potential food market might have been overestimated.
The truth is that the markets for the products on which India’s food companies have concentrated—higher value-added items such as breakfast cereals, jams, and sauces—are indeed small because these products are aimed at an elite. The big, and so far largely untapped, opportunity lies with mass-market products—packaged wheat flour (atta), biscuits, poultry, and liquid milk—which could eventually account for more than 80 percent of the total market. In some of these categories, hundreds of millions of customers will be added over the next few years: by 2005, more than 140 million Indians will consume packaged atta, for example, and 300 million packaged milk. This growth in consumption means the overall market for value-added foods will treble from $21.4 billion today to $62.5 billion by 2005.
Changing consumption patterns
Two factors are driving the change in consumption patterns. The first and most important is rising incomes, which will enable poor people to begin to emulate the diet of the rich. The second is the greater experimentation in eating that results from increased choice. Although most people will tend to remain faithful to cultural notions of what good food is, diets will evolve as a new generation grows up with a higher income.
An analysis of the development of eating patterns across 20 countries shows that they go through a distinct evolutionary process (Exhibit 2). In the first "subsistence" stage, the emphasis is on obtaining basic foods for survival: cereals, fats, oils, fruit, and vegetables. This is the stage typical of developing economies, and the point at which most of the Indian population stood until recently. While a population remains at this stage, there is little growth in consumption as a percentage of total expenditure. The flattening out takes place at $1,000 purchasing power parity (PPP) per capita income.
The transition to the next "basic" stage typically takes place $1,000 PPP per capita income. Here, the subsistence diet is supplemented with foods such as milk and dairy products, meat, fish, poultry, and eggs. As incomes grow, so does the emphasis on the quality of these basic products.
The third "premium" stage comes into play at an income level of $7,500 PPP per capita. Here the focus is on wider choice, increased processing, rising quality, and more exotic ingredients. Consumption includes eating out. This is the stage reached by highly developed economies.
Because India is a large and diverse nation, all three evolutionary stages are present at once. While lower-income groups move from subsistence to basic foods, upper-income groups progress from basic to premium items. But over the next decade, the first of these shifts will be more important. The basic sector will double in size by 2005, taking in 33 million more households or nearly 200 million people; the subsistence sector, meanwhile, will grow by only 14 percent (though this will represent an extra 18 million households). The premium segment will grow by 150 percent, though this will only amount to 2.5 million additional households as the segment is so small (Exhibit 3).
Basic foods for basic needs
A simple matrix makes it easier to understand the nature of the opportunity. The matrix uses two conventional parameters of industry attractiveness: market size and market growth. Opportunities can be grouped into four quadrants: activate, consolidate, ruminate, and liquidate (Exhibit 4).
Activate
This is the quadrant with the greatest potential. Businesses here are typically high growth, mass based, high volume, and low margin. Products include packaged atta, which will expand into a $4 billion industry by 2005; packaged milk ($10 billion); bakery products ($3 billion); and soft drinks (also $3 billion). Overall, the quadrant’s markets will be worth more than $40 billion by 2005.
To be successful in these areas, manufacturers will have to deliver the right quality product in one of the world’s most price-sensitive environments (Exhibit 5)—something that requires skills not possessed by most branded processors in India today. Atta is a good example of the challenge ahead. Packaged atta’s market penetration is currently less than 1 percent; in Pakistan, by comparison, it accounts for 20 percent of the urban market. In India, most people still buy whole wheat and take it to the local chakki wallah (flour miller) for grinding. They do so because this is a cost-effective way to ensure that the product is fresh and of consistent grain quality. The packaged product, in contrast, is often of inconsistent quality, has a short shelf-life—sometimes less than the time it takes to transport it—and costs substantially more than the freshly ground variety.
The food processor’s task is compounded by regional variations in demand: different regional tastes require different varieties of flour. Success therefore depends on the supplier’s ability to deliver a higher-quality product, to the customer’s specific requirements, priced to within a few cents of today’s whole wheat price.
Despite the obstacles, the sheer size of the markets in this quadrant makes them attractive. By 2005, poultry, for instance, will be an $8.3 billion business growing at 15 percent a year—larger than the entire Indian automotive industry today.
Consolidate
This quadrant is characterized by high volumes but low growth. It is dominated by two huge but problematic industries, sugar and vegetable oils. The sugar industry will be worth $6.7 billion by 2005, vegetable oils $13.9 billion.
