Revised FDI Policy in E-Commerce Sector: Choppy Waters Ahead

“Economics has made a substantial contribution to our understanding of the law, but the law has also contributed to our understanding of economics.… The study of law gives economists an opportunity to improve the understanding of some of the concepts underlying economic theory.”

— David D. Friedman

Law and economics refer to the study of the application of the economic theories of law on the applications of law, was a brainchild of the Chicago School of Economics. The bringing together of the legal theory and economic reasoning brings out the psychological aspects of the changes that the new legal trends bring about and its impact on the rationality of the people. Law and economics albeit being new and recent, has been a development and a work in progress as we look at and the divergence of which cannot be fully explained and known presently. With the evolution of science and technology and the internet reaching its far heights, the value of consumer protection and more use of legally binding contracts and agreements are becoming increasingly at par with the ever-growing industries everywhere. With the advancement of the e-commerce industry, the business to business (B2B) and the business to customer (B2C) governing laws have turned out to be a major concern of this uprising front of the industry. The B2B laws govern the transactions between two or more businesses, whereas the B2C laws govern the laws and their contracts with the general public. Varied applications of the economic impacts of the law on the country and the people and vice versa is just a glimpse of what this developing study of law and economics pertains to.

Electronic commerce has been defined as the purchase and sale of commodities via the use of the internet. There can be sale of physical products as well for which money transfer takes place online. E-commerce takes into account different forms such as retail, wholesale, crowdfunding, subscription, physical products and services. The embellishment reasons of e-commerce are that with immense ease, it also cuts down on the cost of inventory management due to which it attracts new customers and bring them into the field of the online market. This enables a trader to stay open all the time and sell their products all across the nation.

E-commerce in India comprises the second largest user base in the world but the market is comparatively smaller than that of the United States or France. It is believed that e-commerce will grow at a very high rate in India touching $150 billion by 2020. Presently, Flipkart Pvt. Ltd. and Amazon.com Inc. are dominating the Indian markets but over time with an increase in the middle-class population, new entities will establish themselves. E-tail and e-travel will dominate the Indian market in the near future. India’s e-commerce industry is expected to contribute 4% of GDP by 2022 and match with China’s demands in 5-6 years.

Nevertheless, the major players in the Indian e-commerce sector underwent a jolt before the new year after the Department of Industrial Policy and Promotion tightened some of the Foreign Direct Investment rules through a Press Note which came as a huge setback for Amazon and Flipkart, the dominant players in the Indian e-commerce sector. This paper analyses the changes brought in by the Press Note 2 and how such changes are going to have an effect on the e-commerce sector in the upcoming times. Unfortunately, it seems the road ahead is full of obstacles.

Introduction

The last week of 2018 brought forth a new development with the new e-commerce policy being announced by the Government.  They went ahead and tightened some norms and regulations for the e-commerce players, a move that struck hard to the likes of Flipkart and Amazon, for now, they cannot sell products of companies in which they have stake.[1] The Department of Industrial Policy and Promotion (DIPP) in its Press Note 2 (Press Note) issued in December last year, made significant changes to Foreign Direct Investment (FDI) rules in the e-commerce sector in India.[2]

The big trigger which led to such changes was the increasing complaints being made to the Competition Commission of India (CCI) and All India Vendors Association (AIVA) from the small brick and mortar traders against Amazon and Flipkart, that they have been favouring their own subsidiaries on their platform to such an extent that the revenues of small scale traders are taking a hit. Some of these changes have been made in the backdrop of a lot of opposition and resistance from the trader’s association such as the Confederation of All India Traders (CAIT).[3] It is pertinent to note that the Press Note was released to acknowledge some of the major concerns raised by the trader’s association after the CCI approved the merger between Walmart and Flipkart where Walmart which happens to be the largest private employer in the USA purchased majority of the shares of Flipkart, the largest e-commerce company of India.[4]

The important point to take into consideration is that a small number of sellers in Flipkart’s online marketplace played a major contribution in its substantial shares. These small sellers were also the customers of Flipkart in the (B2B) segment as a result of which they were given preferential treatment by way of hefty discounts from both the B2B segment and online marketplaces.[5] However, even after taking note of such major concerns, the CCI decided not to address such competition concerns on the grounds that such concerns were not incidental to the impugned combination, thus playing a safe hand. The failure of CCI to address such issues led to the Government making major policy changes to provide relief to the small traders and sellers.

