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eCommerce in India: Opening Pandora’s Box?

posted: 23 September, 2014

India’s ‘bricks-and-mortar’ retailers are facing many challenges in their quest to expand store networks. Amongst the most pressing concerns are the eye-watering cost and scarcity of suitable real estate, and the distribution of a potential customer base across a land mass approximately three times that of Europe.

While the root causes are unlikely to be removed any time soon, by attempting to work around them, many of the county’s retailers may be encouraged to pursue their greatest opportunity. On the surface at least, India is primed for the rise of eCommerce.

Online shopping in India is in its embryonic stages. At $2.3bn, eCommerce currently accounts for a modest 0.4% of the country’s total retail sales. However as Internet penetration rises, this is expected to increase to $32bn (3.0%) by 2020. Unsurprisingly this has caught the eye of foreign venture capitalists and private equity firms. Recent months have seen foreign direct investment (FDI) in market heavyweights Flipkart ($1bn), Amazon ($2bn), and, eBay-backed, Snapdeal ($234m). Given the market potential, nothing terribly unusual about that you might think.

What you need to bear in mind that while India currently permits up to 100% FDI in eCommerce, it applies only to those companies engaged in business-to-business activities (B2B), not business-to-consumer (B2C). Consequently neither Flipkart, Amazon, nor Snapdeal technically engage in online retailing. Rather, they operate as a ‘marketplace’, providing a platform on which third-party vendors sell to consumers in return for a sales commission and, typically, control of back-end logistics.

Without a product inventory of their own, they are unable to benefit from bulk purchasing. The marketplace model translates into smaller margins, and less control over quality of service, all before considering the significant challenge of developing a reliable delivery network and payments system. Yet despite all this investors are still queuing up – why?

The clue might lie in the restructuring that Flipkart has gone through over the last couple of years. Since its incorporation in 2008, foreign-funded Flipkart operated on an inventory-based B2C model. However following an investigation by India’s Enforcement Directorate into alleged FDI violations, Flipkart converted to a marketplace. Ownership of the company which previously ran its B2C activities (WS Retail) was separated from the B2B company (Flipkart Online Services) – the one that attracted the foreign investment.

While WS Retail must maintain an arm’s length relationship with Flipkart Online Services in order to comply with FDI regulations, WS Retail is now just one of the many third-party vendors who sell through the platform… albeit one with a few friendly faces.

The potential of eCommerce in India means a big prize is at stake, but it requires very deep-pockets and a whole lot of patience. However with the right footwork, it would appear a relaxation in eCommerce FDI regulations may not necessarily be required to attract foreign investment after all.