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Prerna Sharma: India e-commerce policy unworkable

Indian Prime Minister Narendra Modi's government has announced plans to allow 100% foreign ownership of companies in the fast-growing e-commerce sector, which is expected to be worth $100 billion a year by 2020. The easing of restrictions on foreign capital is overdue, and could lead to significant benefits for Indian consumers. But there is a catch.

     The proposed rules are so hedged with provisions intended to protect struggling brick and mortar retailers -- including draconian controls on pricing -- as to appear largely impractical; the administrative machinery required to police the rules would be a step back to the so-called license Raj, when officials governed almost every aspect of business activity. The government is right to encourage fresh capital to flow into e-commerce, but it is wrong to link that objective with aid to old-fashioned shops, which can be helped in other ways.

     The prize is huge. India's $11 billion e-commerce market is growing at a compound rate of 60% a year, with more than 360 million Internet users and 220 million smart phone accounts, equivalent to 28% and 17% of the population respectively. Yet e-commerce accounts for less than 2% of India's total retail market of $600 billion, suggesting immense growth potential.

     The policy guidelines announced by the government allow 100% foreign direct investment in online retailing of goods and services sold through what is called the "market place model" -- e-commerce platforms that are restricted to facilitating sales by third party companies. However, such platforms would be prohibited from influencing the prices of goods sold, and would have to ensure that no single vendor company accounts for more than 25% of sales revenue. This is intended to address allegations of monopolistic behavior by large online vendors.

     The new rules broadly prohibit full foreign ownership of e-commerce companies operating the so-called inventory model, where the owner of a platform sells its own goods to customers. There are exceptions for investments in Indian manufacturers selling their own goods online (or, in some cases, a small proportion of goods sourced from other Indian companies), and for single brand retail trading entities operating through brick and mortar stores. FDI exceeding 51% in these businesses would require approval, and would depend on Indian content requirements being met.

     These measures are well intentioned; the idea is to create a level playing field between online and offline retail, but the government will find it difficult to implement them on the ground. Worse, they might stifle the growth of e-commerce in India.

     The policy guidelines come at a time when online retail platforms are increasingly being criticized for deep discounting that adversely affects the sales of brick and mortar retailers, who cannot match them because of their higher costs. Platforms are accused of exploiting sellers by charging transaction fees as high as 35% of sales prices. There have also been claims that fake or poor quality goods have been sold at discounted prices.

     Returning goods and getting refunds remains a nightmare for online buyers, and government revenues are being hit by ineffective taxation of online sales of goods and services, including downloads of music, movies, and books and software.

     The new rules are complex, but their impact will vary. For example, Snapdeal, a top online marketplace, will benefit because it does not maintain inventory and none of its vendor companies accounts for more than 25% of sales through its platform. Its rival Flipkart, which does sell its own goods, will be hampered by the inventory model rules and by the sales cap: Its biggest seller, WS Retail, accounts for more than 70% of revenues.

Level playing field

Amazon will also face problems. Cloudtail India, a joint venture between N. R. Narayan Murthy's Catamaran Ventures and Amazon, accounts for over 40% of Amazon's sales in India because of its dominance in electronics and fashion apparel -- two of the three top selling categories of merchandise.

     The rules prohibiting online retailers from influencing sale prices are aimed at creating a level playing field between online and offline retailers, which are losing customers and have been lobbying for government intervention for some time. But prohibiting discounts has the potential to make online retail less attractive to both shoppers and investors, which would limit its growth potential. It also means that consumers will face higher prices as competition is reduced, both within e-commerce and between online sellers and brick and mortar retailers.

     These well-intentioned but impractical measures leave some important questions unanswered. First, how can a government in a market economy tell sellers not to give discounts or set prices that benefit customers? Second, is the government really in a position to implement the rules?

     For example, online market platforms will be allowed to provide warehousing, logistics, payment collection and other services. What happens if they offer these services to vendors for free, or at very low costs, with the expectation that sellers will unilaterally cut their prices to grow sales as their costs fall. This is clearly a potential response to the rules, given that online retailing in India is already mostly about achieving high volume sales at low margins.

     Will the government put inspectors into platforms or vendor companies to check whether the price rules are being followed? If it does, that will suffocate a sector with high growth potential, preventing it from contributing to economic growth and job creation. Online retailers are creating many of the jobs that the Modi government desperately wants to see; their impact on the labor market is widespread, from engineers and managers with post-graduate business degrees to delivery boys.

     Theoretically, this measure is intended to move retailing away from a model in which vendors build volume through heavy discounting. That may be a good idea, but implementing it will be full of challenges. Industry experts say that online retailers will quickly find a way around the rules to continue with deep discounting.

     In any case, though, if brick and mortar retailers can offer discounts, why is it fair for the government to stop online retailers from doing the same thing. This point has not been answered by the regulatory authority, the Department of Industrial Policy and Promotion.

     If the government wants to help brick and mortar retailers it needs to address their main worry -- the fast rising rental cost of retail space, especially in cities. The main cause is scarcity of land. But federal and state governments are sitting on vast tracts of urban land that could bring down rental costs if released for commercial development.

     Speedier regulatory approvals would also ease constraints on the supply of retail space and help brick and mortar retailers. Offline retailers' high costs are also in part a consequence of India's infrastructure shortcomings, including an inefficient network of ports and roads.

     Fixing these problems will not be easy, but would make traditional retailers' lives easier without inflicting unnecessary damage on the online sector. It would then be for offline retailers to figure out how to minimize overhead costs in ways that might allow them to compete.

Prerna Sharma is vice president and head of agriculture, food and retail at Biznomics Consulting in Mumbai. This article expresses the author's personal view.

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