The Press Note No. 3 (2016 Series) is written in the usual dry style of government notices. Except this time it is short, sharp and crisp, and thus, less likely subject to misinterpretation.
I’ll get to the specifics of the policy in a bit. But one thing is clear: if, and that’s a big if, the new e-commerce policy is implemented in letter and spirit, 29 March 2016, will be recounted as the day India’s Internet landscape changed from a free-for-all swinging match enacted by a jugalbandi of global venture capitalists (VCs) and e-commerce giants to a more sane market with a clearer set of rules.
The tussle between offline retailers (including Reliance, Future Group and Aditya Birla Group) and online firms (like Flipkart, Snapdeal and Amazon) has been playing out for a few years now. It culminated in a ruling by the Delhi high court on 20 November 2015, which in turn set in motion the events that led to this Press Note.
At the core of it, the public battle between online and offline retailers centred around the pricing strategies adopted by the online firms—whether it was legal to offer prices lower than those decided by brand owners and the fact that these firms were operating beyond the pale of any regulation.
The moot point: what could this policy mean for the future of both online and offline retailing in India?
In the past 10 years, a staggering $7 billion (around ₹ 46,340 crore today) has been pumped into online marketplaces in India. These funds have been “expensed" by the online firms with little to show in terms of permanent infrastructure. In other words, these online marketplaces have vaporized several billion dollars in their hunt for market share.
In this attempt to decipher what the government has enacted into law, the points below apply to marketplaces that have raised or propose to raise foreign direct tnvestment (FDI). Inventory-led models have been disallowed from raising FDI and I am leaving out single-brand retailers and Indian manufacturers such as the brands Cottonworld or Fabindia, who have been specifically permitted to use e-commerce for sales.
In essence, the government has said:
• A marketplace is simply a platform where buyers meet sellers using technology and the role of the marketplace platform should be limited to facilitating the transaction (through payments, warehousing, logistics).
• The marketplace should not influence the terms of the transaction—buyers and sellers should carry it out at their own risk and reward. The seller should be liable for product quality and warranty.
• Discounts, offers or inducements of any kind have to be offered solely by the seller, and will not be layered on “directly or indirectly" by the online marketplace. The word “indirectly" means that, “Folks, let’s not get clever about it and create some nice loyalty point programme, bundle streaming movies or free delivery and subvert the law."
• No single seller can be more than 25% of the marketplace revenue. However, this single seller can be a group company of the marketplace and since it could influence such a seller, this restriction does not allow more than 25% of its revenues from such a group company. This 25% limit is a boon actually as you will realize when you read ahead.
• Online marketplaces are rendering a service to the sellers and they should charge them for such services. That should dictate the economics of these models.
Thus, a marketplace like Amazon, Flipkart or Snapdeal may invest in brand-building, attracting customers, building vendors, showcasing products and indulging in all kinds of marketing on “behalf" of the sellers, but they cannot offer any inducements to the customers that the seller has not explicitly agreed to give.
In effect, they’ve levelled the playing field between offline retail and online retail—and stopped any deviant behaviour by online firms who were using capital to distort pricing and induce customers.
Sellers now have control over their own destiny and if they choose to offer different prices online and offline, that is their prerogative.
Several industry experts have declared that this is a form of pricing control. I disagree.
Online retailers were supposed to create efficiencies and pass them on to customers, create new markets, and develop vendors. They were supposed to use the power of technology, analytics and access to millions of Indians on smartphones to cut wastage, reduce inventory losses and create super-efficient, super-lean businesses. They were supposed to open under-served markets and take brands to markets that were hard to reach—and facilitate creation of superbrands in India.
But all we’ve seen is an abominable level of price-cutting, unprecedented media blitzes, wastage and inefficiencies that would boggle a rational mind. This caused massive collateral damage to offline companies and brands who lost control over their pricing. These are price distortions that are hard to stomach for brand owners.
This artificial price war in this race-to-death (or as VCs politely put it, last-man-standing) by online firms is not a recipe for developing a market—it’s a recipe for destroying one.
Organized retail penetration is under 10% in India; in comparison, organized retail has over 85% share in the US and in China, it is above 20% (the overall retail market in China is 10 times the size of India’s). Our malls have barely penetrated tier I and tier II cities and they are already failing and turning into ghost malls. The VCs saw this weakness and decided to press a pillow over their faces. Retailers have struggled over the past three years—they have almost gone on a permanent discount mode and have struggled to keep up with the insidious assault by online firms. Brand owners lost control over their brands. They were lulled into believing that they could get additional revenues by joining online platforms. Instead, all they got was a few percentage points of extra sale, but lost significant value when their brands ended up being put on deep discounts and commoditized.