These changes aim to make the marketplaces far more genuine for there has always been complaints that the online marketplace as a channel offers regulatory arbitrage. The whole logic and the reasoning of a marketplace functioning is to have a genuine marketplace where there are only connecting sellers and buyers. This reasoning often used to get questioned. The FDI e-commerce policy clearly states that while FDI is allowed in the marketplace but it is not allowed in the inventory-led model.[6] The likes of Amazon and Flipkart hold major stakes in their online marketplace such as Cloudtail and RetailNet respectively which are big sellers on their respective platforms. This led to preferential treatment by way of providing hefty discounts to such marketplaces. With the new changes coming into place major players such as Amazon and Flipkart will have to make sure that they maintain fair play on the platform and maintain an arm’s length distance while providing discounts to such sellers.

While these changes are welcomed and the intention of the Government in bringing such changes might be to curb the unfair practices and ensure fair play in the marketplace, however, these changes are not entirely free from the lacunas and the Government will have to address such grey areas in the near future for proper functioning of the marketplace.

Business Models

In order to understand the changes brought in by policy, it becomes important to first understand the inventory-led model and which are the prevalent business models in the e-commerce sector.

Inventory Model: A brand while selling online on sites like Amazon and Flipkart is most likely to first sell to an intermediary alpha seller entity like Cloudtail or RetailNet and then these entities are selling to the end consumer on the e-commerce marketplaces like Amazon and Flipkart.

Marketplace Model: In this model, the brand directly sells to the end consumer via Flipkart or Amazon with e-commerce marketplaces. This can be done in two ways. First, one could ship the product form his own warehouse directly to the end customer which is said to be the pure marketplace model or, second, one could follow the Fulfilled by Amazon (FBA) model or Flipkart Advantage (FA) model where a brand could keep some of its stock in Amazon and Flipkart warehouses and then when the orders are received these stocks are shipped to the end consumers from those warehouses, the products being owned by the vendors while they use their warehousing services.

Changes

The DIPP issued guidelines and clarifications on rules pertaining to FDI in e-commerce. The highlights of the Press Note were the definitions of the marketplace and also the fact that the Press Note categorically states that FDI will be prohibited in inventory-led e-commerce models while 100% FDI through the automatic routes will be allowed in marketplace models.

Firstly, the policy mandates that 100% FDI is only allowed in the e-commerce marketplace model.[7] Secondly, no equity participation is allowed by the marketplace in the selling entity[8] thus prohibiting such marketplaces from selling products of entities related directly or indirectly on their platform. Thirdly, the marketplace cannot exercise control on the inventory. In fact, they have clarified this point further by saying that not more than 25% sales of the selling entity can come from one marketplace or a group[9] such as Flipkart, Myntra and Jabong which are one group. Fourthly, no exclusivity can be offered by the marketplace.[10] Fifthly, discounts and cashbacks cannot be influenced by the marketplace[11], although this rule has been in place for some time now but the word “cashback” has been added because people were circumventing in discounts in form of cashbacks. Sixthly, the contact details of the selling entity need to be clearly made visible on the marketplace to the customers.[12]

Implications

The no-equity participation rule and the 25% sales in one marketplace rule have direct ramifications for the marketplaces if they have been selling through the alpha sellers, for example, Cloudtail and RetailNet in cases Amazon and Flipkart respectively. The future of these models has now become unclear and now such brands need to think about alternative measures. Now, all the brands need to rethink about directly participating in the marketplace model. This could be done either through one’s own warehouse if they are equipped to handle single piece orders or through the models like Fulfilment by Amazon (FBA) model or the Flipkart Advantage (FA) model which are already in place.

The 25% sale in one marketplace rule and the exclusivity rule will have major ramifications for online brands and private labels of marketplaces because invariably they will end up having more than 25% of share in one marketplace. Further, the decline on the private label side can be expected which will provide an opportunity to homegrown Indian brands to go and capture the market.

If the 25% sale rule and exclusivity rule are coupled along with the curb on discounts and cashbacks rules, it becomes a great level playing field for traditional online as well as offline brands who were finding it difficult to compete due to the predatory pricing mechanism of these e-commerce marketplaces.

Furthermore, the contact details of the seller, being directly visible on the marketplace and the customer satisfaction being the responsibility of the seller would mean that brands will have to evolve their consumer relationship management (CRM) practices. Marketplace orders now need to flow into an integrated CRM where the call centre will be able to pop-up the Amazon order and answer any questions.

