Another Brick In The Wall?

India’s fast-growing e-commerce bazaar suddenly seems to have plunged in the womb of a disruption. Apparently, the disruption looks so bullying, so ominous, as if it’s posing an existential threat to a burgeoning sector that has, for most of the last decade or so, remained the blue-eyed baby of India’s start-up scene.

The factor that triggered this disruption was the new press note by the Department of Industrial Policy and Promotion (DIPP) of the Ministry of Commerce & Industry in December 2018 on reviewing of FDI in e-commerce that came into effect on Feb 1, 2019. 

As per the new set of regulations, e-commerce players cannot sell products or services supplied by their affiliated companies or from companies in which they have an equity holding. Also, while the new rules allow B2B ecommerce, they prohibit B2C e-commerce as well as offer of special discounts or exclusive deals, while imposing a limit on how much one vendor can sell on a particular portal.

Since then, fear and loathing have been hogging the limelight. In a kneejerk reaction after the notification, Amazon’s party owned sellers Cloudtail, Appario Retail Private Ltd, Amazon Retail, and Shoppers Stop Limited were forced to remove almost their entire inventory from the website, totaling to hundreds of thousands of removed products.

According to New York-based Marketplace Pulse that provides intelligence and data on global e-commerce, both Amazon and Flipkart drove more than half the sales on their marketplaces either through co-owned sellers, like Cloudtail and Appario on Amazon and the obsolete WS Retail on Flipkart.

Between Jan 17 and Feb 2 alone, as many as 25 million listings were removed from Amazon India, as it was preparing for the government’s updated e-commerce policy. Rival Flipkart too went through a smaller drop, Marketplace Pulse expected.

And the dust doesn’t seem to be settling down now, even after a fortnight since the storm was triggered by the new regulations. But the fear is not unfounded though.

The tighter FDI regulations, which online retailers say have been implemented ‘in haste’, have stifled Amazon and Flipkart -- the two biggest architects of India’s e-commerce which together account for 70% of India’s total online sales – with CRISIL estimating their loss to the tune of 30-40% of their sales. 

“Nearly 35-40% of e-retail industry sales, amounting to Rs 35,000-40,000 crore, could be impacted due to the tightened policy,” said Anuj Sethi, Senior Director, CRISIL Ratings, adding that the impact on e-retailers would be largely in the electronics and apparel segments, which account for a bulk of their revenues.

Unfair game?

So is India really at war with online retailers, especially the big global players who were welcomed just a few years back to the country’s enticing e-commerce market? If so, have the unflinching success tales of online retailing in India come to a screeching halt, as is feared by those who question the government’s regulations? 

Are small Kirana retailers or mom-and-pop stores (that dot the nook and corner of India) really at loss due to the sharp price discounting policy of online retailers, as is claimed by those who back the regulations? 

In other words, are online retailers really the ‘bad guy’ nibbling on the share of small retailers? And last, but not the least, are the golden days of India's fledgling e-commerce sector over now because of the stringent set of rules?

These are some of the fundamental but simmering questions lying unanswered beneath all the fuss triggered by the new regulation.

On the face of it, these new regulations may sound anachronistic, coercive and penalizing. But, in reality, they are not. 

E-commerce players in India have been subject to a number of government regulations in a market such as India where retail remains one of the most regulated, and at the same time, one of the intensely competitive sectors. In 2016, India’s central government came up with rules permitting FDI in B2B e-commerce under the automatic route. FDI in B2C online retail too was allowed, but with strings attached.

The rules also allowed 100% FDI under automatic route in ‘marketplace’ model of e-commerce, while prohibiting FDI in ‘inventory’ based model. It’s pertinent to explain here that in marketplace model, the e-commerce player merely acts as the facilitator between the buyer and seller, in the inventory model the player actually owns the goods and services to be sold through the online channel. 

By demarcating between marketplace and inventory models, the regulations had made it clear for e-commerce players about what the online retail structure should be going to be in the years to come. 

But that was not to be.

So what went wrong? 

While the March 2016 regulations sought to create a competitive and a balanced e-commerce market in India, in reality, the market turned out to be somewhat different from what was actually intended for by the government. 

As experts say, while FDI was only allowed in marketplaces and never in inventory based models, the companies were using marketing strategies to sell directly to consumers through a structure of affiliate companies. 

To elaborate it differently, while on the face of it players such as Amazon and Flipkart operated on the marketplace model, in practice, it has been a mix of marketplace-cum-inventory models. 