While currently profitable, sugar is one of the most highly regulated and politicized industries in the country; its longer-term profitability therefore depends on political decisions. Oil is inherently a low-profit industry in which tax and other incentives have led to overcapacity and low utilization levels. Take vanaspati (hydrogenated vegetable oil), for example: capacity continues to be added because of the incentives available, despite the fact that current processing capacity is sufficient to meet demand for at least 50 years even at the most conservative estimates (Exhibit 6).
To consolidate and build scale in this quadrant will require substantial skills and investment. For most businesses, the challenge will be not how to enter the market, but how to exit it. The fact that such a large proportion of the food industry is stuck in this quadrant may explain why few business people are attracted to the food industry.
Ruminate
This is the quadrant of high growth but small volumes, corresponding to the premium stage of consumption. Most foods in this segment are higher value-added, more expensive products targeted at the affluent. They include wheat noodles, breakfast cereals, and frozen vegetables. The relatively small market for frozen vegetables will be worth $100 million in 2005, while the total market for jams, sauces, and purées will be $300 million.
Although these sectors will remain small, they can be profitable. Specialist players with the sophisticated processing, branding, and marketing skills they require may be expected to build small to medium-sized businesses in the more attractive areas such as fruit drinks (likely to be worth $550 million by 2005), vegetable ingredients, and fresh produce. Western dairy products such as cheese, butter, and flavored yoghurt will together be worth $1.3 billion.
Liquidate
This is the quadrant of small size and low growth. As such, it is instrinsically unattractive, and few business people would be so unwise as to pursue markets here, particularly when the food industry as a whole is highly profitable.
Profitability
In any country, food is likely to be one of the most profitable industries. In developed economies, in particular, it is often among the top three sectors, with the profitability of basic food businesses regularly keeping up with or outperforming stock market averages. In the United States, the three-year average return on capital employed of Archer Daniel Midland’s $13 billion wheat business is 15 percent, compared with an average of 12 percent for the S&P 500. In the United Kingdom, the three-year average ROCE of Dalgety Food Ingredients has been 14 percent, compared with an average return of 9 percent for the FT-SE 100. The ROCE of liquid milk is even higher: 17 percent in the United Kingdom and 20 percent in the United States.
The food industry also manages to achieve this high rate of return in emerging markets, as reflected in stock market prices. With growth of 249 percent over the period 1990-95, the food industry showed the second highest stock price rise of any industry in these markets. The signs are that there are fortunes to be made in basic foods. Although no empire has yet been built in an emerging market to equal ConAgra’s $25.6 billion food business in the United States, the $3.9 billion business created by the Thai conglomerate CP in poultry shows that developing economies do present large and profitable opportunities in basic foods.
Unlocking the opportunity
If the opportunity in India is so large, why have so few taken it? There are two reasons. The first is that companies have focused on products in the "ruminate" quadrant that reach only a tiny fraction of the population; here business can play without bringing about radical change because products have a high degree of price elasticity. The second reason is related to the first. The system is so inefficient at every stage from agriculture to distribution that it is impossible to control price and quality effectively in price-sensitive, low-margin markets. We estimate these inefficiencies to total more than $10 billion—at least 15 percent of the value of food produced in India.
This value destruction takes many forms, including waste, lost quality, and the excessive accumulation of margins charged by middle men. The potential value of increased yields and better quality is not included in our estimate, but probably amounts to even more than the inefficiencies.
Numerous intermediaries
Among the inefficiencies, the procurement system and the number of intermediaries it supports stand out. That intermediaries exist between farm and customer is not surprising; there were two or three in the United Kingdom’s fresh produce procurement system until a decade ago. But in India it is common for there to be up to six in such sectors as fruit and vegetables (Exhibit 7).
Even so, intermediaries are important because they are a substitute for infrastructure: they perform the distribution function that in other countries would be carried out by transport companies, commodity processors, and cooperatives. Produce is consolidated at village markets and reconsolidated at least twice by intermediaries en route to its final destination. But although each intermediary may add relatively little to the cost, collectively they add a great deal, do not add sufficient value, and, on occasion, even destroy value.
As a result, average prices of vegetables treble between the farm gate and the customer. Farmers in India receive only 20 to 30 percent of the retail price of fruit and vegetables, compared with 50 percent or more in the United States. And whereas in the United States 80 percent of the price increase from the farm gate to the consumer is due to the value added by intermediaries, in India only 50 percent of the price increase is accounted for by the value added. Yet milk cooperatives have demonstrated that even in India, the farmer’s share of revenues can be increased from half to more than 90 percent of the processor price if the number of intermediaries is reduced.
