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The Big Picture Behind FDI Norms

After assuming power in 2014, PM Narendra Modi travelled to Silicon Valley, urging foreign companies to invest in India and oost foreign direct investment (FDI). The following years witnessed a considerable increase in investment from foreign e-commerce giants as well as a flurry of mergers and acquisitions. However, with the impending General Elections, the scenario has changed, contrary to what Modi had proposed in his election campaigns.

Earlier, global e-commerce giants had been reluctant to invest in Indian markets. Gradually, initiatives like Digital India kicked in under the NDA government. This, followed by the easing of the FDI norms in the form of 100% FDI being allowed under the automatic route, led to a boom in the e-commerce sector. The fact that the government easily approved the Walmart-Flipkart acquisition in 2018 points to the government’s efforts to develop this sector.

While such enhancements in the e-commerce sector worked well for certain entrepreneurs and consumers, they also led to growing disappointment among some 14 million small offline shopkeepers and retailers. Millions of small Indian retailers and traders who wield tremendous power in terms of votes have grown disenchanted due to government policies like demonetisation and GST, in addition to the increasing presence of multinational e-commerce giants. However, with the BJP still having a few months left to boost their populist policies (as certainly noticeable in the Interim Budget), how could Modi overlook the interests of retailers who exert considerable influence on the election outcome? His government has recently championed vigorous economic nationalism, passing norms to rein in the power of foreign e-commerce giants like Flipkart and Amazon. Late on the 26th of December 2018, the government announced several restrictive changes in its Foreign Direct Investment policy for the e-commerce industry. But this wasn’t where the story started! The Return of License Raj?

The FDI norms were first floated in 2016. Back then, the move was intended to mollify brick-and-mortar retailers who had had a longstanding grievance against e-commerce sites for offering discounts to win over customers. Consequently, the government rolled out the following major guidelines to ensure a level playing field in the market. However, these norms, so ‘spotless’ as are all the policies of the government, had so many unanticipated shortcomings that it took not more than 2 days for companies to figure out their loopholes. 100% FDI under automatic route was permitted only in the marketplace model of e-commerce whereas no FDI was allowed in the inventory-based model. This simply means, an e-commerce company, if funded by foreign capital, cannot sell its own stocked inventory of purchased goods to online buyers. Such business models are generally used by Alibaba in China, Walmart in the US and even Amazon at some places. On the other hand, in a marketplace model, the e-commerce firm (like Flipkart, Amazon, Snapdeal etc.) will only be acting as a facilitator. When the customer places an order, he/she is actually buying from a registered seller on the firm’s website.

In India, Flipkart & Amazon legally followed a marketplace model but had created, through successful circumvention & trickery, a virtual inventory based model. Flipkart India Pvt. Ltd., the wholesale arm of Flipkart, carries on B2B transactions with some preferred vendors like RetailNet, SuperComNet, India Flash Mart, Omnitech Retail and Trunet Commerce. Funding for this wholesale unit comes from Flipkart Singapore since FDI in B2B companies is allowed up to 100%. These preferred vendors then make the final sales to customers via the marketplace. In essence, the wholesale arm of Flipkart sold merchandise to their preferred vendors who in turn sold the same goods to customers via Flipkart’s online marketplace. Amazon worked on similar lines, with Cloudtail (a joint venture between Amazon & Catamaran Ventures) & Appario (a joint venture between Amazon & Patni Group) as its two major vendors. Secondly, the guidelines mandated the e-commerce entities to refrain from indulging in predatory pricing in an attempt to potentially put an end to the discount wars. The products on these online platforms are predominantly available at high discounts to the customers, thereby providing a negligible vent to small offline retailers to compete and affect any sales through the brick and mortar system. The virtual inventory-led model did the job of keeping the “flash sales”, “Big Billion Days”, and “Great Indian Sales” legal. The wholesale arms of Flipkart & Amazon, having found the perfect loophole, supplied products bought in bulk to their preferred vendors who sold them at discounted prices. In a legal sense, since the prices of these products were set by the preferred sellers, they were not seen to be set/manipulated by these e-commerce giants. However, unbeknownst to the public, as well as the ‘adept’ bureaucrats, it was just a manipulated inventory-led model.

In an effort to widen the seller base and include more traditional retailers, under the 2016 norms, a vendor would not be permitted to sell more than 25% of its total sales through a single marketplace. This was essentially introduced keeping in mind the fact that Amazon & Flipkart provided preferential treatment to specific vendors like Cloudtail, Appario and WS Retail. Due to the fact that the wholesale units of Flipkart and Amazon directed most of their products to these limited vendors, Cloudtail and vendors of such sort were able to afford huge discounts and hence had an edge in terms of appealing to the customer base.