For instance, by virtue of its equity stake in vendors such as Cloudtail and Appario, the Seattle-based e-commerce giant was able to reinforce its dominant position, which as per the FDI regulation of 2016, was not permitted. 

As Siddharth Mahajan, Partner, Athena Legal, a New Delhi-based legal firm says, “They were complying with earlier regulations by creating innovative structures to overcome the regulations. They complied with the letter of the law but not the spirit of it. FDI was only allowed in marketplaces and never in inventory based models. However, the earlier regulations were loosely worded to give certain leeway to the likes of Flipkart and Amazon.” 

So in reality, what these new regulations announced in Dec 2018 seek to do is to plug those loopholes by mandating that foreign entities only operate marketplaces in India and not do direct selling either directly or indirectly.  

This means, online retail biggies complied with the letter of the 2016 law but not with the spirit of it, and what the new regulation of December 2018 have done is to redefine the FDI rules in a clearly worded manner. 

“The new regulations aim to convert these platforms into pure-play e-commerce marketplaces which ought to give access to all third-party sellers on a non-discriminatory basis,” Mahajan adds.

Victim of own success?

It goes without saying that e-commerce has seen unparalleled growth in India in the last few years. Driven by both demand and supply factors such as rising usage of mobile phones, increasing broadband usage, rise of an aspirational consumers in urban as well as rural areas, and proliferation of venture capitalists, etc., India emerged as one of the fastest growing markets of e-commerce, waiting for the global online retail giants to be courted.

Between fiscals 2014 and 2018, to cite CRISIL’s figures, e-retail in India grew at 40% a year to reach Rs 1 lakh crore, way faster than brick-and-mortar’s growth at 13%, during this period, that scaled to Rs 3.2 lakh crore.

No wonder, global bigwigs of the likes of Walmart, Amazon, and Chinese e-commerce giant Alibaba Group, came rushing in to capture a slice of fast-growing India’s retail pie. In the past four fiscals alone, FDI inflows of over Rs 95,000 crore landed onto India-e-commerce space.

Last year alone, Walmart forked out $16 billion to acquire Flipkart (world's largest e-commerce deal so far), rival Amazon bought 5% stake in Shoppers Stop, the country’s largest department chain operator. 

However, a part, though not the whole, of this boom in online retailing fed on the culture of deep discounts and sales to consumers. Global players, especially Walmart and Amazon pursued aggressive marketing strategies to capture the minds of the price-conscious Indian consumers, often pushing them to the brink of impulsive buying through rock-bottom price discounts or ‘predatory pricing’ .

It was fair enough till this much, as predatory pricing is a common free market practice that has been followed in several e-commerce markets and India has been no exception.

However, in this tug-of-war to get a bigger slice of an average Indian consumer’s wallet and stand taller than others, the e-commerce bigwigs in a way lost sight of the fundamental rules of marketplace retailing in India. 

Under the old regulations, Amazon and Flipkart were typically run on a marketplace-cum-inventory led model with the dominance of few big sellers in which the platform owners i.e. Amazon and Flipkart also had a stake. 

Special incentives were given to customers buying from these sellers. Even goods were purchased from related party entities by these preferred sellers for sale on platforms of Amazon and Flipkart. 

Anuj Trivedi, Partner at Link Legal, a Delhi-based law firm within the Globalaw network says, “Even the earlier legal regime did not permit an e-commerce entity providing a marketplace to exercise ownership over the inventory i.e. goods purported to be sold. However, many of the e-commerce entities in India created complex multi-layered corporate structures to get around these requirements.” 

No wonder, the recent changes have caused the business models of marketplaces such as Amazon and Flipkart to wobble and not really of the entire e-commerce sector per se. In fact, other online players such as snapdeal and shopclues, have welcomed the regulations. 

Click Vs brick

While trade bodies such as the Confederation of All India Traders (CAIT) have accused online biggies of causing significant damage to small traders through predatory pricing, the view that online commerce really dented the sales of small traders in India remains disputed.

Deep discounting by e-commerce players is a global phenomenon. But the lack of established correlation so far between the ‘ill’ effects of online retail on offline retail because of indiscriminate discounting has made it difficult to prove that online retail has actually breached antitrust laws.

Anil Talreja, Partner, Deloitte India, too refutes the argument that the massive Indian brick-and-mortar retail sector is facing any threats from the steep discounts of online retail in India.

“No, in my view there is no threat as a result of steep discounts. The market is very large and there is room for all to play,” he maintains.