In the backdrop of elections as well as traders lobby putting a fair degree of pressure, the Government has made some significant changes in the policy. The few ones that merit significant attention is that though 100% FDI is permitted under the automatic route[13] it has been made applicable only to the marketplace model and not the inventory-based model of e-commerce. This provision albeit existing, was being openly flouted. However, the present Press Note went on to make this rule more stringent bringing in new regulation measures per which inventory-based model can appear only through ownership or control. A vendor is supposed to not only hold an ownership stake in the new product but also control that inventory. With the marketplace controlling that inventory, it becomes an inventory-driven marketplace in which FDI is prohibited.[14] This change in effect means that marketplace entities going forward cannot exercise any degree of control over the actual supply of the products. Further, they have also changed to the effect that insofar as any after-sales delivery and customer satisfaction is concerned, the product has to be solely handled by the sellers.[15] Both these changes are of immense implication for the ongoing marketplaces.

Other major changes that garners attention is that the Press Note imposes an embargo on the marketplaces by stating that if any of the group companies are selling more than 25% of what the vendor is selling on the marketplace, it will fail to qualify as a marketplace and will be seen as an inventory-driven FDI marketplace where FDI is prohibited.[16] According to these new regulations an entity can take up only 25% of the purchases from its subsidiary. Given the fact that entities such as Cloudtail contribute almost 40% to the business of Amazon and similarly RetailNet which contributing a fair share to Flipkart’s sales, this regulation going to have a huge impact on the big giants.

The impact of this rule can be broken down into two levels. Firstly, that the wholesale arms of these marketplaces cannot be selling more than 25% of what the vendor is purchasing. The important point to note here is that Amazon wholesale or Flipkart wholesale were supplying products in huge volumes and value to a number of vendors who were selling on these marketplaces. The new regulations have placed an embargo on such practice by restricting the vendors from purchasing more than 25% from group entities of the marketplace. Secondly, the other big restriction brought about by the new regulations is that the marketplace entity or any of the group companies of the marketplace entity cannot own a single percentage of equity in any company which is a vendor on the marketplace.[17] Such a regulation ties into the whole point of players such as Cloudtail and RetailNet or other marketplaces where there is indirect foreign investment. However, it remains to be seen whether no equity participation would also include indirect equity participation as in some of the marketplaces and seller entities the foreign investment is not there at the direct level but it is one layer above. The intent of the policymakers is clearly to keep the marketplace genuine where the scope or the relevance of the marketplace in driving sales has to be kept limited.

As a result of such regulations coming into place, Morgan Stanley warned that Walmart may exit the Indian e-commerce sector.[18] It is a major concern as Amazon decided to shut down its retail business in China after the Chinese Government imposed similar restrictions in the country.[19]

Before the new regulation coming into effect, Flipkart and Amazon could sell their own line of products such as AmazonBasics, Flipkart SmartBuy etc. which proved to be profitable for them as they could lower the costs and the supply chain process. As a result of these new restrictions marketplace such as Amazon reduced its stake in its group company Cloudtail from 49% to 24%.[20]

The Press Note also imposes a ban on the exclusive tie-ups with the sellers.[21] The intention behind this regulation is to create a level playing field and ensure uniformity in the market. This regulation seeks to take away the dominant position of some of the marketplace entities such as Flipkart and Amazon and exclusive sale of smartphone brands such as OPPO, VIVO, XIAOMI, etc. could be a thing of the past.[22] This rule restricts marketplace entities from giving preferential treatment to particular sellers and thus maintains an arm’s length basis.

Further, the Press Note mandates that cashbacks that are provided to the buyers by a group of companies of a marketplace entity should be fair and non-discriminatory.[23] This regulation has got its origin and background in the context of the fact that the earlier policy stated that the marketplace entity should not directly influence the price at which products are to be sold[24]. However, number of trader associations had raised grievances before the Government that the particular policy is not being followed in letter and spirit following which the Government went on to become extremely prescriptive to address the perceived abuse. The new regulation, however, does not change the overall nature of the restriction that was already present.

