The Taming of Indian E-Commerce

Press Note 3 of 2016 that was issued earlier this week was greeted with the kind of knee-jerk enthusiasm has become customary when high profile regulations are issued by the government. But the initial euphoria around the clarity on FDI in ecommerce marketplaces has since been replaced by a gathering sense of impending doom.

The Press Note makes a distinction between the “Inventory” and “Marketplace” models of e-commerce. While the former relates to e-commerce companies that directly own their inventory, the latter relates to those that offer a technology platform and merely act as a facilitator between buyer and seller. While FDI is prohibited in Inventory e-commerce it is allowed up to 100% under the automatic route in marketplace companies.

This is all well and good except that marketplaces have never been prohibited. Flipkart and Amazon have built multi-billion dollar businesses in India using a marketplace structure that, while often questioned, has never been challenged. In that context it seems as if the Government has expended a lot of effort to tell us something we already know.

However, as will become evident shortly, the real reason why this Press Note was issued has little to do with ratifying an already well established structure. This, it seems, is the government’s way of imposing stringent operating conditions on the industry, where none previously existed. The key obligations with which e-commerce marketplaces must now comply are as follows:

  1. Turnover Limitation — sales by any one vendor on the e-commerce marketplace (including through its group companies) cannot exceed 25% of the total sales turnover of the e-commerce marketplace
  2. After Market Support — Delivery of goods post-sale, customer satisfaction and warranties or guarantees for the goods sold must be the responsibility of the seller (and not the e-commerce marketplace)
  3. Pricing — E-commerce marketplaces cannot directly or indirectly influence the sale price of goods

Each of these new conditions directly address key stakeholder oppositions to India’s current e-commerce model.

Anchor Vendors

Most Indian e-commerce companies have set up their marketplace structure with one anchor vendor who is effectively the principal seller on their platform. While large platforms usually have many hundreds of listed vendors on their site, the anchor vendor typically accounts for a significant proportion of the sales on the site. Offline competitors of e-commerce companies have loudly protested against this model calling it a sham and alleging that e-commerce companies have created a fictitious structure to get around the specific restrictions of the FDI policy.

By requiring the turnover of any one vendor to be restricted to 25% of the total turnover of the entity, the Government is forcing marketplace e-commerce companies to tear down this anchor vendor structure. In the time frame that has been specified in the Press Note (the conditions come into force with immediate effect) this is impossible to achieve. But in the near term all this will probably result in is that instead of having one anchor vendor, marketplace e-commerce companies will have to have find four unrelated entities — an option that, given the scale of some of these operations, is easier said than done.

After Market Support

One of the benefits of the e-commerce model in India was the almost aggressive customer focus that marketplace entities brought to the sales experience. Defects in products were immediately rectified or, where required, replaced or refunded. While sales were made by vendors it was quite evident that the platform played a strong role in supporting vendors with after market support.

There were obvious consumer benefits from this approach, but what was far more interesting were the (perhaps) unintended consequences of this model. Thanks to this big brother approach, a large number of small vendors have, over the years been emboldened to dip their toes in the online universe, relying on the fact that these giant e-Commerce platforms were going to take on the responsibility of after market support and product liability. Now that Press Note 3 requires marketplaces to ensure that vendors assume responsibility for post sales support and customer satisfaction, it is possible that many small vendors will lose the appetite to participate in the online marketplace.

Pricing

Perhaps the most visible impact that e-Commerce companies had on the retail ecosystem was in relation to pricing — in particular the deliciously deep discounts that they offered. While, at first, discounts were used to attract customers to this new shopping experience, as time went by, discounts became the defining feature of the online model to the extent that their brick and mortar counterparts have filed numerous complaints before Competition Commission.

Without paying heed to proceedings that are currently underway, the Press Note has forbidden e-Commerce marketplaces from influencing the sale price, either directly or indirectly. The obvious reason for the inclusion of such a condition is to eliminate the practice of discounting. That said, it is hard to visualise how e-commerce marketplaces will be able to function without at least in some way, establishing prices on their platform. One is almost tempted to ask why, if shopping malls and other offline sellers can offer festival sales, e-commerce players are being denied the same privilege. Or is it the intention of the government to ban discounts completely?