The comparison between online and offline retail, and that too measuring the effect of online retail on brick-and-mortar retail is futile. This is simply because of the huge difference in their market sizes.

Just consider some numbers. Despite the surge in India’s e-commerce so far, online retail made up just 2.9% of India’s total retail sales in 2018, according to the research firm eMarketer’s report in June 2018, in which it forecast India’s e-commerce sales to climb 31% in 2018 to reach $32.70 billion. 

According to another estimate by CARE Ratings, the size of e-commerce industry in India is $38.5 billion, accounting for only 5.7% of the overall Indian retail industry.  

In fact, contrary to the popular notion that that predatory pricing of e-commerce is bad for brick-and-mortar, e-commerce has actually proved beneficial for India’s vast Small & Medium Enterprises (SME) sector. 

In a recent report ‘Impact of e-commerce in SMEs in India’ KPMG notes that “While traditional SMEs have focused on their core operations without experimenting with new and advanced technologies, e-commerce has helped technology-enabled SMEs to challenge the status quo and grow significantly over the last few years.”

KPMG’s also debunked the notion that e-commerce is a threat to India’s mon-and-pop stores.

“Although it has often been debated that FDI in B2C retail or e-commerce would cause Indian mom-and-pop stores to shut down, the study of developed markets where e-commerce has been in existence for more than quarter of a decade suggests otherwise,” it noted.

As per KPMG India’s analysis, India’s e-commerce presence is miniscule when compared to the offline expanse of the kirana stores. This coupled with issues of last-mile connectivity, high payment costs, diminished profits, limited skilled manpower and regulatory barriers keep the competition at bay.

Instead, it said, mom and pop stores offer a value proposition which is very different from that offered by the e-commerce players.

Kirana stores are hyperlocal in nature and tend to focus their attention on the loose and unbranded products which can be customized as per the consumer’s requirement as opposed to online e-tailing which focusses on the sale of standardized products to an organized market. 

Kirana stores also depend on catchment areas of a few kilometers, the dominance of which can never be challenged by organized retail, KPMG report maintained.

The report by CARE Ratings notes that the online retail growth has followed a disruptive course across markets. In relatively mature markets, like US, where the organised retail penetration is high, multi-channel retail chains lead to online markets. 

While in newer markets like India (with about 10% organised retail of which about 1.2% share held by e-tail) and China (with 20% organised retail), web-only players are dominating the market given the low organised retail penetration.

Back to the drawing board…

Despite the rumble around the issue, one thing is clear that the new FDI regulations will create a level playing field for e-commerce players in India, which was not the case before Feb 1. 

The big brothers – Amazon and Flipkart – who are the most hit, will now have to let go of exclusive deals, but that does in no way mean it’s the end of the great e-commerce success story in India.

The very nature of regulations has forced Flipkart and Amazon to fundamentally restructure the business models. What this effectively means that there will be no more flash sale, or for that matter, exclusive deals. One of the fundamental changes that the regulations have brought about is in the nature of supply chain that these retailers used to operate with. 

Now that they are not permitted to sell items from affiliates in which they have an equity, online retailers now have to search for new supply partners/ sellers on their marketplace. 

And this is what the big players have already started working on.

When BW Businessworld contacted Flipkart’s top officials to comment on the firm’s future course of action, the following comment of Dirk Van den Berghe, Executive Vice President and Regional CEO Walmart Asia & Canada was shared: 

“Walmart’s and Flipkart’s commitment to India is deep and long term. Despite the recent changes in regulations, we remain optimistic about the country. We will continue to focus on serving customers, creating sustained economic growth and bringing sustainable benefits to the country, including employment generation, supporting small businesses and farmers, and growing Indian exports to Walmart’s global markets.” 

Amazon, the other big player, too seems to be getting used to the new ‘normal’ and has started restructuring its vendor policy. 

For instance, as per reports, Cloudtail is no longer a group company of Amazon after NR Narayana Murthy's Catamaran Ventures increased its stake in Cloudtail's parent company Prione Business Services to 76% from 51% earlier, reducing JV partner Amazon Asia's stake to 24% from 49% earlier.

Further, as Market Pulse data reveals, 10 days after India's new e-commerce FDI policy came into force, most of the catalog of Amazon India that was taken offline was back. While on Jan 17, the number of products listed on Amazon India was 180 million, it reduced to 169 million by Jan 24, 163 million by Jan 23, and 154 million by Feb 2. However, by Feb 10, the number of listed products was restored to 168 million. 