The issue of marketplaces influencing sale prices gained attention in April 2018 after the Income Tax Appellate Tribunal in Flipkart India (P) Ltd. v. CIT[25] noted that Flipkart is indulging in predatory pricing and that it has its nexus with certain specific retailers for increasing its profit. Thus, the Government vide Press Note has made efforts to curb the issue of predatory pricing and preferential treatment by clearly stating that the group companies can provide only fair and non-discriminatory cashbacks and prohibiting the marketplaces from giving preferential treatment to specific vendors. This restriction has come as great relief to brick and mortar retailers and small e-commerce players with Snapdeal’s CEO Kunal Bahl welcoming the new regulations.[26]

Plugging the Loopholes

The Government released the Press Note to establish a level playing field in the Indian e-commerce sector and making the sector fair and just for all. However, the Government in its pursuit to address the concerns of the e-commerce sector have left some grey areas which may merit re-evaluation in the future.

The timeline provided to marketplaces to implement changes was fairly short given the fact that significant changes were brought in by the Press Note and that would have required a significant amount of restructuring by the existing marketplaces as the regulations has a significant amount of ramifications for the current business model on which the current marketplaces are running. Flipkart’s Chief Executive, Kalyan Krishnamurthy in his letter to India’s industry department requested the Government for extension of time for implementing the new rules as he feared that the new regulations could cause significant customer disruption in the case of non-extension of the deadline for implementation of new rules.[27]

The new norms have also banned the exclusive tie-ups which will have big implications on a lot of brands that have been looking at specific tie-ups with either Flipkart or Amazon. The Government here has gone a little overboard in its measure to check the anti-competitive practices. In order to ensure and streamline the process of a genuine marketplace, the Government has taken away the party autonomy that comes with any business model. If a brand intends to tie-up with particular marketplace for it offers better commercial value to them then they should be allowed to do so. Such a condition restricting a vendor to tie-up exclusively with one particular marketplace does not even serves the objective the Press Note seeks to achieve which as a matter of fact has not been laid down clearly in black and white. This regulation has taken away the party autonomy and is not in line with any intent that one could have deciphered from the policy announcement.

Further, the new regulations have severely hit the marketplaces such as Flipkart and Amazon while excluding the domestic marketplace entities such as Patym Mall, Snapdeal, etc.[28] The prime intention of the Government in bringing new regulations was to create a level playing field in the Indian e-commerce sector and ensure fairness and justice. However, the new regulations failed to take the domestic entities within its ambit thus giving rise to the possibility of such domestic entities indulging in unethical business practices which would further raise competition concerns in the sector as this will give a clear advantage to these domestic players thus defeating the objective of the Government behind introducing the Press Note. While on one hand, the FDI marketplace is finding it tough to adhere to the new norms and regulations, on the other hand, these regulations provide an opportunity for the domestic players to take undue advantage.

The Press Note has also banned the marketplaces from providing hefty discounts and cashbacks. However, since the Government did not appoint any agency to ensure proper compliance of the rules, these marketplaces are likely to come up with innovative methods of providing discounts.[29] Also, there is a threat that such a restriction will have a negative impact on the customers at large as deep discounts and cashbacks are the primary incentive for most of the people in India behind shopping online. Further, these regulations do not take offline retailers within its ambit neither the same is clear from any provision which gives the offline retailers undue advantage. Further, although the Press Note talks about cashbacks provided by the group companies it is silent on the point of cashbacks provided by the marketplace entities. Marketplace entities can provide deep discounts and hefty cashbacks that could result in unfair and discriminatory pricing.

Furthermore, the Press Note failed to take into consideration the problems of implementation of some regulations. The Press Note does not even mentions any criteria to assess whether 25% purchases of a vendor are from the marketplace entity or its group companies considering the fact these marketplace entities do not even have the access to the accounts book of most of its vendor.

The new regulations also prohibit preferential treatment to any vendor in similar circumstances without providing any proper interpretation of the term “similar circumstances” thus giving uncontrolled discretionary power to the regulatory bodies.

Conclusion

The new policy brought in by DIPP should be welcomed as in the long run it has the potential of creating a level playing field. In the short run, entities might face some operational challenges of moving from the alpha seller model to the marketplace model directly. However, no matter how good the intention of the Government might be behind bringing the changes, they need to open their eyes soon and take step towards curbing the loopholes in the new policy as it clearly discriminates between foreign and domestic companies giving a clear-cut advantage to the latter. If these problems are not solved soon then the whole objective of the Government will face a major setback. In fact, as stated earlier there is a threat that major marketplace like Flipkart might end their operation in India. Such a possibility cannot be ruled out given the fact that Amazon decided to take an exit from the Chinese e-commerce sector in light of similar restrictions. Therefore, to prevent such extreme measure the Government should look forward to work in collaboration with these big entities and come up with rules, that is beneficial for all.

