The new government rules regulating e-commerce marketplaces will impact Amazon and Flipkart negatively, while Snapdeal and other ‘pure’ marketplaces will come out on top.
New Delhi: The government, on late Tuesday evening, released a set of rules that ostensibly tackle the manner in which foreign direct investment can enter the e-commerce industry, but also take a hard look at the corporate structuring of the online retail sector and the impact that deep discounts have had on India’s traditional retail market.
Consequently, while Department of Industrial Promotion and Policy (DIPP) has allowed 100% foreign direct investment (FDI) in the marketplace model of e-commerce, the new guidelines also come with devastating consequences for two of the foundational pillars of India’s online retail industry.
The first biggest take-away is that the DIPP has effectively outlawed discounts, predatory pricing and those “big-billion sales” that fuelled consumer demand even as it burnt millions of dollars in venture capital money. In a list of conditions for companies that accept FDI and operate an e-commerce marketplace, the new guidelines state: “E-commerce entities providing marketplace will not directly or indirectly influence the sale price of goods or services and shall maintain a level playing field.”
The second blow involves the manner in which most e-commerce marketplaces such as Flipkart and Amazon have structured their seller base. To this, the DIPP has attached a condition that reads “An e-commerce entity should not permit more than 25% of the sales effected through its marketplace from one vendor or their group companies.”
Historical perspective: Corporate structuring
In order to understand why the new 25% rule is potentially game-changing regulation, it’s important to understand what exactly the government has announced. For one, it has reaffirmed the long-standing position of disallowing FDI in business-to-consumer e-commerce (B2C).
This has been the legal position of past Indian governments and was the regulatory position when companies such as Flipkart and Snapdeal started out as small start-ups. No FDI in B2C e-commerce means that foreign-funded players such as Flipkart couldn’t operate under an inventory-led model. An e-commerce company, if funded by foreign venture capital, could not simply buy merchandise from various wholesalers, stock that inventory in their own warehouse and then sell those items on a website to online shoppers.
A number of FEMA and FDI violation inquiries and cases prompted Flipkart and Snapdeal to shift from an inventory-led model to an e-commerce marketplace model. In the marketplace model, companies such as Flipkart and Snapdeal merely became an intermediary for sellers and shoppers. The online retailers themselves don’t own inventory. Anybody from a mom-and-pop shop to a big electronics company like Samsung could earmark some inventory towards an e-commerce company and sell through Flipkart or Snapdeal to its customers.
Though an e-commerce marketplace model may not have been officially allowed, it was seen as a clever work-around that allowed companies to skirt FDI regulations while servicing the Indian market. When Amazon first launched in India, it launched through a marketplace-led, e-commerce model.
Here’s where things get interesting though. The problem with an e-commerce marketplace model is that the quality of service, shopping, delivery and overall customer satisfaction tends to be low. When any seller, regardless of quality, can sign up to be part of the Flipkart or Snapdeal marketplace, faulty delivery orders and fraud are likely to be common occurrences. The famous case of a man ordering a Samsung smartphone off of Snapdeal and receiving a bar of soap instead is a classic example of how marketplace-led models can go wrong.
In order to get around this, what Flipkart and Amazon have done is create a ‘primary seller’; a way of getting around the weaknesses of the marketplace model. For instance, for Amazon, Cloudtail India Pvt Ltd. is the biggest seller on Amazon India and according to some estimates contributes nearly 40% of the company’s sales. Who is behind Cloudtail India though? It’s a joint venture between former Infosys CEO N.R Narayana Murthy’s Catamaran Ventures and Amazon Inc.
On similar lines, Flipkart’s largest seller is WS Retail Services, an organization that can be traced back to Flipkart itself. In this manner, Flipkart and Amazon skirt the FDI regulations on inventory-led e-commerce models while overcoming the weaknesses of a pure marketplace model.
