Home / Industry / Retail /  Fancy valuations of e-commerce marketplaces run into policy hurdle

New Delhi/Bengaluru: When the Indian government on 29 March allowed 100% foreign direct investment (FDI) in online retail of goods and services under the so-called marketplace model, a strange thing happened: there were no victorious celebrations. Most top e-commerce firms simply remained silent.

One would have expected Internet companies to cheer the fact that India finally sought to legitimize existing businesses of Indian e-commerce companies, which were more or less operating outside of the law until now. As usual, however, the devil is in the details, in particular three conditions attached to the approval of FDI in e-commerce.

These three conditions could either hurt e-commerce companies or force them to find new ways to get around them.

One, no group company or seller on a marketplace can contribute more than 25% of the sales generated. Two, marketplaces cannot influence product prices, meaning an end to the era of steep discounts that has led to exponential online sales growth. Three, small sellers will now have to take responsibility for the quality of goods and after-sales support.

Under the inventory model, an e-commerce firm buys, stocks and sells goods, while in the marketplace model, it simply acts as a platform connecting buyers and sellers.

Industry body Internet and Mobile Association of India (IAMAI) circulated an internal paper, a copy of which was seen by MintAsia, that wondered if e-commerce marketplaces need to seek an extension from the government to comply with the new FDI norms. However, according to three people directly associated with the development, this idea was shot down as several IAMAI members failed to reach a consensus around the need for an extension.

It isn’t immediately clear if the new rules apply to all online businesses or not. However, several lawyers MintAsia spoke to confirmed the law covers a wide range of Internet firms, including online travel agencies, cab-hailing services, hotel start-ups, home services providers, food ordering and grocery delivery apps.

“These regulations create more confusion and more grey areas for firms to leverage on," said Debashish Mukherjee, partner and head of the consumer and retail industries practice at consulting firm AT Kearney.

The new rules certainly apply to India’s top e-commerce firms.

And the end of discounting, if it happens, will also significantly hurt the steep valuations of e-commerce firms, including Flipkart ($15 billion), Snapdeal ($6.5 billion) and Paytm (more than $3 billion). It would also severely restrict the rapid sales growth of Amazon India, which, in February, increased its capital commitment to 16,000 crore ($2.4 billion), exceeding the $2 billion the firm promised in July 2014.

Online retail is expected to increase to $48-60 billion by 2020 from $4.47 billion in 2014, according to UBS AG. The potential size of India’s online business has attracted an unprecedented rush of cash from venture capital investors, who pumped in more than $9 billion into e-commerce firms over the past two years. A huge chunk of this money has been spent on attracting customers through advertising and, more importantly, discounts.

The new regulations would put at risk the rapid growth of online retail—and the high valuations of e-commerce firms—in India.

To reiterate the government’s intention of stopping online marketplaces from influencing prices, Ramesh Abhishek, secretary in the department of industrial policy and promotion (DIPP), warned on 31 March that e-commerce firms offering discounts despite the government prohibiting pricing intervention run the risk of violating the law.

Some law experts criticized the government’s move to regulate pricing on online marketplaces. “Pricing should best be determined by market forces," said Pratibha Jain, partner at law firm Nishith Desai. “Besides, the job of the Competition Commission of India (CCI) is already there to see there is no predatory pricing. The government should not determine if marketplaces should be indulging in discounts or not. Such a move is bad for future investments in start-ups. This sudden flip-flop in the government’s attitude towards the start-ups sector will affect investments in future."

Many experts said the norms around pricing are designed to favour offline retailers, which have been hammered by the explosive growth of online retail. The deep discounting by e-commerce firms has attracted shoppers away from offline stores, which have lobbied hard with the government to rein in e-commerce firms.

The pricing regulation makes it much more challenging for online marketplaces to continue undertaking promotional activities to attract new customers through discounts or cashback schemes, said the law firm Trilegal in a report on the new FDI regulations.

“This provision also reinforces the intention of DIPP to allow only pure online marketplaces, and the impact of this rule on the nascent Indian e-commerce market will be significant as they will have to fine-tune their business model to comply with this requirement," the report said.

In any case, e-commerce firms across the board are trying to find new ways to continue offering discounts and figuring out how to restructure their companies to comply with the new FDI rules.

E-commerce firms already use imaginative methods to offer discounts.