---

†  3rd year student, NUSRL, Ranchi.

[1] Govt. Tightens Norms for Etailers, Bars Exclusive Deals, The Economic Times (27-12-2018, 11.57 a.m.) <https://economictimes.indiatimes.com/news/economy/policy/government-tighten-norms-for-e-commerce-companies-for-sale-of-products/articleshow/67258251.cms>.

[2]  Press Note 2, Department of Industrial Policy and Promotion <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[3]  War Against Flipkart! Traders Association CAIT Complains to ED; Alleges Violation of Trade Rules, Financial Express (1-6-2018, 3.23 p.m.) <https://www.financialexpress. com/industry/war-against-flipkart-traders-association-cait-complains-to-ed-alleges-violation-of-trade-rules/1189833/>

[4]  Walmart International Holdings, In re, 2018 SCC OnLine CCI 103.

[5]  Walmart International Holdings, In re, 2018 SCC OnLine CCI 103, (para 13).

[6] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.3(ii)  <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[7] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.3(i) <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[8] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.4(v)  <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[9] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.4(iv) <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[10] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.4(xi) <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[11] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.4(ix) <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[12] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.4(vi) <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[13] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.3(i) <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[14] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.4(iv) <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[15] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.4(vi) <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[16] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.4(iv) <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[17] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.4(v) <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[18]  Nishanth Vasudevan and Samidha Sharma, Morgan Stanley Warns Walmart may Exit Flipkart Post New FDI Rules, The Economic Times (5-2-2019, 4.27 p.m.) <https://economictimes.indiatimes.com/industry/services/retail/morgan-stanley-warns-walmart-may-exit-flipkart-post-new-fdi-rules/articleshow/67843595.cms>.

[19]  Amazon Plans to Shut Online Store in China, BBC (18-4-2019) <https://www.bbc.com/news/business-47972634>.

[20]  Shambhavi Anand and Chaitali Chakravarty, Key Amazon Seller Cloudtail Returns in a New Avatar, The Economic Times (7-2-2019, 11.29 a.m.) <https://economictimes.indiatimes .com/industry/services/retail/key-amazon-seller-cloudtail-returns-in-a-new-avatar/articleshow/67877172.cms>.

[21] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.4(xi) <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[22]  Subhayan Chakraborty and Karan Choudhury, New Govt. Norms may End Amazon, Flipkart Flash Sales and Discounts, Business Standard (27-12-2018, 4.22 a.m.) <https://www.business-standard.com/article/economy-policy/amazon-flipkart-may-feel-the-pinch-after-govt-bars-exclusive-deals-118122600873_1.html>.

[23] Press Note 2, Department of Industrial Policy and Promotion, Para 5.2.15.2.4(ix) <https://dipp.gov.in/sites/default/files/pn2_2018.pdf>.

[24] Press Note 3 (2016 Series), Department of Industrial Policy and Promotion, Para 2.3(ix) <http://dipp.nic.in/sites/default/files/pn3_2016_0.pdf>.

[25]  ITA No. 693. Bang/2018 (Asst. Year – 2015-16) <https://taxguru.in/wp-content/uploads/2018/08/Flipkart-India-P-Ltd.-Vs-Asstt.-CIT-ITAT-Bangalore.pdf>.

[26] Govt. Tightens Norms for Etailers, Bars Exclusive Deals, The Economic Times (27-12-2018, 11.57 a.m.) <https://economictimes.indiatimes.com/news/economy/policy/government-tighten-norms-for-e-commerce-companies-for-sale-of-products/articleshow/67258251.cms>.

[27] New E-Commerce Rules: Flipkart Warns of Major Customer Disruption, Livemint (29-1-2019) <https://www.livemint.com/industry/retail/flipkart-amazon-new-e-commerce-rules-1548756549308.html>.

[28]  E-Commerce FDI Norms Should be Applied on Domestic Players Also: CAIT, Business Standard (1-1-2019, 1.23 a.m.) <https://www.business-standard.com/article/companies/e-commerce-fdi-norms-should-be-applied-on-domestic-players-also-cait-118123100412_1.html>.

[29] E-Commerce Discounts May Continue, But in Innovative Ways, Livemint (28-12-2018, 12.39 p.m.) <https://www.livemint.com/Industry/QCRLPPX16uWwsTfFX07V0M/Ecommerce-discounts-may-continue-but-in-innovative-ways.html>.