Waste and value loss
India wastes more fruit and vegetables than are consumed in the whole of the United Kingdom. Cumulative waste on the farm, in procurement, and at the retailer is worth an estimated $6.7 billion, the equivalent of 40 percent of the total production of fruit and vegetables. Wastage of wheat, at 8 percent, is less severe, but still high given that this is a relatively nonperishable item.
A road trip from Uttar Pradesh, a key vegetable growing area, to New Delhi reveals one reason for the waste: the poor road surface which means that fragile produce is easily damaged. Other problems exist that could more readily be resolved. At the farm, produce is handled roughly. It is piled into large cane baskets or on to truck beds without cushioning or packaging, and transported in open trucks that leave it exposed to the sun in temperatures often exceeding 40 degrees celsius. Twenty-four hours or more after harvest it arrives at the retailer, typically a pushcart or open-market vendor. The produce is then kept out in the sun in baskets or in open piles where it deteriorates rapidly. Much of it becomes inedible within a day or two of harvesting.
Low yields
India’s low agricultural production yields are the final part of the story. Yields for most key products are 25 to 40 percent of world-best levels. Even in areas such as milk, fruit, and vegetables, where India is the world’s leading producer, yields are less than 40 percent of the world’s best. The scope for improvement is demonstrated by China. Although India has 75 percent more arable land than China, it produces 30 percent less.
Improving yields is not just a great opportunity, it is imperative. India’s population is forecast to increase by half over the next 40 years. Meanwhile, the growth rate of arable land is negligible. This can only mean that to feed itself, the country must increase yields dramatically.
The reasons for low yields are again obvious. Seed and breed technology in India is nowhere near leading-edge. The country has few large seed companies capable of research on the scale required. Although India’s academic research is respected internationally, the challenge is for the state research institutions to get innovative technology from the laboratory to the field. Farming techniques and investment in equipment also lag behind. Farmers are frequently unaware of such simple practices as the appropriate spacing of seeds and the leveling of land. Indian farmers use less soil nutrient than Chinese farmers and have lower levels of mechanization (Exhibit 8 and Exhibit 9).
Low yields, combined with the excessive number of intermediaries in the procurement chain, the waste, and the loss of value, lock India’s food chain into a vicious cycle of low investment, low skill, low yield, low efficiency, and low added value. Describing the problems is easy, but transforming the vicious cycle into a virtuous circle is not. Industry will have to show imagination and commitment to transcend the boundaries commonly found between food processing, sourcing, and agriculture.
The policy environment
While most of the effort will have to come from industry, the government also has a role to play in producing a policy environment conducive to change. This is evident from our discussions with over 150 players in the Indian food industry. They have highlighted a wide range of hurdles that discourage large-scale investment, among them high taxation, complicated food legislation and administrative processes, and the lack of intellectual property rights.
There is much substance to these complaints. At one end of the spectrum, official policy has in the past treated processed foods as an irrelevant luxury for a westernized elite. At the other end of the spectrum, intervening in agriculture has been a political hot potato. Industry involvement in corporate farming, for instance, has been viewed as suspect and not politically viable. This has left the food industry hemmed in.
The good news is that space is opening up for investment in the middle ground, in the area of mass-market, basic foods. The government’s focus has recently turned to encouraging the role of agriculture in India’s development. In consequence, it is actively reforming both food legislation and the taxation structure. The recent budget gives a strong indication of the government’s increasingly positive attitude to the food industry: it removed biscuits and ice-cream from small-scale industry legislation, deregulated cold storage and rice milling, and reduced import duties and taxation on processing equipment.
Much remains to be done, however. Food products still face a great many unhelpful regulations. Some two dozen food laws seek to regulate who does what and the recipes they may use. Ice-cream manufacture is an interesting example. As a Western dairy product, ice-cream is in the "ruminate" quadrant of our matrix and seems the natural province of specialist food-processing companies. In India, however, ice-cream manufacture was until recently budget restricted to the small scale industries sector (SSI). In addition, the Prevention of Food Adulteration Act stipulates that ice-cream should have a minimum fat content of 10 percent. The act goes so far as to classify all frozen milk products as ice-cream, thereby ensuring full compliance with the official recipe. Gaining legislative acceptance for new recipes can take up to three years.
