Turbulent Times For e-tailers

The e-commerce sector in India was a hotbed of activity in 2018 — from the jaw-dropping deal of Walmart acquiring Flipkart for $16 billion to BigBasket raising $300 million from Alibaba and Amazon pumping additional $2 billion in investments in India. It was the year when private labels and in-house inventories grew substantially, and discounts continued to lure more shoppers to the online channels.

The cheer, however, has been short-lived. On December 26, 2018, the Department of Industrial Policy & Promotion (DIPP) introduced certain changes and clarifications to the 2017 policy governing Foreign Direct Investment (FDI) in the e-commerce. (100% FDI is allowed in marketplace model whereas no FDI is allowed in inventory-based model). The policy, that is set to come into effect from February 1, 2019, has the potential to completely change the dynamics of the e-commerce landscape in India.

“Companies that run part market place models, businesses that promote private labels over 3rd party brands and use a network of their own services for fulfillment stand to be impacted with the implementation of this policy,” says Ashish Fafadia, partner, Blume Ventures, a seed-stage venture fund that has invested in start-ups such as Purplle, Milkbasket and RailYatri.

Policy Prism

To put things in context, let us understand what the policy states. Firstly, an e-commerce entity cannot exercise ‘ownership’ and ‘control’ over inventory, i.e. more than 25% of the vendor purchases cannot be from e-commerce entity or group companies. This amendment intends to curb scenarios where e-commerce or their group entities primarily sell goods to vendors, who ultimately sell to consumers on the platform of such e-commerce entity, states Ankur Pahwa, partner and national leader – e-commerce and consumer internet, EY India.

Secondly, a vendor will not be allowed to sell on an e-commerce platform if the platform has ‘equity participation’ in the vendor. Experts believe that such restriction may impact online vendors (with equity participation from e-commerce entity or group companies) which are engaged in manufacturing or single brand retailing, if they intend to sell on the platform.  

Thirdly, the policy allows services such as logistics and warehousing to be provided to vendors by marketplace or group entities in a fair and non-discriminatory manner. Similarly, cashback to buyers on the platform by group companies of an e-commerce entity needs to be fair and non-discriminatory. But ambiguity in defining ‘fair and discriminatory’ makes it highly difficult to implement as no guidelines have been provided. 

Fourth is a clause that has raised quite a few eyebrows: ‘exclusivity’. It mentions that e-commerce entities shall not mandate any vendor to sell product exclusively on its platform. However, it does not refrain vendors from voluntarily selling exclusively on the platform. “Given that there are numerous online only businesses and exclusive launches and partnerships are part of the commercial strategy, it’s important that this clause be considered holistically rather than focus just on the concept of exclusivity,” says Pahwa.

Fifth is introduction of the prescribed annual compliance by e-commerce entity (along with report of its statutory auditor) that needs to be made with the RBI by September 30. No format has been currently prescribed, hence one needs to lookout for potential complications that may arise in reporting, once notified. 

Immediate Impact:

According to the DIPP, such an intervention was needed as the Government continued to receive complaints that e-commerce players were violating the policy by influencing the price of products and indirectly engaging in 'inventory-based' model. The new policy aims to plug gaps in the earlier policy (aka innovative structuring via JV and subsidiaries), ensure all sellers on the platform are truly independent from “ownership” and “control” perspective, discourage the marketplace platform from influencing pricing, promotions, and product exclusivity and provide both small and large vendors a level playing field with multiple platforms to sell.

“Marketplace as a definition means that you are a platform that provides warehousing, logistics and a way to connect buyers and sellers. Some players tried to figure an alternative framework to do inventory-based model which wasn’t in 100% compliance. That is perhaps why DIPP has come out with clarifications,” says the founder of a leading e-commerce company on condition of anonymity.

One of the biggest impact is likely to be on the private label business built by players such as Flipkart, Amazon and Myntra across categories such as apparel, home furnishing and grocery. Private labels not just help in better margins, but also allow e-commerce entities to control sourcing, quality and pricing, and are often sold at prices lower than that of established brands. It is expected that with the introduction of this policy, the platforms will no longer be able to promote their own brands more than others. In the context of sale of private labels products, the DIPP has clarified that the policy does not impose restriction on nature of products that could be sold on marketplace. 

Pahwa opines that while certainly a level playing field and supporting MSMEs is the intention of the law and trader bodies, players not being allowed to sell their own brands or private labels will have significant impact on unit economics and profitability.

Big online players will, in fact, need to relook at their holding and operating structures within India to ensure that they do not take inventory risk relating to goods listed on their platform. “This will include any equity participation they may have in any vendor which lists products on the platform and also any supply arrangement they may have to such vendors directly or indirectly...In short term, we will see more parity in prices between offline and online for a number of categories,” says Singh.

Amazon and Flipkart, which account for a lion’s share of Indian e-commerce sales, encourage customers to purchase goods through vendors like Cloudtail and until recently WS Retail for Flipkart, as they have a controlling stake in these companies. Additional cashback, faster delivery and pricing benefits are offered on purchases through these vendors. They also have exclusive partnerships with brands such as OnePlus and Huawei, on Amazon and Flipkart respectively.

Fafadia states that the rationale behind the policy is to possibly try to set up a level playing field with full market place model vis a vis deeply funded using FDI. “But honestly I don’t fully understand the timing of the policy and why they would do it unilaterally with such a short time.  The policy also results in ensuring that these entities that are foreign controlled or managed cannot have their own portfolio of brands benefit at the cost of the other 3rd party brands,” he says, adding that the clarifications leave lot of scope for further clarifications and would largely be seen as beneficial to the local retail sector.

While shared economies companies, such as food delivery, OTT players, music, classifieds and pure-play marketplace models, such as Snapdeal and ShopClues, will not be affected, the biggest beneficiaries of this policy are likely to be offline retail stores. They have, for a long time, faced the burden of irrational discounting offered by e-tailers.

Kishore Biyani, group CEO, Future Group, in a recent interview to the Economic Times said, “The policy saw one of the best clarifications from the government because there were rules which talked about marketplace B2B business and doing retail business was in circumvention of that policy, an ambiguity, which in some way people were taking advantage of…We are very happy that there is a level playing field.”

As per Government and brick and mortar store owners, the e-commerce foreign investment norms were not being followed in spirit by adopting creative structures using managed/ friendly group structures. “The new e-commerce policy strives to leave little room for such creativity to ensure parity between online and offline sales channels,” says Amarjeet Singh, partner – tax regulatory and internet business, KPMG in India.

One mustn’t miss out on the fact that pricing, discounts and private label mix are equally relevant in brick and motor multi-brand retail businesses as they are for e-commerce companies. “It will certainly be interesting if we see similar stringency being applied there as well, especially if the intention of this is to protect small vendors and suppliers, who would be seeing the same impact irrespective of online vs. offline,” signs off Pahwa.