“While we remain committed to complying with all laws and regulations, we will continue to look to engage with the government to seek clarifications that help us decide our future course of action as well as minimize the impact on our customers and Indian sellers,” said an Amazon spokesperson.

Also, experts turn down cynicism emerging from some quarters that there could be lesser enthusiasm by consumers now to shop online as there are no more exclusive deals or flash sales that used to drive millions of them to shop online earlier.

“The move to restrict exclusive deals will definitely be a dampener when it comes to consumers looking for a steal. However, I believe price is only one of the elements that is driving the boom in the e-commerce sector today. Access to a larger array of products, better pre and post purchase customer service, accountability and convenience are driving the growth of the industry more than the pricing. I don’t see a long term impact from a consumption perspective,” says Ankur Nandu, Director of e-commerce at chargebee.com, a Chennai-based subscription-management and billing firm that works with customers across different sectors especially e-commerce. 

…but retail story remains intact

With the giants having announced they would accept the new regulatory, India’s e-commerce story continues to remains on track.

In its another report ‘E-commerce retail logistics in India’, KPMG notes that the online retail market in India has grown by leaps and bounds from its nascent state in the mid-2000s to its current market of $19.5 billion worth of transactions.

A market which has about 80-100 million online shoppers, is growing organically with the increasing employment ecosystem and new shoppers who are already among the 450 million+ internet users in India predominantly from the tier II and below cities and towns in India. 

The latter are coming in to the online shopping bandwagon due to various digital interventions by e-retailers as well as other ecosystem players, KPMG notes.

The long and short of it is, although the new regulations have disrupted the online retail business model in India this is just a transitory phase. Despite the disruption in the existing business model brought about by the new regulatory paradigm, the rationale behind India’s e-commerce business will always remain there. 

“The e-commerce industry is being driven by a lot of fundamental changes and I don’t see the recent changes affecting the e-commerce sector as a whole,” adds Nandu of chargebee.com. 

According to ASSOCHAM-Forrester study paper, India’s e-commerce is one of the fastest growing channels for commercial transactions. E-commerce in India is growing at an annual rate of 51%, the highest in the world, and is expected to jump from $38.5 billion in 2017 to $200 billion in 2026.

India Brand Equity Foundation (IBEF), on the other hand, expects that by 2021 India’s traditional retail will have a major share of 75%, organised retail’s share will reach 18% while that of e-commerce will reach 7% of the total retail market.

Melissa Frakman, Managing Partner, Emphasis Ventures (EMVC), a US-based $25mm venture fund backing innovation in India's ecommerce, fintech, and internet sectors sums it all up, “There remains a massive market for serving hundreds of millions of Indians and over 40 million small and micro local businesses in the country. Despite the current ambiguity about how things will shake out in the short term, the outlook over a medium-to-long-term for Indian ecommerce is strong.” 

“Consumer-driven demand, coupled with a national payments system with unparalleled convenience as well as increased smartphone penetration, will drive adoption. There is room for more than two dominant actors,” she adds.

Politically motivated?

So far so good. 

While it makes sense to appreciate the motive behind the new FDI regulations expected to play a greater role in ensuring a level-playing field for online retail in India, what has brought the whole issue under the scanner of conspiracy theorists is the timing of these regulations. 

At a time when India is going to elect a new Parliament through general elections in just a couple of months, many see these regulations as a move by the ruling BJP party to appease small brick-and-mortar traders, who remain one of the party’s core supporters.

However, while the timing of the regulations makes the whole exercise look politically-motivated, it’s not 100% true either. The government came up with the new set of regulations only following complaints from brick-and-mortar retailers and traders.

In October 2018, for instance, the All India Online Vendors Association (AIOVA) had filed a petition with the Competition Commission of India (CCI) alleging that Amazon favours vendors such as Cloudtail and Appario in which it has equity stake. A few months earlier, in May 2018, AIOVA had filed a similar complaint against another giant Flipkart, alleging preferential treatment of select sellers.

The timing factor apart, however, the more important fact is that India’s e-commerce sector has entered a new growth phase, a new normal era where rising disposable incomes, favourable demographics, rapid digitalization and increasing urbanization will all play as tailwinds and enable both online as well as the brick-and-mortar retailing to soar high.

With no apparent dearth of capital or entrepreneurship, the competition among e-commerce players is only going to get intense in the next few years that can only be good news for India’s aspirational consumers, especially its burgeoning middle class.