Food taxation is an even greater problem. Taxation is higher in India than in neighboring countries (Exhibit 10). Until the recent budget, import duties on cold storage and capital equipment added 25 to 50 percent to costs, while local excise added another 10 to 40 percent. The end product also incurs high taxes: 25 percent of the retail price in the case of ice-cream.
While these problems are not show-stoppers, they have discouraged serious investment in the industry in the past. However, there now seems to be increasing recognition that developing the food industry is crucial to raising agricultural productivity and achieving rural prosperity. As a result, large-scale investment is being more actively encouraged.
The answer: Scale and integration
Such investment is essential to transform the food system, and in particular to capitalize on the huge potential of mass-based, high-volume foods. We estimate that $40 billion needs to be invested across the system—in agriculture, procurement, distribution, and processing—to address the inefficiencies that exist at every level. If wheat millers want to produce low-cost, high-quality flour, for example, they will have to invest in procurement to obtain the right grade of grain and reduce the cost of wheat. They will also have to invest in helping farmers to procure and grow the most appropriate varieties.
The wheat industries in the United States and Europe show the way forward (see text panel "The evolution of the US wheat industry"). They once had similar difficulties: too many intermediaries in the food chain, too much waste and loss of value, and low yields. But they evolved to become the most efficient in the world through the efforts of food processing companies such as Cargill, ConAgra, ADM, and Tyson, co-operatives such as Mid-American Dairymen Incorporated, and retailers such as McDonald’s, Sainsbury’s, and Kroger. These businesses made huge investments. In the US alone the book value of investments for the 20 largest food companies is estimated at $83 billion.
Opportunities in poultry
Can integrated development take place in India? The answer is yes. A few industries have already made modest beginnings.
Poultry is one of them. India’s poultry industry today is similar to that of Thailand in the early 1970s (see text panel, "The Thai poultry industry"). Poultry in India is expensive, costing up to half as much again as it does in the United States, and three-quarters more than it does in Brazil (Exhibit 11). As in Thailand, high costs are driven primarily by low maize yields (which are one-eighth of US levels) and the resulting steep cost of feed. While poultry companies have started to improve breeds and processing facilities, little effort has yet been made to cut feed costs.
However, one medium-sized poultry company in the province of Maharashtra has realized that the opportunity in poultry lies in reducing production costs by "backward integrating" to reduce feed costs. Its first step has been to invest $17 million in a 2,000 tonnes per day feedmill, making it the largest feed manufacturer in India. It is also beginning to work with local farmers to increase maize production in the hope that the area will become a center for maize farming enabling it ultimately be able to source maize much more cheaply. If this happens, the company will be able to expand from being a niche supplier of upmarket processed chickens into supplying the larger wet market, and become a world-class poultry producer over the next decade.
Opportunities in wheat
Wheat milling provides another promising example of an Indian company with the vision to integrate across the food chain. This flour company has recognized that to manufacture high-quality atta at low cost, it needs to integrate backward into the supply chain. It has started with procurement.
First, it studied wheat mandis (local wholesale markets) and built a database of the quality and quantity of wheat arrivals in order to develop a grading system. Second, it is establishing a network of commission agents at the mandis who were trained in the grading and storage of grain. This should help reduce procurement costs by up to 20 percent. Third, it is setting up grain silos at its flour mills to help it both reduce waste and procure grain in season, also reducing wheat costs by as much as 20 percent. Finally, it is integrating back into production, working with farmers in adopted villages to improve wheat quality and increase the supply of the better varieties at the mandis.
Eventually, millers will build greater scale, enabling them to reduce waste from 8 percent today to the international level of 2 percent. The markup from the farm gate to the mill should drop from the current 25 percent to less than 10 percent.
Efforts such as these are the tip of the iceberg. The opportunities to supply basic foods for basic needs to hundreds of millions of consumers whose requirements are expanding with rising incomes, will be worth more than $40 billion over the next decade—more than the value of India’s entire industrial sector today. 
About the Authors
Kito de Boer is a principal and Amit Pandey is a consultant in McKinsey’s Delhi office.
This article is based on a report produced jointly by McKinsey’s India office and the Confederation of Indian Industry, entitled FAIDA—Food and Agriculture, Integrated Development Action. Faida means to benefit or enrich in Hindi. The report can be obtained from the Confederation of Indian Industry, 23, 26, Institutional Area, Lodi Road, New Delhi 110003, India.