For instance, a friend went to the showroom of one the world’s best audio speaker brands and saw the price tag for a unit at ₹ 28,000. He scanned the barcode and saw the same unit at an effective price of ₹ 16,000 on an online platform. The salesman looked at him helplessly and told him to buy it online since he could do nothing about the discount that the marketplace was offering.
So, no, it’s not pricing control. It’s more like an anti-dumping law has been imposed to stop the blatant abuse of business tactics by online firms.
Why are we assuming that sellers and brand owners will not want to find a way to reach the billions of Indians on smartphones?
As a supplier, I will tend to adjust my pricing for a certain channel, keeping in mind the costs associated with that channel. So, as long as I have control over what price the marketplace actually tags on my product, I will use online marketplaces to open new markets and create value for my brand.
If the online channel presently has a higher cost structure (since it competes with legacy kirana costs in several categories), as a brand owner, I will happily offer a higher margin to the intermediary (the marketplace) to ensure that I have salience on these platforms. After all, an online marketplace channelizes millions of consumers every day—much more than any retail bricks-and-mortar format. In fact, now that I have certainty of control over my price and positioning, I can design “Internet only" brand extensions.
An Internet marketplace functions by matching demand and supply between buyers and sellers who transact on a platform. A successful marketplace is one that creates demand and supply at such scale that a “network effect" of sorts clicks into place. It then becomes a default destination for demand and hence the best place for suppliers to find their customers and vice versa.
The first challenge in building a successful marketplace and hitting network effect is to inspire demand. This can be done in two ways:
1) By creating a brand and services that consumers trust and providing the best “lubricants" that the market needs. We’ve seen Indian e-commerce firms do a spectacular job creating a nationwide logistics network, easy returns, cash-on-delivery and try-and-buy services.
2) By “bribing" customers with artificially low prices to buy on the platform—and changing their behaviour using cash-backs or other means to buy their loyalty. This method is usually easier and needs only capital to out-run competition.
Online firms, especially over the past two years, have driven this second method of demand creation to irrational levels.
The government has now said that this bribe-the-customer behaviour has to pass the test of reason. The intermediary (the marketplace) was distorting the market. With the new law, it has made it clear that the marketplace is an agent of the seller. The seller may choose to discount its goods via the platform. But the platform on its own accord cannot create an artificial price. So in essence, there is no price control. A seller can choose to discount its product by 80% or create other incentives.
So what are the likely implications?
• The range of price distortion will narrow down from the 20-30% in certain categories to 5-10%. Clearly, sellers will have to offer discount online in order to woo customers to buy without touching or feeling the products.
• Brands will create different price points in different markets. If your physical bricks-and-mortar distribution does not reach Raipur, you will offer incentives to the consumers based there (that’s easily doable in the marketplaces). Overstock (unsold inventory) will start getting liquidated online without creating confusion among customers as it does today.
• Mid to large brand owners will have to rejig their commercial models. While online retailers were indulging in deep discounting, brand owners could assuage their offline channel partners (who account for 90% of their revenues) by arguing that they had no control over online prices. They will now have to accede to the demands of their dominant offline channels.
• The rationalization of prices of big brands creates new opportunities for private labels and Internet-only brands, which can create selling points with complete freedom as they don’t have to keep any offline retail channel conflicts in mind.
• Loyalty, cash-back and such incentives will continue, except now they will have to pass trade-norm tests. For example, it is normal for offline brands to give 5% back to customers via loyalty programmes. I don’t think anyone will grudge similar range incentives for the marketplaces.
• Online platforms will focus on becoming lean and efficient to survive. That’s how Amazon did it in the US.
• Expect growth to slow for the e-commerce leaders for a few months, as they restructure to face the new reality. Layoffs and downrounds (a round of financing where investors purchase stock from a company at a lower valuation than the valuation placed by earlier investors) are inevitable. Eventually though, we’ll see a healthier industry.
• There is still room for e-commerce firms to create deep discount categories to woo customers and even try elements of subscription-commerce to create loyalty and lock-in. The new rules allow e-commerce firms some flexibility to use a group company supplier model, as long as it does not exceed 25% of sales. A group company can create private label products which can be offered at great prices.
• This move may have also strengthened the moats of the existing e-commerce giants. If you evaluated the market from Alibaba’s perspective, on a day before this policy pronouncement, it would be simple. Why should I pay a $10-15 billion valuation to buy out Flipkart when I can give away maybe just $4 billion to woo the 40 million customers that Flipkart has? Now, it will no longer be simple to start from scratch and build. You will now have to build by creating true brand preference, which is a longer and riskier bet.
