My first encounter with the policy around foreign direct investment (FDI) in e-commerce was when my company Chaupaati Bazaar was being acquired by India’s leading retailer Future Group in 2010. The audit firm doing legal diligence of the deal had raised a flag of FDI non-compliance and it took some doing to get past it.
Then in 2011-12, in the middle of political flip-flops about FDI in multi-brand retail, e-commerce companies were getting hyper-funded and the question of policy impact on e-commerce started coming up. As an afterthought, the government clarified that FDI in e-commerce remains disallowed. Despite that clarification, several billions of dollars from foreign institutions made their way into e-commerce businesses in India between 2012 and 2015. All leading e-commerce businesses, without exception, were inventory-led, though structurally disguised as marketplaces. In this light, how should we look at last weekend’s notification about 100% FDI in marketplace e-commerce through the automatic route? Here’s my take.
Chaupaati had started as a classifieds business and transformed to a phone commerce marketplace. From converting consumer intent to leads, we started to further convert these leads to confirmed orders. After receiving the payment from end customers, we passed these orders to merchants for fulfilment. We were a marketplace with less than 10% of the company owned by foreign individuals.
Chaupaati was flagged by an auditor as FDI non-compliant. The auditor argued that end customers were paying Chaupaati and we were paying out to merchants after deducting fees and commissions, thus making us an e-commerce retailer, even though we were not stocking inventory or controlling pricing. Since each invoice to the customer was issued by the merchant with a bill-to Chaupaati, and ship-to the customer, we were eventually able to establish with the auditor that we were a platform providing a range of digital and marketplace services rather than a retailer buying and selling merchandise.
On the other hand, FutureBazaar.com was an inventory-led e-tailer, one of India’s leading e-commerce companies at the time, over 20% owned by foreign institutions and yet fully compliant. As we merged into Future Group and I started running the e-commerce business, I took a deep dive to better understand the structure. I learnt that there was an Indian-owned front-end entity that invoiced the customer and a partially foreign-owned back-end entity that provided a range of services. The two entities had a business contract between them.
And then I learnt that this was the modus operandi of all leading e-commerce companies operating in India, whether they were partially, largely or wholly owned by foreign institutions. The same auditors were deeming them compliant year after year. Since the letter and spirit were clearly at odds, all e-commerce companies had a sweaty neck about this structure and did not know when the enforcement guillotine might snap. With every passing year and every billion dollars invested, this loophole became more and more legit.
One had to be blind to miss the double standard and farcical hypocrisy of the policy. The growing popularity of hyper-funded, foreign-owned e-commerce made it the elephant in the room. On the one hand, the key principles behind the policy around FDI in multi-brand retail or e-commerce were that foreigners should not own the Indian consumption story, Indian markets should not be flooded with foreign-made products and each state should retain control over accepting or rejecting the policy. On the other, the same government which had once upheld these principles with great passion had now come to power and as passionately proposed a conflicting charter to bring in billions of dollars in foreign investments, bring the digital economy to the country and deregulate tech entrepreneurship.
That required turning a blind eye to the fact that e-commerce firms were foreign-owned and their sales primarily constituted Chinese-made products. The gap between de facto and de jure, between spirit and letter, between policy and enforcement, seemed to reflect the conflict between the Bharatiya Janata Party government’s opposition to FDI in retail and encouragement of foreign investment, conflict between promoting Make in India and opening up digital entrepreneurship led by e-commerce.
Large institutional investors like Tiger, Softbank, DST, Naspers, and dozens of other funds that own e-commerce start-ups have a lot to lose if their investee companies are shut down or retroactively penalised. Public corporations like Amazon and Alibaba have even more to lose. In the US, they have to manage shareholder expectation of compliance even while gunning for global domination. In India, they have to manage populist perception of being imperialist powers, even as Snapdeal and Flipkart are as foreign or domestic as them, and even as consumers want to consume the world’s best while clinging to a misplaced sense of nationalism.
On the face of it, the policy clarification legitimises what was already happening for several years. De jure just caught up with de facto and that is neither a no-change nor a big-change. I do think it is a step in the right direction. It simplifies the artificially complex structures of e-commerce companies, if only by a bit. It keeps the bureaucratic trouble makers away, if only by a bit. It simplifies business contracts between entities, if only by a bit. It levels the playing field for retailers, if only by a bit. It diffuses the potentially controversial political rhetoric, if only by a bit.
Leading e-commerce companies will continue with an inventory-led business strategy and substantial control over pricing and physical movement of inventory. The policy notification will lead to changes in structure rather than alteration of business strategy. Business can continue as usual and that is great because without the policy notification, there was uncertainty around whether it could.
In the last week, the expert verdict on the policy notification has ranged from “this changes nothing" to “this changes everything". Like the policy and its enforcement, I think there is no black and white answer. It is shades of grey. The government has done enough to keep The Golden Tap flowing. Until enforcement ambiguity was good enough to achieve that, they stuck with that. Now that policy clarity is required to gain global investor confidence, they have done just that.
Kashyap Deorah is the author of The Golden Tap: The Inside Story of Hyper-Funded Indian Startups. He is an entrepreneur and investor who shuttles between India and Silicon Valley. He tweets at @righthalf