Time to redo FDI in e-commerce in India

India’s restriction on foreign investment in retail, extended to e-commerce, led to complex structures to navigate the limitation. The government’s recent regulations, instead of simplifying the policy, have endorsed the marketplace model, potentially leading to ongoing convoluted practices that may hinder consumer benefits and business ease.

This article was first published in The Mint. You can read the original at this link.

India’s restriction on foreign investment in retail was originally inspired by government’s concern for the well-being of shopkeepers and small retailers. When the green shoots of e-commerce first became visible, this anxiety transferred to the digital world. The government issued a press note (Press Note 2 of 2000) that made it clear that restrictions in the offline world would apply with just as much vigour to the online world—establishing an equivalence that was unwarranted at the time between the nascent e-commerce industry and traditional Indian retail.

The only exception permitted was for business to business (B2B ) e-commerce—mirroring the concession available to wholesale trading.

For most of the decade and a half that followed, batteries of consultants and legal advisers came up with various complex structures designed to navigate their way around this restriction, driven to innovate increasingly aggressively in order to feed the growing hunger of the Indian digital consumer. Some of these structures involved the establishment of large B2B establishments that were little more than vehicles into which foreign investments were routed while the actual sale of products to the retail consumer took place through virtual storefronts operating on wafer-thin margins to ensure that as much profit as possible was retained in the B2B entity.

The Indian e-commerce industry is a product of this regulatory history, compelled to establish inefficient business models simply because the government transposed onto the online world a restriction that should only have applied to brick and mortar businesses. This is why most of the e-commerce players in the country operate marketplaces in which the e-commerce website itself is just a platform through which vendors offer their products while the actual sale is conducted by various vendors out of whom one anchor seller usually commands the lion’s share of sales. It is an open secret that these anchor sellers are associated entities of the platform entity, usually entitled to preferential treatment on the platform.

Two years ago, the government awoke to the realisation that the e-commerce industry had become large and was growing steadily larger. The sector needed to be regulated—but by then, it was too late to question the many complex layers of retail, wholesale, warehousing, logistics and financing structures that had become an integral part of the industry. At the same time, there was pressure to address various issues that were causing angst to traditional retail—deep discounts, exclusive selling arrangements and preferential treatment to anchor sellers.

The government had two choices. It could press the reset button and simply permit foreign direct investment (FDI) in e-commerce, thereby neatly wiping out 16 years of apathy. Or it could give its tacit approval to the structures that had already been set up and try, looking forward, to bring order to the chaos it had allowed to fester. With a reset, the industry might have complained about the money wasted setting up their many complex structures but would eventually have accepted the long-term benefits of a refresh. Continuing with the existing models would have meant having to deal with convoluted structures in the knowledge that any regulation would only invite further creative structuring.

Press Note 3 of 2016, the first real amendment to the e-commerce regulations in 16 years, chose to bless the existing models, confirming that FDI was permitted in the marketplace-based model of e-commerce and prohibited in inventory-based models. While this legitimized the operations of large Indian e-commerce companies, it meant that they had to continue with the awkward and inefficient structures they had built. It meant they had to keep sales separate from the platform by continuing to operate using tiered wholesale entities that were at least one level removed from the customer. What’s worse, any attempt to regulate the industry on issues such as deep discounts, exclusive arrangements and the stranglehold of the anchor vendor would have to take into account the fact that they had to apply to an inter-woven matrix of related entities.

This is why the government’s most recent regulatory flurry is so unfortunate. Press Note 2 of 2018 puts in place a whole slew of regulations aimed at making sure that e-commerce businesses are in fact true marketplaces and not masquerading as such while controlling the downstream supply chain. It introduces tests to determine whether the marketplace entity has control over the vendor’s inventory and implements a fair and non-discriminatory standard that has to be applied to all vendors on the platform. It prevents platforms from providing warranties or requiring that vendors sell their products exclusively on their platform.

All these restrictions are only necessary because the government has chosen to endorse the marketplace model instead of simply rethinking its policy on FDI in e-commerce. If we continue down this path, with each new iteration of the e-commerce regulations, the industry will find newer and more convoluted ways to fit its businesses into the regulatory requirements. This dance between the regulator and the regulated could well continue indefinitely but at some time we have to ask ourselves whether the cost to the consumer and the ease of doing business is worth it.