Case Study

India's Ecommerce Crackdown Upends Big Foreign Players90

Saifuddin Bhanpurawala is one of dozens of shopkeepers on a dusty Mumbai back street that bustles with customers buying everything from tobacco to perfume.

But Mr Bhanpurawala's mobile phone shop is going through hard times, selling as few as two handsets in a bad week. He says the reason is obvious: the huge discounts available online at Amazon and Walmart-owned Flipkart, the two biggest players in India's fast-growing ecommerce sector.

"If we sell something at Rs5,000 [$70], they might sell it at Rs2,500 we don't understand how it's possible," said Mr Bhanpurawala, 28. He argued that the Indian government's tolerance of such practices has demonstrated its lack of concern for small businesses: "The rich are getting richer and the poor are getting poorer."

With a general election just four months away, prime minister Narendra Modi is moving to address such complaints. Amazon and Flipkart have been given until the end of this month to comply with new restrictions, announced in late December, that sharply restrict the use of their hefty balance sheets to boost sales on their virtual marketplaces.

But while the move is intended to strengthen the government's credentials among India's millions of small retailers, it has sparked alarm for two of the country's biggest outside investors. Walmart's $16bn buyout of Flipkart last year was the biggest foreign direct investment in Indian history, while Amazon has commi

With a general election just four months away, prime minister Narendra Modi is moving to address such complaints. Amazon and Flipkart have been given until the end of this month to comply with new restrictions, announced in late December, that sharply restrict the use of their hefty balance sheets to boost sales on their virtual marketplaces.

But while the move is intended to strengthen the government's credentials among India's millions of small retailers, it has sparked alarm for two of the country's biggest outside investors. Walmart's $16bn buyout of Flipkart last year was the biggest foreign direct investment in Indian history, while Amazon has committed $5bn in capital to its Indian operation.

"A sudden change in rules is not helpful," said Mukesh Aghi, president of the US-India Strategic Partnership Forum, which works to build economic ties between the countries. "It sends a message to groups that the environment is not transparent."

'Behave like a marketplace'

When India opened its economy to foreign capital in the 1990s, it was careful to maintain protection for small retailers. Foreign investment was allowed in single-brand but not multi-brand retailallowing clothing labels, for example, to open stores but keeping out the foreign supermarket chains that were feared by many shopkeepers.

As ecommerce took off, New Delhi updated these rules for the internet age. Foreign-backed companies would be allowed to run virtual "marketplaces"platforms enabling independent sellers to connect with customers. But they were barred from selling goods themselves, stopping them from functioning as online supermarkets.

The vague wording of the rules, however, meant that Amazon and Flipkartbacked with billions in capital from foreign investors led by US fund Tiger Globalquickly found ways to use their balance sheets to turbo-charge growth, outraging peers in the industry.

"We were flabbergasted all the while at the blatant violations of the FDI policy," said Sanjay Sethi, chief executive of ShopClues, one of the largest rivals to the dominant duo. "We started doubting ourselvesare we not interpreting these rules correctly?"

Partnering a fund controlled by Narayana Murthy, co-founder of IT services group Infosys, Amazon formed a joint venture that in turn owned Cloudtail India, a new company that would sell products ranging from electronics to breakfast cereal. Cloudtail is by far the biggest seller on Amazon's Indian marketplace, with revenue of $1bn in the last financial year ending March 2018.

Flipkart pursued a different tack. Instead of forming directly controlled sellers, it supplied many of them through a huge wholesale distributor, named Flipkart India. The distributor's revenue has far outstripped that of the online marketplace entity, while incurring heavy losses.

In the last financial year, Flipkart India made a net loss of $293m on sales of $3bn. That dwarfed the revenue of Flipkart Internet, the marketplace business, which booked sales of $398m, mostly on commissions charged to sellers.

From 2016, Amazon also dramatically increased the scale of its wholesale operation. In the last financial year, that business had revenue of $1.7bn, up from $458,000 two years before.

"They would strike a large deal with a brand and buy in bulk," claimed one rival ecommerce executive, alleging that the wholesaler would then supply the goods at low prices to certain "controlled sellers". The sellers would then offer the products on the marketplace at steep discounts from the prices available in offline shops.

"This was compliant with the letter of the law, but not the spirit," the person said.

But the new rules, announced in December (2018), strike hard at such practices. They stipulate that no seller on foreign-funded online marketplaces can source more than 25 per cent of its inventory from a wholesaler linked to the marketplacebanning sellers set up to shuttle goods between the two. They also state that no entity may sell on these marketplaces if any of its equity is owned by the marketplace or by any of the latter's "group companies".

"The government is saying: 'You're a marketplace, so behave like a marketplace,'" said Rajiv Chugh, a partner at EY.

Crackdown to benefit big Indian retailers

Amazon said it had "always operated in compliance with the laws of the land" and was "evaluating the new guidelines to engage as necessary with the government to gain clarity so that we remain true to our commitment".

Flipkart said it hoped "to be able to work with the government to promote fair, pro-growth policies that will continue to develop this nascent sector", adding that it would "ensure our compliance with all Indian laws".

But privately, the companies are lobbying the government to allow them more time to comply with the new rules, arguing the January 31 deadline will cause huge disruption to their businesses.

"There are a lot of sellers who buy from our wholesale entityit will be hard for them to diversify the supply base so quickly," said a person with knowledge of Flipkart's position. "Such a massive impact so suddenly will leave capacity under-utilised."

Amazon-backed Cloudtail, meanwhile, will be faced with "huge losses" from hundreds of millions of dollars' worth of inventory that it will be unable to sell by January 31, warned Sanchit Vir Gogia, founder of retail research firm Greyhound Knowledge Group.

Some analysts have also questioned the motives behind the government's new rules. Arvind Singhal at Technopak, a consultancy, noted that the crackdown on foreign-backed ecommerce companies would benefit big Indian retail groups that are not subject to the new rules.

By far the biggest of these is Reliance Industries, controlled by Mukesh Ambani, Asia's richest person. While most of its revenue in recent years has come from oil products, Reliance also includes the country's biggest retail chain, and is now eyeing large-scale growth in ecommerce, after its $30bn mobile internet venture Jio signed up more than 250m users. Jio was among the local groups that took part in government consultations on ecommerce policy last year, to which Amazon and Flipkart were not invited.

By imposing restrictions on foreign-backed groups but not on locally owned conglomerates, New Delhi has signalled "that international companies will not have a level playing field", said Mr Aghi at USISPF.

But the measures will prove in the interest of Indian consumers, said Kunal Bahl, co-founder of Snapdeal, which bills itself as an even-handed online marketplace for small vendors. While shoppers may lose out on short-term discounting, he argued, they will enjoy a more competitive market in the long run.

"If they were providing great pricing while generating a profit, it would be a different conversation," he said. "But everyone knows that these companies are haemorrhaging cash while giving out all these promotions, and at some point they'll want to pull this back. They're not charitable organisations."

QUESTIONS:

What negotiating power do foreign retail companies have with the Indian government?

What are the implications for companies like Amazon and Flipkart to expand into other developing countries?

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