APRIL 22, 2016

By Anil Talreja, Partner and Bhoutik Vyas, Manager Deloitte Haskins & Sells LLP

THE recent guidelines issued by the department of industrial policy and promotion (DIPP) relating to foreign direct investment (FDI) on e-commerce may have been welcomed by industry experts, e-retailer and business chambers but whether this move will give a relief to e-commerce companies is yet to be seen.

The Government has been well aware of the ongoing tussle between online and offline retailers and their counterparts in bricks and mortar. Thus, the intention of the Government for proposing such guidelines was to provide clarifications on certain key aspects concerning the FDI in e-commerce and also give a level playing field to brick-and-mortar rival stores.

Issues prior to FDI guidelines on e-commerce

FDI policy allowed 100 per cent foreign direct investment only in business-to-business (B2B), what is commonly called the marketplace model, whereas it did not allow any foreign investment in B2C e-commerce or the inventory model . B2B stands for Business to Business where the trading is between business entities such as manufacturers and wholesalers or between wholesalers and retailers. B2C on the other hand stands for Business to Consumers where online businesses sell directly to the customers.

This had caused a number of e-retailers to adopt the marketplace model, where the actual transaction took place between the buyer and the seller, with the e-retailer only acting as an intermediary.

It was alleged by the retail lobby that marketplaces do more than just facilitate sales and the online retailers not only hold inventories on behalf of the sellers but also ship them to the buyers. Further, the e-commerce marketplaces have been pricing products and have also been advertising themselves as online retail companies.

The retail lobby sought the Government's help in clarifying the situation as FDI rules could not be applied differently to e-commerce marketplaces while retailers were not allowed to get FDI. More clarity was required with respect to the definition of the term marketplace and the difference between retail and wholesale trading on online platforms.

After intense pressure from the retail lobby, the Central Government began with drafting of the guidelines to address the issue of ongoing tug of war between e-commerce retailers and their counterparts in bricks and mortar.

DIPP in the year 2013-14 issued the discussion paper on e-commerce and on the basis of the comments received on the discussion paper and in consultation with the stakeholders, DIPP issued the final guidelines in respect of the FDI Policy in e-commerce

On roll out of the FDI guidelines on e-commerce

The salient features of the FDI guidelines on e-commerce are as follows:

- 100per cent FDI under automatic route is permitted in marketplace based model of e-commerce, which is defined to mean providing an information technology platform by an e-commerce entity on a digital & electronic network to act as a facilitator between buyer and seller.

- FDI is not permitted in inventory based model of e-commerce, which is defined to mean, an e-commerce activity where inventory of goods and services is owned by e-commerce entity and is sold to the consumers directly.

- E-commerce activity has been specifically defined as “buying and selling of goods and services including digital products over digital & electronic network” wherein “Digital & electronic network” will include network of computers, television channels and any other internet application used in automated manner such as web pages, extra nets, mobiles etc.

If an e-commerce player has an inventory based model, it does not qualify for FDI. This comes as a major blow to major e-commerce players who are working on either an inventory model or a mix of marketplace and inventory.

Further, the Central Government, while defining the marketplace model of e-commerce, has permitted 100 per cent FDI under the automatic route. In addition, it has also stipulated some restrictive conditions for the marketplace model.

100 per cent FDI in marketplace entity is permitted subject to the following conditions:

a) Marketplace e-commerce entity may enter into transactions with its registered sellers on B2B basis;

b) Marketplace e-commerce entity may provide logistic, warehousing , order fulfilment, call centre, payment collection and other services;

c) E-commerce marketplace entity will not exercise ownership over the inventory at all and such an ownership over the inventory will render the business into an inventory based model in which FDI is not permitted;

d) The name, address and contact details of seller should be clearly mentioned;

e) The seller shall be responsible for post sales, warranty and guarantee of goods sold by it;

f) Guidelines on cash and carry wholesale trading as contained in the exiting FDI policy will apply to B2B e-commerce business;

g) Payments for sale may be facilitated by the e-commerce entity in conformity with the guidelines issued by Reserve Bank of India;

h) More than 25 per cent of the total sales should not be done by one vendor or its group companies; and

i) Marketplace e-commerce entity should not influence the pricing of goods sold on its platform

Of all the above conditions, the last two riders may be the ones which can potentially be a major roadblock for the e-commerce, thus far flourishing in an environment of discounts, causing deep gashes on the brick-and-mortar retailers and their business models.

The deep discount era might become history, since the Government is insisting that e-commerce companies only act as a platform to facilitate their listed vendors to sell, instead of underwriting minimum sales prices and offering discounts, and absorbing the resulting loss themselves.

Thus, e-commerce companies that drive majority of their sales from their related firms would have to rework the mode of operation to that part.

However, this could be a boon in disguise as these e-commerce players would now be forced to push only such discounts that are absorbed by their vendor partners, which in turn may bring in profitability and investor confidence in these players.

On the other hand, since there is a strong possibility that online prices will now revert to levels that are comparable with offline prices, this could make online marketplaces less attractive to shoppers and investors.

It could also impact the e-commerce valuation which might shrink in short term primarily due to the fact that these companies will no longer be able to show huge growth in revenues. However, on the positive side, in the medium to long term, the profitability will recover as heavy discounts end, and that should improve investor perception about these companies, and subsequently valuations.

Thus, the above riders may push the e-marketplace sector to undergo a gradual transformation in the near term to a more sustainable business model. It will focus more on optimizing processes (supply chain, warehousing and overall fulfilment) from a deep discounting for customer acquisition strategy.

This announcement on bringing clarity on e-commerce sector is a welcome step. It will remove the ambiguity surrounding in the sector on account of non-existence of any guidelines in relation to e-commerce sector. Also, it is in line with the Government intent of promoting ease of doing business.

The instant guidelines may have provided a similar level playing field to all e-commerce companies, by separating inventory based model from marketplace model.

Thus, the next few months will be the most testing for the e-commerce sector in India. The parity in playing field has come but has brought with it its own set of challenges. The biggest challenge being transformation of the business model which, inter-alia, would impact the massive sales clocked by the major players having a direct bearing on their valuations.