Background
The trade unions of India have always been worried about the unfair market practices of the E-commerce entities such as heavy discounting and massive cashback offered in online marketplaces. Their woes only got aggravated after the anti-trust watchdog approved the merger between Walmart and Flipkart. In response to the same, the Department of Industrial Policy and Promotion issued Press Note 2 which has laid down guidelines that need to be followed by huge international marketplaces that operate in India such as Flipkart and Amazon. This article examines the impact of Press Note 2 on the Indian e-commerce sector and primarily focusses on Amazon and Flipkart. Further, it analyzes how the press note has failed in its objective of creating a ‘level playing field’ in India.
Key Changes
Three major changes need to be followed by international marketplaces that operate in India. Firstly, vendors are not allowed to sell their products on the marketplace entity’s platform if such entities do not have any stakes or equity participation in the vendor. Secondly, they are prohibited from entering into exclusive ‘tie-ups’ with sellers. This ensures that small vendors are not at a disadvantageous position. Thirdly, they are not allowed to offer massive discounts to facilitate a fair and non-discriminatory environment for all vendors.
Additionally, an e-commerce entity is now required to furnish proof of compliance under the FDI regulations. A certificate and the report of the statutory auditor of the Reserve Bank of India needs to be submitted in the month of September every year.
Furthermore, the press note clarifies that FDI is permitted to the tune of 100% in this sector under the automatic route. However, this applies only to the marketplace model and not the inventory-based model which was allowed under the earlier rule. The inventory-based model of e-commerce under the previous regime was prompted only when the marketplace exercised ownership over the inventory.
The Press Note has rigidified the regulations by incorporating a clause due to which the new rules would apply to inventory-based models based on factors of ‘ownership’ or ‘control’. The requisite of control is satisfied only if more than 25% of sales of the vendor are generated from the marketplace entity. The failure to meet the said requirements will render the marketplace entity as ineligible to receive FDI.
The Press Note has also taken into account, the decision of the Income Tax Appellate Tribunal in Flipkart India Private Limited v Assistant Commissioner of Income-Tax where it was advocated that ‘predatory’ pricing by Flipkart and its tie-up with specific traders needs to be curbed. This mandate has also been extended to other facilities such as financing, payments, logistics, warehousing, advertising, etc. Therefore, heavy discounts to lure customers might not exist anymore but cashback is still allowed. Such restrictions can help the small local vendors in the market to co-exist along with the big players like Amazon and Flipkart.
Challenges faced by Amazon and Flipkart
- The affiliate sellers of e-commerce companies to ensure the continuity of their business activities of providing goods and services need to shift the majority of their business to other retailers.
- They will be required to alter their equity structure substantially in order to avoid disruption of their business with the sellers.
- There will be a massive reduction in big discount sales offered by them since they cannot derive the benefit of selling at low prices and large scale purchases due to the press note.
- Flash sales which were earlier conducted by them to promote or sell certain products on their platform is now prohibited under the new regulations.
Rejigging done by Amazon and Flipkart
During the previous FDI regime, Amazon and Flipkart used to sell their own line of products like Amazon Basics, Amazon Echo, and Flipkart Smartbuy. Notably, Amazon in India had formed an entity called Cloudtail by entering into a joint venture with Narayan Murthy’s Catamaran Ventures. A big chunk of sales for Amazon was facilitated by this joint venture. Marketplace entities usually embrace such measures to cut down on supply chain costs and to increase their profits. Pursuant to the amendment, Amazon pulled the plug on these ventures due to the pre-cursive requirement to comply with new regulations. As a result, Amazon also cut short its shareholding in Cloudtail from 49% to 24% forcing it to alter its operating models due to the restrictions imposed by the Press Note.
Moving on to Flipkart, it has set up a ‘layer of B2B entities’ to comply with the Press Note. It has appointed various intermediaries to buy goods from Flipkart wholesale. Further, the intermediaries sell the goods to preferred sellers like SuperComNet, Omni-Tech Retail, and RetailNet who in turn sell them on Flipkart. This will help Flipkart evade the rule which has imposed a 25% cap on buying directly from one seller since it will not buy and sell the goods directly. Instead, the same will be done through the use of intermediaries.
Negative Impact of the Press Note
- It has been reported that Amazon and Flipkart lost 50 billion dollars in market capitalization due to the fall in their share prices. Amazon’s share price fell by 5.38% on NASDAQ and Flipkart’s share price plummeted by 2.06% on the New York Stock Exchange as soon as the amendment was announced.
- Online sales worth Rs.35,000 to Rs.40,000 which can be attributed to 35 – 40 % of the sales of the e-commerce industry might get affected because of the FDI policy in place for the fiscal year 2020.
- Amazon and Flipkart will no longer be able to enter into exclusive tie-ups with a particular seller to sell a particular product. Consequently, this will make it strenuous for stores to offer discounts which had made them more attractive than offline retailers to costumers.
Lacunae in the Press Note
The Press Note has not provided any method to evaluate whether 25% of a vendor’s purchases need to be from itself or its group companies. Additionally, the Press Note has restricted its applicability only to e-commerce players with FDI but excludes domestic players like Snapdeal, Naaptol, or Paytm Mall. Such omission has created a big void in the Press Note’s attempt to regulate such entities.
The fact that entities with FDI need to comply with various requirements and that domestic entities need not do the same is ironic in nature and goes against the objective of the amendment. The entities which receive FDI are burdened to alter their operating models in order to be compliant with the Press Note. Conferring domestic entities with preferential treatment over foreign entities depicts India as an unattractive market for foreign investors. It is pertinent to note that India is a signatory to the General Agreement on Trade in Services which requires it to adhere to the national
treatment principle. Failure of the Press Note in doing the same might lead to unintended repercussions for India.
The wording of provisions related to the applicability of the fair and non-discriminatory test to offline retailers are innately ambiguous. This can give offline entities an undue advantage over online entities. The Press Note has committed to the principle of non-discrimination through the term ‘similar circumstances’. However, the interpretation of ‘similar circumstances’ is obscure and needs clarification. This gives excessive powers to regulatory bodies to interpret ‘similar circumstances’ which might prove to be inconsiderate towards online entities.
Closing Remarks
E-commerce giants like Flipkart and Amazon are well experienced in their field and have been successful long enough to battle it out in the e-commerce sector without any hassles. Although, the amendment has had a considerable impact on their operating models, they will bounce back soon due to their adaptive nature to the constantly changing regulations. Additionally, they possess the data of consumer behavior which will incessantly give them an edge over their competitors in the current logistical retail market.
Even though, the new reforms of the Department of Industrial Policy and Promotion might be advantageous for the small traders in the long run, it can have an adverse effect on the inflow of Foreign Direct Investment in the sector of e-commerce. Indeed, the Press Note has contradicted its objective of providing a ‘level playing field’ by not treating domestic companies and foreign companies impartially. Therefore, these loopholes need to be plugged immediately so as to prevent the retreat of major foreign e-commerce players as predicted by Morgan Stanley.
This article is written by Eshvar Girish of Christ (Deemed to be University), Bangalore.
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