For instance, Amazon funds discounts by sellers indirectly through a route it calls “promotional funding". This is how it works: Amazon recommends the amount of discounts to sellers of products on its platform, but doesn’t force them to adopt these suggested prices. Sellers, however, end up keeping these suggested prices because Amazon finances the discounts. At the end of a certain period, sellers send a debit note to Amazon. This note contains the amount of discount the seller gave on apparel, electronics, toys and other products sold on the site. Amazon then pays the seller by cheque.

Payments and e-commerce firm Paytm offers discounts through so-called cashbacks. Often, the company gives cashbacks—anywhere between 10% and 80%—on products instead of direct discounts; these cashbacks are then returned to customers’ Paytm wallets and are used to buy other products.

“We give discounts to sellers to empower them and not to customers. Nowhere does the recent regulation question the marketing costs we have (to bear) to help the merchants selling on our platforms," said a senior industry expert and adviser to e-commerce firms, requesting anonymity. “This (discounting) if contested, will not stand in a court of law."

Paytm said the company is not flouting the new pricing norm in any way. It claimed most of the discounts and cashbacks are funded by sellers on its platforms and only a part of it is offered by Paytm.

“Cashbacks for us are largely a loyalty programme. Every payment system in the country, whether credit cards or banks, offer cash-backs as part of their loyalty programme; we, too, are a payment company and I see no reason as to why we should be seen in a different light," said Sudhanshu Gupta, Paytm’s vice-president, business.

An Amazon India spokesperson said in an email, “We have and we will continue to operate within the parameters of the laws and policies of India as we do in each country we operate in."

And for now, neither the new rules nor the warning that followed have succeeded in stopping online marketplaces from offering deep discounts. Since the new rules were announced, all of India’s top e-commerce companies have continued to offer deep discounts and cashbacks on a range of products, including smartphones, laptops, clothes, toys and books.Apart from discounting, another key issue is the amount of sales contributed by a single seller.

Flipkart’s largest seller, WS Retail Services Pvt. Ltd, easily generates more than 25% of the company’s sales; Cloudtail India Pvt. Ltd, the biggest seller on Amazon India, contributes even more.

Cloudtail India, a joint venture between Amazon.com Inc. and Infosys co-founder N.R. Narayana Murthy’s Catamaran Ventures, is now the key growth driver for Amazon India, generating at least 40% of the company’s sales in key categories in some months.

Cloudtail is particularly dominant in electronics and fashion, two of the three largest categories for Amazon India (promoted by Amazon Seller Services Pvt. Ltd).

The new regulations mean that Flipkart and Amazon India may have to find new seller entities on their platforms.

Even online fashion retailers such as Myntra, which is owned by Flipkart, and Jabong currently depend on one seller for most of their sales.

While Myntra gets over 90% of its sales from Vector E-commerce, Jabong’s sales largely depend on Xerion Retail.

Several lawyers and industry experts point out that the companies which till now have been swinging between a marketplace- and inventory-led business will have to take a clear stance soon.

“The new law is effective (immediately) and hardly gives breathing time to companies to implement the changes. However, if these companies continue to operate under ambiguity, they can be severely penalized by the government," said Akash Gupt, partner and leader of the regulatory practice at PricewaterhouseCoopers India.

Several e-commerce companies started operations with inventory-led models. However, since FDI wasn’t allowed in direct online retail, these companies had to be restructured to accommodate foreign money.

Most companies moved to a two-layered structure with a wholesale trading arm that got all the foreign capital and an independent customer-facing entity that ran the online platform and sold to the customer directly.

While the regulations around the wholesale trading and B2C (business-to-consumer) e-commerce model have remained unchanged, companies find little or no value in this model and prefer to run a marketplace.

“If the foreign investment is being made in the B2B (business-to-business) entity with the e-commerce platform being run by a separate front-end entity, the value must be captured in the wholesale entity. The advantage of the marketplace model is that the value of the business could be shifted to the platform entity," said Rahul Matthan, partner, Trilegal.

Even the regulatory conditions on sellers bearing responsibility for after-sales services and warranty clearly re-emphasize the role of the inventory model, Matthan said.

“There will be several unintended consequences of these regulations. For instance, small vendors who only came on to online platforms because of the comfort that post-sale issues would be handled by the e-commerce marketplace may no longer be willing to trade on these marketplaces," he added.

Priyanka Sahay contributed to this story.


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