The shrewd and unchecked operations of these e-commerce giants are hampering the revenues of not only millions of offline retailers but also those of small online vendors. Hence, the only beneficiaries of such unrestricted deceit seem to be foreign investors.

In 2018, however, pressured by the criticisms of CAIT (Confederation of All India Traders) and other small retailers stating that the two giants were unfairly circumventing the 2016 norms, the DPIIT (Department for Promotion of Industry and Internal Trade) introduced new norms in an attempt to make the existing norms more stringent and less evasive. Apart from restating the 2016 norms, these new norms clarified that the e-commerce entities could not enter into exclusive deals with any specific brand, which Flipkart & Amazon very frequently did with brands like Xiaomi, Vivo, etc. No doubt India lags behind in the ‘ease of doing business’ rankings (77th rank in the list of 190 countries). A well thought out move by the government, or was it?

In an attempt to disturb this cleverly thought out Virtual Inventory based model, the norms clearly stated that the e-commerce entities should not have any stake in any of the vendors selling on their platform. For Amazon, this meant that Cloudtail & Appario, it’s two largest vendors, could no longer sell on the platform. As Amazon tried to comply with new e-commerce rules imposed by the Indian government it led to the temporary delisting of more than 4,00,000 items that account for nearly a third of Amazon’s estimated $6 billion in annual sales in India. Now, thanks to these ‘well thought out’ revisions to the 2016 FDI norms, Amazon and Flipkart were quite evidently able the decipher how to evade them. While the new FDI rules state that an online marketplace cannot sell products from a vendor in which they have a stake, they do not extend to the subsidiaries of such companies that may sell their products on the online platform. Consequently, Amazon was left with two options. It could dilute its stake in these entities. Or, it could convert Cloudtail and Appario into wholesale entities undertaking business-to-business (B2B) transactions in order to comply with the e-commerce FDI rules. Cloudtail and Appario would then sell to a battery of preferred third-party vendors as well as their own subsidiaries that will undertake final sales to consumers. Though Amazon went ahead with the option of selling its stake in Cloudtail, there were speculations that it would again be able to dodge the so-called stringent changes in the policy by opting for the latter, once again posing a mockery to the government. Flipkart, having no stake in its preferred vendors, is compliant with the latest norms and hence there has been no major disruption. All products, including platform-exclusive ones, are still available. These FDI norms certainly lack clarity. Though the e-commerce players grumble about the lack of clearly enunciated policies, they have also exploited the benefits that this ambiguity has provided them. Ambani, again?

As if on cue, not more than 2 weeks after the rolling out of the reforms by the government, the Chairman of Reliance Industries Ltd., Mukesh Ambani, announced the company’s expansion plan. It will launch an e-commerce platform in Gujarat as a part of the same. Reliance has settled in quite successfully in the offline market and has encompassed a wide array of customers. The ‘coincidental’ timing of these events could turn out to be a game changer for them. While the government says such policies are necessary to bring a level playing field in the market, it is quite suspicious that it is only putting restrictions on foreign companies. A Game of Outwitting.

Three days post the implementation of the norms, sales of Flipkart & Amazon were down 30%. This seems to be a good sign for the small offline retailers, but for how long? Now, the most basic and essential question that strikes our mind is who won and who lost. As for the e-commerce giants, this might as well just be a temporary phase like always. They have already started exploiting the fact that the ‘controlled vendors,’ in which they have a stake, can start acting as wholesalers to third-party vendors who then sell to the customers. Let’s see how many months it takes them to dodge the implications of these norms.

In all respects, the government was at no loss. It appeared to be quite satisfied sitting on the colossal amount of 10,000 crores that it had collected last year from the Flipkart-Walmart deal. Whether it is a conspiracy by the government or a mere coincidence that these norms were perfectly timed with the elections drawing close, is uncertain. Funnily enough, the JAM (Jan Dhan-Aadhaar-Mobile) conspiracy we all are aware of replicated itself this time as well, with Ambani all set to launch his own domestically funded e-commerce platform and the pro-Ambani government showering its complete support by attempting to erode Flipkart & Amazon’s market share. Customers, having lost the discounts they used to avail on the regular sales by these e-commerce giants, will now blame their fate if not these companies. There is still high uncertainty as to whether the discounts, the flash sales, the festive offers will ever be back. As
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