• Malls that create a blend of food, retailing and entertainment will draw customers back. We will see more innovation in bricks-and-mortar retailing. They had just stopped investing due to the uncertainty created by online pricing.
• If the game shifts to efficiency and lean ways of working, the global leaders like Amazon and Alibaba will have a clear advantage. They know the business and have the technology and payment platforms, and their costs are defrayed across global operations.
Online retailing was supposed to overcome our physical infrastructure limitations and be the most efficient format of retailing. Now it will have to be so in practice.
Offline retailers: Don’t say “Yahoo" yet. Most of you run as inefficiently as the platforms you point fingers at, and that’s the reason you don’t make profits. If you don’t use this pause in the battle to invest in your digital avatars, you will still lose the war. These marketplaces will become super-efficient—now that they will be capital-starved, and they have the tools to remain the gatekeepers to every purchase decision. Consumers will research online before they make a buying decision and the marketplaces will own that path. So, you will have to innovate constantly to keep pace.
I foresee a better future. It will no longer be a few winners who have had the luck to be hyper-funded, but the real, well-run businesses that will win.
• Will online discounts stop?
No, online discounts will continue. For two reasons: One, sellers will compete on the platforms, for example, will Samsung just give up online sales to Micromax or Oppo and not compete online? Two, the 25% “group company supplier" norm will allow platforms to sell their own private brands at a discounted price. Suppliers will also enter into online-exclusive deals like the over 15 smartphone models we see on Flipkart even today.
• Is this policy foolproof?
The single biggest issue the government has to clarify is whether a marketplace can enter into opaque contracts with any sellers and find ways of influencing prices indirectly by compensating these sellers with marketing commissions or kickbacks.
For example, can a seller on Flipkart or Amazon buy a Sony TV at 50,000 and sell it on the marketplace at 25,000 and get the difference compensated through another route? Could this be a route for the “group company" seller? Will this back door be left open?
• Does the regulation hurt online businesses?
Online firms have natural advantages: instant national reach, personalization, ability to segment markets and consumers, higher depth and width of categories. For example, Big Bazaar is unlikely to succeed at selling cars, bikes or insurance, but Flipkart can. Technology and innovation are the weapons for winning, not under-cutting and price distortion. I don’t see anything but a temporary dampener on their growth rates.
India is the only market of its size and scale that is fully accessible to foreign capital—Google, Facebook, Twitter and WhatsApp already control almost all of our Internet traffic. But we need to calibrate their actions when they can hurt our ecosystems. Else why do we protest Net Neutrality? Similarly, every global e-commerce firm is driving their stake in the ground here and pouring billions. Should their actions be calibrated?
• Is the policy comprehensive?
No, I think it has several lacunae. For example, if an Indian investor acquires Flipkart or Snapdeal, he seems to have no restrictions at all. We need to level the ground for domestic marketplaces and rationalize policy on single and multi-brand retail. Whenever regulation lags a market, there are bound to be gaps. Plus, lobbies play their role. Our retail deregulation has been patchy at best and we need clarity on the path ahead.
• Will domestic offline companies have an unfair advantage if they go online?
I don’t think it will be as easy for a bricks-and-mortar retailer to win online. Online retailing requires an entirely different mindset and skills. One look at the online sites and apps of the current incumbents will tell you they are years behind on even getting the basics right. So while the threat of well-funded domestic companies looks imminent, I think more is being made out of it by the folks who are crying “protectionism". The regulation will evolve by the time they become a real threat.
Offline retail is already in a losing battle—this “unnatural" pummelling by online was just destroying the sector. The policy gives them a breather and some manoeuvring room to get customers back into stores.
(Author’s Note: The policy impacts every firm trying to do business online in India. Whether you sell products, services, tickets or subscriptions, VC-funded businesses face a new paradigm.
In this piece, I have tried to evaluate the implications of the policy on the giant e-commerce marketplaces that will have to change strategy with immediate effect. This is also expected to have an impact on the profitability and survival of offline retailers or indeed every offline business, since if you don’t face an online competitor today, you soon will.
The policy also covers sale of services and digital goods, and thus covers businesses like Ola, Uber, MakeMyTrip and Yatra who sell digital goods. Online grocery chains like BigBasket too are governed by this policy—they have large single-seller/inventory-based models and will probably have to be reworked almost entirely. The implications for these businesses are massive—it could hamper their ability to build scale by directly incentivizing customers.)
Haresh Chawla was founding chief executive of Network18. He joined the firm in 1999 when it had revenue of ₹ 15 crore. When he moved out in 2012, he had built it into a ₹ 3,000 crore media conglomerate. He is now partner at India Value Fund, and mentors several start-ups.
Read an unabridged version on www.foundingfuel.com