Where the new regulations kick in now is by specifically allowing 100% FDI in e-commerce marketplace, albeit with a rider that “no one vendor on the marketplace should be allowed to contribute more than 25% of the company’s overall sales”. This means that Amazon and Flipkart need to stop passing off a quasi-inventory-led model as a marketplace model. Instruments such as Cloudtail and WS Retail Services will slowly have to wind down and contribute less to the company’s sales, thus ideally resulting in a more level-playing field to India’s traditional retailers.
In a statement, the All India Online Vendors Association, a group of sellers that sell primarily on e-commerce marketplaces, state that the new 25% rule will allow online retail companies to widen their seller base.
“This will curb the malpractices of WS Retail, Vector E-commerce and Cloudtail whose agreements with e-commerce companies are not in public domain,” the statement says.
Amazon and Flipkart have, understandably, not yet officially commented on the new regulations, Snapdeal co-founder Kunal Bahl, on the other hand, has come out enthusiastically in favour of the new guidelines. In a tweet, Bahl said “Always a great feeling when you stick to the course that you believe in, pays off: Focusing on a pure marketplace and not doing inventory.”
Since 2012, Snapdeal preferred a more purer version of the marketplace model, eschewing measures such as propping up a primary seller. While this may have slowed its growth and resulted in quality concerns, it also means it has less overhead and requires less capital to grow. Consequently, the new 25% seller rule will not affect it as much as Flipkart and Amazon.
The second major impact, primarily to consumers, has been the issue of discounts and predatory pricing.
In a strikingly, anti-free market approach, the new guidelines state that online retailers can’t “directly or indirectly” influence the price of goods and services. While this phrasing may sound a little peculiar, it’s been laid out as such in order to deal with the innumerable ways that online retailers fund discounts in the current industry.
The Mint, for instance, details out how Amazon funds discounts by its sellers through a method called ’promotional funding’. E-tailers such as Amazon informally recommend a price that sellers on marketplace should quote while selling a certain time, but doesn’t actually ask them to adopt that particular price. When sellers do fix that suggested price, they can send a “debit note” to Amazon that covers the cost of discounts that they give on a specific item. Amazon then quietly refunds its sellers.
It is unclear at this point though whether other methods of discounts such as ‘cashbacks’ — of which online payment service and marketplace Paytm is a big pusher — will also be viewed as indirect methods of influencing the prices of goods and services.
One way of viewing the DIPP’s note is, therefore, to see it as a way of urging the Competition Commission of India into taking a more proactive stance in making sure there is no predatory pricing. While this is certainly a big blow for online Indian shoppers, who have been weaned away from the offline retail model through low prices, it also offers e-tailers a chance to switch off the money spout; though there is very little reason to believe all online retailers will toe the line and not look for creative workarounds instead.
“This will be a nightmare when it comes to compliance. It would be far better to properly and consistently allow FDI into offline, traditional multi-brand retail. That’s a proper way of bring about a level-playing field,” a top executive of an Indian online retailer told The Wire.
Liability and being an intermediary
These new regulations, on the whole, look to correct the shoddy structuring of the e-commerce industry as a whole, while also laying out methods in which e-commerce marketplaces should interact with their customers. While some of these steps, such as the move to ban discounts, are protectionist in nature, other conditions that come attached to FDI approval are contradictory in nature.
Two conditions in the new guidelines, for instance, state that: “Any warranty/guarantee of goods and services sold will be the responsibility of the seller.. Post sales, delivery of goods to the customers and customer satisfaction will be the responsibility of the seller.”
This essentially means that the guidelines view e-commerce marketplaces strictly as a technological mediator and absolve them of legal liability. If a customer receives a bar of soap instead of a smartphone, they will find it difficult to hold Flipkart or Snapdeal liable.
While online retailers are unlikely to take this to heart, considering that quality of service and delivery is a competitive advantage in the e-commerce industry, it does mean that sellers on e-commerce marketplaces will have to step up and take greater responsibility and not hide behind the Flipkart or Snapdeal brand name.
The decision to give greater responsibility to the seller seems odd when considering how various state governments have viewed Ola and Uber as a technological mediator. In these cases, radio-taxi licences are given out to online taxi companies only after they establish strict background checks and institute safety-call centres in each city that can be used to track down erroneous drivers and receive complaints.