The potential of the Indonesian retail market in the medium-to-long term remains substantial despite an expected flattening of growth in national retail turnover this year, consistent with the slowdown in the Indonesian economy.

The Association of Indonesian Retailers (Aprindo) expects the value of modern retail sales in 2014 to grow by 10 percent to reach Rp 162.8 trillion (US$13.4 billion). Demand for fast-moving consumer goods (FMCG), in particular food and beverages, remains the principal driver and contributor to retail demand (greater than 60 percent).

Several consumer drivers are likely to act as catalysts for positive national retail growth going into the future. First, rising incomes are expected to increase spending on retail items. Second, an increasing population, especially an expanding middle class, is expected to boost consumption. According to AC Nielsen, 48 percent of total spending on FMCG comes from middle-class income.

A demographic dividend, urbanization and changes in the lifestyle of the middle class will also enhance spending in the modern retail sector. Third, the Indonesian Consumer Confidence Index, which indicates that the level of optimism among Indonesian consumers is still quite high in comparison to other countries, should also drive consumption. And last but not least, the rapid growth in commercial property supports the development of the retail sector. The penetration of modern retail into '€œsecond-tier cities'€ is also on the rise with an ever-expanding number of outlets being opened by retailers in cities on the outskirts of Jakarta as well as in other cities both in and outside of Java.

AT Kearney'€™s 2014 Global Retail Development Index (GRDI) places Indonesia in 15th position among developing countries as a retail investment destination. The Asian countries that made it into the Top 30 of the GRDI besides Indonesia were China (2nd), Malaysia (9th), Sri Lanka (18th), India (20th), the Philippines (23rd) and Vietnam (28th).

The GRDI rates the Top 30 developing countries for retail investment based on several macroeconomic variables as well as retail-specific variables. In the study, it was explained that Indonesia remains a promising retail market and provides great retail investment opportunities in the medium-to-long term albeit with a variety of existing challenges, especially as relate to increasingly stringent government regulations. These include a rule concerning the maximum number of modern franchise outlets allowed (including foreign ones), which is capped at 150, and a rule on the proportion of '€œlocal content'€ among products being sold '€” at least 80 percent of the amount and type of goods traded.

These challenges notwithstanding, in general it can be said that the Indonesian retail market is still attractive to foreign retailers. This is evidenced by the continuing influx of world-class retailers to Indonesia in 2013, such as Lotte Shopping (South Korea), Galeries Lafayette (France) and Uniqlo (Japan). Meanwhile, there are a number of other foreign retailers that plan to begin operating in Indonesia in 2014, including IKEA (Sweden), Courts Asia (Singapore), Parkson Group (Malaysia) and Central Department Store (Thailand).

While traditional retail is still dominant (56 percent), the increase in the market share of the modern retail trade in groceries in Indonesia over the last 10 years has been quite rapid because of its convenience (in terms of location, payment methods, etc.). Traditional retail sales are expected to grow around 6-9 percent per annum, compared to 15-18 percent in modern retail sales.

The minimarket and convenience-store formats are expected to continue leading growth of these types of sales. According to projections from Euromonitor, sales from minimarkets and convenience stores are expected to grow at an average of 16 percent per year from 2013 to 2015. Meanwhile, looking at the growth of outlets in terms of numbers, in the last 10 years the minimarket format has grown at an average of 17.4 percent per annum, and hypermarkets at 17.9 percent per annum, whereas the supermarket format has been increasingly left behind with average growth of just 3 percent per annum. The penetration of Indonesian modern retail outlets in terms of numbers is on average lower than that of other ASEAN countries.

Each modern retail format has its main player. Development of minimarkets is driven by the expansion of the Alfamart and Indomaret businesses that control about 87 percent of the market share in their format. The top three players in hypermarkets are Carrefour, Hypermart and Giant, which account for about 97 percent of market share. The main players in the department-store format are Matahari Department Store and Ramayana, which enjoy around 55 percent of market share. Meanwhile the supermarket format is very fragmented so there is not a single player with a market share above 7 percent. Super Indo and Hero are the main players in this format, with a combined market share of around 12 percent.

Rental costs, labor costs and utilities form the largest portion of the operational-cost structure for retailers (60 percent-80 percent). The cost of renting a retail space in a big city like Jakarta is expected to rise in 2014, driven by an increase in retail-space service charges due to rises in the price of electricity and wages. Meanwhile, tight competition often pushes the cost of advertising and promotions higher. For retailers that sell products with high import content, ongoing fluctuations in the rupiah are also of concern. Depreciations in the value of the rupiah have an effect on the cost of goods sold by several retail companies.

In summation, despite its promising market opportunities, the retail sector is also facing an increasing number of challenges in the form of tighter competition, rising operational costs, as well as increasingly stringent government regulations. Faced with all these pervasive challenges, the major players in the retail sector need to keep expanding. Expansion is one of the strengths that companies in the consumption sector can use to maintain their market share, in addition to continuing to innovate and diversify their products, maintaining efficiency and making technological advances in the supply chain. Tight competition in the retail sector is also expected to drive the development of e-commerce in Indonesia.

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The writer is an industry analyst at Bank Mandiri.

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