On 26 December 2018, the Department of Industrial Policy and Promotion (DIPP) announced new rules for e-commerce players in India. While it delivered a surprise gift box to brick-and-mortar retailers, the new regulations were an unexpected blow to e-commerce marketplaces (ECMs) such as Amazon and Flipkart.
Between FY14 and FY18, e-retail in India grew at 40 percent annually to reach Rs 1 lakh crore in sales, way faster than offline retailers’ growth of 13 percent during the same period. The new rules will likely put a brake on this rapid growth of online players.
In 2016, the government permitted 100 percent FDI in the marketplace model of e-commerce, but not in the inventory-based model. In a marketplace model, ECMs act as platforms for vendors to sell their products. In the inventory-based model, ECMs own and sell products.
The DIPP, the nodal agency for formulating FDI policy, revisited its 2016 regulations and announced more stringent rules for foreign-owned ECMs following complaints from traders and small businesses that foreign-funded online companies were violating the existing FDI norms.
The key changes
-If an entity is owned by an ECM, it cannot sell its products on the platform run by the same ECM
– A single vendor can’t account for more than 25 percent of sales in an ECM or platform
– The rules puts curbs on exclusive partnerships with brands or providing favorable services to a few vendors
-The regulations also state that ECMs may not “directly or indirectly influence the sale price of goods and services” — a condition that could put an end to the blockbuster seasonal sales promotions that have aided the rapid growth of online revenue
– ECMs will have to report compliance with these guidelines to the Reserve Bank of India on an annual basis
In the past, ECMs did not hold inventory or sell products directly to consumers to comply with regulations. However, as a workaround, they established affiliates (through joint ventures with local investors) that operated as inventory-holding companies.
For instance, Amazon had Cloudtail Retail and Appario, whereas Flipkart had WS Retail, RetailNet and Omnitech Retail. These companies became among the largest vendors on the platforms of the respective ECM
Shift in dynamics
Amazon and Flipkart, accounting for about 70 percent of India’s e-retail industry revenue, generate about half of their sales through group companies, as per CRISIL.
Therefore, the new rules would require them to significantly restructure their supply chains. Both have begun to reset their business model to adhere to revised guidelines in less than 40 days from the date of implementation which was 1 February. This will not only increase compliance costs but also slow down their revenue growth.
How are ECMs dealing with the changes?
– Amazon has already divested its holdings in Cloudtail India, its largest online vendor on the amazon.in website. Cloudtail is a 49:51 joint venture between Amazon India and Catamaran Ventures (headed by Narayana Murthy).
– The Walmart-Flipkart deal may be at risk because of regulatory uncertainties.
– Amazon may have second thoughts about going ahead with its proposed stake purchase in Future Retail.
– Amazon’s existing business terms or shareholding pattern in Shoppers Stop could come under the scanner, thus affecting the latter’s operations.
How do offline retailers benefit?
The rules are aimed at soothing the nerves of numerous unorganised retail entities, who have had a tough time competing against online heavyweights.
Such small retailers stand a good chance to get empanelled with ECMs, since the latter would now have to source and sell a vast majority of their products through “independent” vendors.
Simultaneously, it would have a positive rub-off on organised offline retailers that have been forced to take a hit on their margins because of high competitive intensity. The likes of Aditya Birla Fashion and Retail, D-Mart, Reliance Retail, Trent, V2 RetailandV-Martstand to gain.
To avail offers and explore a wider product range (that wouldn’t be available on ECMs to the same extent), customer footfalls at stores could increase. Furthermore, to enhance brand and product visibility, these companies can use this opportunity to improve their online portals.
CRISIL estimates that the new rules will impact nearly 35- 40 per cent of ECM’s retail sales, estimated at Rs 35,000 -40,000 crore. This presents a window of opportunity for brick-and-mortar retailers, which may witness a bump in growth. If the offline retailers can garner even one-fourth of the impacted sales of ECMs, it would lead to top-line gains of Rs 10,000 crore.
Who will face the heat?
Shoppers Stop and Aditya Birla Retail (which operates ‘More’ grocery outlets pan-India) could lose the most. The duo was heavily banking on the stake sale agreement with Amazon to not only bolster topline but also pare debt.
The way ahead
Since interests of small retailers are protected, it would create a level-playing field for all, thus preventing monopolisation by a few.
In the last 5 years, India has steadily moved up in the ease of doing business rankings. The notification could be viewed as regressive by global businesses, who may have been eyeing the Indian markets for further growth. Regulatory uncertainties, coupled with proposed talks of data localisation, only add to their woes.
Online retail has attracted robust FDI inflows of over Rs 95,000 crore in the past four fiscal years. With the possible exception of telecom, no other sector in India has seen that pace and scale of funding. Amazon has been operating in India since 2012 and has spent an estimated USD 7 bn to build its operations in the country. Walmart has spent USD 16bn to acquire Flipkart.
While the new rules are intended to appease small businesses, an important electoral constituency, they will be detrimental for online retailers. In the long term, foreign capital flows will be at risk if the cost of doing business for online players increases significantly. Amazon exited China in 2007 for similar reasons.
Nonetheless, with multi-billion dollar investments at stake, foreign-owned ECMs will adapt to the evolving regulations and would continue growing, albeit at a relatively slower pace in the near term.―Money Control