Some e-retailers are lobbying in order to try and persuade the government to ease the rules. We need capital, no question about that. We are today sitting in a no-man’s land. We either play for growth or for survival.” That’s Harish Bahl, founder and chief executive of New Delhi-based Smile group, an investor in several shopping sites.
India’s e-commerce retail sector is caught in a peculiar bind. On the one hand, the sites are gaining customers as people become more comfortable with buying things online.
But on the other, the government’s decision in September to bar foreign direct investment (FDI) in the online retail business has led to some amount of desperation among shopping sites, especially the smaller ones.
Just when they need to be spending money to gain customers, the FDI pipeline is running dry. Those who are already invested are trying hard to ensure that their companies are compliant—and the sites seem to have found a way around the rules. Meanwhile, a clutch of e-retailers are lobbying in order to try and persuade the government to ease the rules.
India’s budding e-commerce market is threatened by depressed valuations, lack of funding and confusion over regulations. Online retail still only accounts for a minuscule $600 million (around Rs.3,600 crore), compared with India’s $518 billion brick and mortar retail industry. according to a report published by Technopak. E-commerce sector has a potential to grow to as much as $76 billion by 2021.
In its 2012 diktat, the government had said it won’t allow FDI in any consumer facing retail business conducted on net. Nor would it allow private equity (PE) or venture capital (VC) funds to directly invest in e-commerce companies. Subsequently, the Enforcement Directorate began to probe Flipkart, India’s biggest online shopping site, funded by PE firms such as Tiger Global Management LLC and Accel Partners.
Flipkart is in compliance with all regulations, CEO Sachin Bansal said through a spokesperson.
“The industry, though in its infancy, is growing at the rate of 100% year on year. Flipkart... continues to support the authorities whenever approached,” he said.
Investors have turned cautious, said Rutvik Doshi, an e-commerce investor with Inventus Capital Partners.
“Up until last year, it was not explicitly mentioned that FDI in e-commerce was banned. But after the regulations were announced, some VCs, especially the foreign-based ones, have become extremely cautious,” said Doshi. “Now, it’s a serious issue and investors are doing all they can to make sure that their companies are compliant with the law of the land. Not just us, but all VC firms are doing this,” he said.
There is a workaround that some companies have adopted in order to allow continued FDI funding. That is to split the back, or wholesale, end of the business from the front, or customer-facing, end, which takes orders from shoppers. The orders are fulfilled by the wholesale entity. The FDI goes into this latter part of the business.
New investors are however wary of putting their money into the sector.
“They worry about returns and the future when a company may want to list. The current structures can complicate future investments,” said the chief executive of a New Delhi-based e-commerce website.
Alternatively, e-commerce firms can operate as so-called marketplaces. Orders are farmed out to independent merchants, who sell products directly to shoppers, the model that eBay and Amazon.in use in India. Some online retailers, including Flipkart, converted themselves to such a structure after the rules were announced.
“When you’re operating as a marketplace, you’re just a platform or meeting point for buyers and sellers. This is a service, so FDI regulations for retail don’t apply,” said Paresh Parekh, a tax partner at consulting firm EY.
But with companies burning cash on chasing customers, investors aren’t convinced the model is sustainable and are cutting back on investing in start-ups.
Out of the 53 e-commerce companies that got $853 million in venture capital over the past three years, only 11 have managed to raise further rounds of funding, said a May report by investment bank Allegro Capital Advisors.
Sites that haven’t been able to gain traction are having a hard time—many are just shutting down. In the six months to May, about 140 e-commerce start-ups folded up, primarily due to lack of funds, according to data collected by Ashish Sinha, who runs the NextBigWhat, an online platform for technology start-ups and investors.
Some small e-commerce retailers are approaching larger companies such as Flipkart and Myntra with buyout proposals at bargain-basement prices, according to industry executives.
“You sell only when you are in distress and if you don’t open FDI, all consolidation will go to the biggies,” said Manmohan Agarwal, executive chairman at Bigshoebazaar India Pvt. Ltd, that owns online portal Yebhi.com.
Online retailers have been meeting commerce ministry officials to persuade them to ease the rules, said Agarwal at Yebhi.com. Some investors said the government is under the impression that online retail will hurt local businesses.
“They think it will impact manufacturing and are trying to prevent foreign retailers to come into the market. There is also a fear of the unknown— that is, the political push backs and ramifications of opening of the sector,” said Bahl of Smile group, which has invested in e-commerce portals such as Fashion and You.com and beStylish.com.
Allowing FDI in retail has been a controversial decision with intense resistance to opening up coming from various political parties.
The lobbying effort is set to intensify over the next few weeks when Nasscom, the industry grouping for India’s $108 billion information technology sector, is expected to announce its newly created Internet Council, which will take up issues related to the e-commerce industry.
“Once we create the Internet Council, we’ll expand our policy agenda for that sector,” said Sangeeta Gupta, senior vice- president at Nasscom. She declined to comment on whether Nasscom would directly handle FDI-related issues as well.
Experts doubted the effectiveness of lobbying. The Indian government is still working on clarifying FDI rules on brick and mortar retail and insurance.
“The issue with opening up the policy is that, unlike traditional multi-brand retail that attracts huge capital investments, opening up of FDI in commerce does not swing the needle for the government materially,” said Arvind Subramanian, partner and director at The Boston Consulting Group (BCG).
The government’s focus on building greenfield infrastructure has been evident in the retail FDI strategy. E-commerce isn’t a critical part of this scheme. “From a government perspective, it’s not a priority sector at all. It’s too small and it neither creates much infrastructure or backend set-up. I don’t see the government’s outlook toward e-commerce changing any time soon. There are other sectors which are far bigger for them to sort out first,” said EY’s Parekh.
Subramaniam said that while investments in e-commerce would help in creating infrastructure such as warehouses and logistical networks, the scale will be much smaller that than of offline retail.
Meanwhile, representatives of US online retailer Amazon.com, which launched its marketplace portal in India last month, have been meeting with the Indian government to further understand the existing policy pertaining to e-commerce. In February this year, Paul E. Misener, global vice- president, Amazon.com Inc., met commerce minister Anand Sharma. “We talked about it. We talked to the government officials on all kind of different issues and..trying to find a better way to serve our Indian customers, both sellers and buyers,” Misener had then said.
Online retailers said they want the government to ease the rules to prevent a monopoly situation cropping up now or later.
“Right now, there are barely any big names in the sector. But if the Tatas or Reliance were to enter e-commerce in a big way then the government would have to take notice because of... their deep pockets,” said a former Flipkart executive who declined to be named. “Until then, I doubt if there will be a focused regulatory framework.”
