India e-commerce: The return of red tape

When India's Department of Industrial Policy & Promotion (DIPP) announced a change in regulations on e-commerce last month, the tweeted thumbs-up from Snapdeal co-founder Kunal Bahl was noted both for its enthusiasm and for its rarity. Reactions from other Indian e-commerce executives were muted, with neither Amazon's nor Flipkart's leaders expressing either support or opposition to the measures.

This low-key response reflects a broader skepticism about the real significance of the new rules, which allow 100% foreign direct investment (FDI) in B2C online marketplaces while restricting the level of control that online retailers can exercise over pricing. Many operators are unsure what impact they will have on business.

"Snapdeal is and has always been a marketplace, so from their perspective it's wonderful. I think you didn't see much of a reaction from the other large players, partly because they're not 100% marketplaces," says Ash Lilani, co-founder and managing partner of Saama Capital. "They are trying to be, but they're not all the way there."

These new rules sort of spoiled the show for Amazon and Flipkart. Their aggressive pricing has been their business strategy, but they’ll need to cut that out completely – Vishal Pereira

The push to reform India's e-commerce industry has been building for a long time. However, there is still uncertainty over regulators' motivations for introducing the measures, and the advisability of promoting a particular form of e-commerce over another.

Motivating factors

First of all, the vast majority of Indian e-commerce start-ups, both marketplace and inventory-led, already receive foreign investment. Flipkart, Snapdeal and Shopclues have all reached valuations of more than $1 billion with support from offshore backers including Tiger Global Management, Sequoia Capital, Alibaba Group, and Tencent Holdings.

Many see the move to open the industry to full foreign ownership as a means of allowing new entrants into the market. Under the revised regulations, a foreign retailer such as Wal-Mart could start a business in India and, as long as it met the proper requirements, it would be considered an online marketplace on the same level as any other.

"Right now, if you look at all these companies, they have some sort of domestic ownership through the founders," says Lilani. "I think what they're trying to say is that any new entrant coming in, even if there's zero domestic ownership, it's fine."

Allowing greater participation by foreign players would also create more opportunities for smaller sellers to market their products online, which is widely considered to be the real reason for the announcement. The new rules specify that a single seller cannot provide more than 25% of the goods on any particular marketplace, a move that would promote a wide seller base.

However, many are skeptical that the promotion of marketplaces will have the desired impact, since the addition of more online sellers could lead to an oversupply and reduction in profits. "You're trying to tell the seller you're protecting him, but really you're not. While you're trying to enable the seller and give him more responsibility and greater exposure to the market, at the same time he is not going to make enough of a margin," says Vishal Pereira, managing partner at CreedCap Asia Advisors.

The DIPP's moves to limit control over pricing also arose from a sense of frustration at the operation of India's online retail sector, especially the inventory-led models pursued by Flipkart and Amazon. The discounts that many retailers use to attract customers have led to continual price wars, meaning low profit margins for sellers. Offline retailers have also complained about this practice, accusing online players of unfairly undercutting them on price and harming their businesses.

Under the new rules, this competitive pricing model will be completely banned, with companies forbidden from "directly or indirectly [influencing] the sale price of goods or services."

"These new rules sort of spoiled the show for Amazon and Flipkart," Pereira says. "Their aggressive pricing has been their business strategy, but they'll need to cut that out completely and the inventory-led model is going to take a big hit, not just on that, but also from the customer side of things."

Grofers gains?

For operators of online marketplaces, defined under the new regulations as sites that connect buyers and sellers but hold no inventory themselves, the change is likely to have less impact. In the case of online hyperlocal delivery service Grofers, for example, merchants set prices themselves, and the company has never offered discounts to customers.

The example of Grofers also highlights a potential loophole in the regulations: while marketplace sites may not offer discounts themselves, individual sellers are still free to do so. A company might therefore suggest discounts or promotions to sellers, even on specific products; as long as the ultimate decision to implement the discount is made by the seller, there is no problem. This could actually give marketplaces a price advantage over inventory-based businesses, which will be allowed no such flexibility.

"Apart from offering discounted promotions, they're also using our platform to run various side promotions as well. A big retail player may choose to run a specific promotion on our platform in one city but not in another," says Prashant Verma, brand lead for Grofers. "It's a natural thing for our kind of business, and it's perfectly fine, because we are not influencing prices directly. We always source from the local players, and they are the ones who are creating these promotions."

The ban on discounts has attracted criticism, with industry players asserting that regulating prices to this extent is unnecessary in a free market. In fact, India may have already passed the point at which pricing is a factor, with consumers, like those elsewhere in the world, now enticed by the benefits that online retail offers in addition to cost.

"If you look at any market, it starts with price, but over time price is not the only factor. The consumer gets used to the convenience and the variety that's available because it's not a physical limitation on how much inventory you can have," says Saama's Lilani. "I think it's mistaken if they think they can control competition purely by putting limitations on price."

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• Topics
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• Saama Capital