100% FDI in online marketplaces: a masterstroke or a new legal quagmire?

The DIPP has finally defined the nature of e-commerce businesses, in India, and the government body has allowed 100 percent Foreign Direct Investment (FDI) in marketplaces which do not carry inventory. This does not change anything other than the fact that money raised, from foreign entities, by platforms like Snapdeal, Flipkart and Amazon can be used to serve consumers rather than routing their business through their holding companies as a B2B activity.

The policy note is also a winner because it states clearly that marketplaces cannot source more than 25 percent of its goods by value from a single vendor. Companies like Amazon India and Flipkart have built ‘special relationships’ with certain vendors, who account for large chunks of the sales on their sites. This equation will have to change. While Prione and Cloudtail, distribution companies funded by Catamaran Ventures, built relationships with big brands on behalf of Amazon, W S Retail has supplied exclusively for Flipkart. Both Amazon and Flipkart have stayed away from commenting on the specifics of the new policy note.

Legal wrangles and distribution companies

The pundits have hailed this as a great move, by the DIPP, on one end, while some realists say that the policy note has still left a few gaps that will bring a host of legal wrangles to the fore with manufacturers or small sellers that use these platforms to do business. The policy loop hole could make e-commerce companies float four or five distribution companies and continue to work directly with brands and ignore small businesses.

Angshuman Bhattacharya, Lead consumer and Retail, Managing Director with Alvarez and Marsal says,

Although we welcome the stability, structurally it may not be a transformation in the way business is expected to be conducted.

He adds that the DIPP has taken the effort to define a marketplace in line with the direction from the Delhi High Court.

“However, a rider that e-commerce marketplaces would not directly or indirectly influence the selling price of products needs to be understood better as it could have an impact on the pricing flexibility that e-commerce firms have actively used to attract consumers. The term “influence” may need further clarity of interpretation,” says Bhattacharya.

Perhaps it will be the courts that will decide if Flipkart, Amazon India, Snapdeal and other e-commerce companies are real marketplaces. The current case filed in the Delhi High Court, by the All India Footwear Manufacturers and Retailers Association, has put forth a prayer to the court alleging e-commerce companies are flouting FDI rules and not operating as marketplaces. So, this policy note will not end the conundrum. As long as the nature of the preferred distribution companies is not sorted, these legal wrangles will be common place.

“All large e-commerce companies in India are majority owned by foreign investors. Since any FDI in e-commerce was illegal because of the older policy, all companies were operating through loopholes and that was a shameful open secret in the country,” says Kashyap Deorah, an angel investor and author of The Golden Tap. He adds that this new policy note eliminates the cat and mouse game that startups and the government have been playing for several years now, along with the bureaucratic overheads and waste that came with it.

“It is going to be good for consumers. There will be more discounts and better services,” says Mohandas Pai, MD of Aarin Capital.

Private Labels or brands exclusive to a platform

Companies like Myntra, which have its own set of manufacturers and has created several brands that it sells under the Myntra umbrella, could also face issues. Since such platforms do not own manufacturing facilities they can be categorised as e-commerce ventures that hold inventory. This will need to be sorted out as the policy document says that only marketplaces that provide a tech platform connecting sellers and buyers plus offers only support services to sellers can have FDI. They may have to circumvent this by convincing manufacturers to hold inventory or work with a distribution company and change the billing process. However, the policy note allows apparel manufacturers like Sanjeev Mukhija, owner of Golden seam Textile Private Limited, who sells his brand Breakbounce on e-commerce platforms like Myntra and others. It also permits such manufacturers to start their own e-commerce ventures and they can raise FDI for the same.

How will the money be structured?

Jaspers Infotech raised money for Snapdeal, Flipkart’s parent company in Singapore was the receiver of funds and so was Amazon’s Singapore entity. It is now clear that Amazon will put money directly in its Indian entity. Our home grown e-commerce companies and their lawyers will be hard at work over the implications of the policy note in fund raising. Will the future deals happen directly in the name of the platforms operating in India? But sources, in each of these companies, say that the flow of money will be under the same financial structure that was prevalent earlier.

“The policy note brings clarity to what e-commerce is. This will smoothen fund raising for several e-commerce companies,” says Ganesh Prasad, partner at Khaitan and Company, a law firm.

Where is the policy note leading to?

May be this is a sign of good things to come in the form of a road map towards creating a Goods and Services Tax(GST) that will create a uniform tax structure for movement of goods across the country. It may be a sign of creating listing norms which will allow e-commerce to list in India even with mounting losses. While a listing by these companies is too distant a reality, the DIPP note has allowed some breathing space for these businesses because more foreign money will mean that there will be more jobs and more pin codes can be covered. According to Ernst and Young, the retail market is close to $550 billion with only 1 percent market share taken by e-commerce today and organised retail accounts for only 7 percent. The money coming in will certainly increase consumer choice and benefit them in the long run in the form of reduced prices.

“With this policy note the government should create a road map to the Goods and Services Tax, which will make e-commerce build supply chain efficiencies across the nation,” says Anil Joshi, managing partner of Unicorn India Ventures.

The next funding round can happen in the next two months. Everyone is already saying it is a war between Alibaba and Amazon. For the Central Government it seems to be the best option to push the interests of the small seller and the job seeker. The e-commerce industry could not have asked for too much heaven. The opportunity has fallen right on their lap to acquire 500 million more Indian consumers. The caveat here is that global markets should continue to hold a bull run or else with current signs of geo-political unrest and a slowing economic cycle, e-commerce in India will not be viable in the long run for home grown companies. It will be the pet of Amazon and Alibaba.