Level Playing Field

What makes this even more confusing is the obligation to “maintain a level playing field” that forms part of the very same pricing condition. There is no clarity as to what field the Government is talking about or for whose benefit it needs to be levelled. Surely they cannot mean a level playing field among all the vendors on the platform — because this is already being done. Most e-commerce platforms ensure that discounts are offered more or less uniformly by all vendors across the platform and that pricing, in general, stays consistent. If the Government is talking about a level playing field across all sales platforms, online and offline, then they are asking for price standardisation that goes against the principles of free market principles enterprise.

There is a silver lining to this very dark cloud. Given that e-commerce entities are now obliged to ensure a level playing field, perhaps they will be exempt from the restrictions on influence sale prices particularly where such influence is necessary in order to level the playing field.

Digital Goods

There is yet another issue worth mentioning and that is in relation to digital products, the sale of which has been expressly called out as an e-commerce activity. This brings App Stores, such as the Google Play Store and the Apple App Store, within the definition of e-Commerce and subject to FDI restrictions. Since Apps are typically developed by third party vendors, these App Stores are, in a very real sense, marketplaces and so FDI up to 100% is permitted in these companies under the automatic route. As it happens, none of these App Stores currently operate onshore so there is no need to think of FDI implications on these businesses.

But there are other types digital goods that could and are being sold in the country. Digital music, movies and ebooks that are sold in India would now all be classified as e-commerce transactions (think Netflix, Amazon and iTunes) and subject to FDI restrictions under the Press Note. Digital media online stores operate very differently from App Stores in that these stores obtain a licence from the owners of digital media works to sell these works to consumers in India. Therefore, unlike apps, digital media is sold directly by Apple, Amazon and Netflix under the terms of their licences. The digital media catalogues of these companies are equivalent to an inventory of goods which, in the context of Press Note 3, makes theirs an inventory based e-commerce model.

So long as these digital media stores operate from outside the country, no FDI is involved and the provisions of these regulation would not apply. However any Indian company that operates a digital media store would be an inventory based e-commerce entity that is prohibited from accessing FDI. If one were to consider the various digital music offerings that our major telecom companies vie with each other to see, an argument could be made that any FDI in these digital music operations are now illegal.

Over-reach

Which brings me to one last point on Press Note 3 and that is the definition of an e-commerce entity. In a press note relating to FDI restrictions one would expect that the restrictions would only apply to Indian companies into which foreign direct investment can flow. However, the definition of e-commerce entities in the Press Note includes extends to companies registered outside the country but that have a place of business in India (through an electronic mode as described under Section 2(42) of the Companies Act, 2013 or as an office, branch or agency under the Foreign Exchange Management Act).

If one were to apply this definition to e-commerce companies operating in India it would appear that the applicability of these newly crafted conditions will extend to foreign companies that offer e-commerce services in India. This could include Apple’s App and iTunes Stores and the Google Play Store, both of which operate through companies registered outside India. Is it the Government’s intent that these foreign companies should also comply with the conditions set out in the Press Note even though they are not registered in India and the very concept of Indian FDI restrictions is meaningless in their context?

Conclusion

In all my years of analysing Indian technology legislation I am hard pressed to point to a regulation that succeeds in falling over itself so many times. It is apparent that much of the Press Note has been written to address concerns that have been vocally expressed time and again by various affected stakeholders. But even considering that, the sheer scale of unintended consequences is unprecedented.

Despite the large valuations and very visible advertising present, the e-commerce sector is still insignificant in comparison to the retail sector as a whole. Placing fetters on a nascent industry in which even the biggest player are still to turn a profit will significantly erode value and investor confidence. The impact of these regulations on the on-demand economy which is even more of a fledgling and is still struggling to build a viable ecosystem, are even more dire.

As this analysis indicates, compliance with these new conditions would require a significant change on the part of affected companies to give abide by these new conditions including significant changes to their business model. Try as they might, it will be impossible to effect these changes even in a reasonable time frame let alone immediately as the Press Note requires.

But what is probably most troubling is that a Press Note issued by the Foreign Collaboration Section of the DIPP, that should have limited itself to foreign investment policy issues, is seeking to impose broad restrictions on the operations of technology companies that are arguably beyond its authority to regulate.

It is my view that the government should retract Press Note 3 in its entirety and issue a fresh regulation that is limited in scope and focussed in outcome. Else they risk fatally crippling one of the fastest growing and most innovatively fertile sectors of the Indian economy.

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