Draft FDI in inventory based model to boost e-commerce in India?

Bar & Bench October 7 2018
Shayan Dasgupta 

With the recent hullaballoo created over the Walmart-Flipkart deal, the Ministry of Commerce and Industry (MCI) had set up a task-force which has submitted its recomendations in the form of a Draft National Policy Framework 2018 (the Policy) claiming to bring a revolution in the Indian e-commerce Industry, which is shrouded in scepticism by the prudent minds and stakeholders of the economy.

With such robust claims of digital facilitations and a strong regulatory framework is it that the major players are worried about the impact of this policy? This is primarily because it has suggested that a limited inventory-based B2C (business-to-consumer) model with 49 per cent foreign equity be allowed. I am here to conduct a post-mortem study of this policy and appraise the benefits it so claims.

What is E-commerce?

The MCI has defined E-commerce as the buying and selling of goods and services including digital products over digital and electronic network. There are two models of the e-commerce in India:

a. Market Model: where it is just an online platform connecting buyers and sellers and has no inventory of its own. For example- Naaptol, ebay etc.

b. Inventory Model: here the marketplace owners owns the products and also manages the complete end-to-end sales process. The inventory of the goods is owned and sold by the ecommerce entity directly to the customers. For example- Jabong etc.

The erstwhile FDI norms regulating E-commerce (Press Note 3)

The Commerce ministry had issued a Press note 3 under the Consolidated FDI Policy Circular 2015 in 2016 regulating the FDI norms circumscribing the e-commerce Industry. Major norms are:

A. 100% FDI under automatic route in B2B e-commerce.

B. FDI in B2C e-commerce, on the other hand, was not permitted. It was only allowed when:

i. Manufacturer was permitted to sell its products manufactured in India through ecommerce.

ii. Single brand brick and mortar entity undertakes to sell through e-commerce.

iii. Indian manufacturer is permitted to sell its own single-brand products through ecommerce retail which manufactures 70% of its products in-house and sources at most 30% from Indian local markets.

C. FDI in inventory based model e-commerce was strictly prohibited.

D. e-commerce entities were obligated not to permit more 25% of its sales to be affected by one vendor or its group companies.

E. They were prohibited to, directly or indirectly, influence the sale price of goods and to maintain a level playing field.

The Walmart-Flipkart Deal paradox - Reason for the Policy

In May 2018, Walmart, the American retail giant, acquired 77% stake of Flipkart for $ 16 billion making it the biggest M&A transaction in the history of India with the Asia-Pacific Retail Giant.

This deal has faced much ire of the small and domestic retailers as they have alleged violations of FDI norms by creating a de-facto inventory model by procuring large sums of goods from their own subsidiaries and group companies thereby violating 25% sales from a single vendor or group companies rule set under  the Press Note. Other players include Snapdeal, backed by Japan’s SoftBank, Paytm backed by SoftBank and Alibaba Group, and Tiger Global-backed ShopClues.

Furthermore, the small retailers have already complained regarding the deep discounted prices offered by these giants which are surreptitiously wiping the small brick and mortar stores from business. To this effect, the Delhi High Court has already issued notices to Amazon and Flipkart based on a PIL filed by the NGO Telecom Watchdog alleging that they have violated FDI norms by finding proxy methods for routing popular products at much cheaper rates through proxy controlled sellers or group companies and pushing out small businesses and brick-and-mortar retailers.

Thus to address these increasing concerns of the smaller players the task force came up with the draft policy.

The Draft Policy Recommendations 2018 - An Analysis

The recommendations of the policy can be broadly categorised as following:

A. ‘Make in India’ initiative

Sale of 100% Indian products:

FDI in inventory model of B2C e-commerce entities (which was earlier prohibited by the 2016 FDI norms) may be allowed in limited manner capacity to promote ‘Make in India’, controlled by resident Indian Founder/promoter and up to 49% stake for a single foreign entity. The idea
is to promote 100% selling of made in India products through e-commerce retailers.

Domestic funding:

To achieve this, the government plans to grant incentives to raise funds domestically, primarily through:

a. Incentivizing investment by large companies in start-ups (What are these incentives? This will be a consideration for later deliberations);

b. Expanding source funding by Venture Capitalists;

c. Listing of start-ups in lucrative bond-markets and amending tax laws to facilitate Angel Investment in e-commerce start-ups.

This is a much-needed dynamic change as this industry is heavily backed and funded by foreign players such as Softbank or Alibaba etc. There is indeed no dearth of domestic money in India and this needs to be assimilated and utilized to create a self-sufficient economic environment
in India. This will further aid and inspire multiple start-ups to surface and create their mark in the market.

Indian control over the company:

Amending the Companies Act 2013 to grant more control and power to Indian shareholder despite smaller shareholding is another recommendation which maybe done by granting special voting rights or dual-class shares as done in the US. This may also draw indignation of the offline companies who would demand similar treatments which ought to be considered by the Government at the drafting stage itself.

Despite being a major manufacturing country, we are being reduced to a consumer status by the flooding of foreign products which are offered to us at throwaway prices in the guise of competition. This initiative will pave ways for our local products to create a brand in
international waters. The opening of IKEA or Walmart in India shouldn’t be as celebrated as the opening of Indian brand in the US and dominating its market share. We already have given away search- engine market to Google and social media to Facebook and its subsidiaries so it pertinent for Indian entities to establish their presence in global IT market and capitalize on its economies. That should be the objective of Indian start-ups and brands and this is a welcome step towards it.

B. Data localization in India

All the players (intermediaries) and e-commerce entities collecting, storing and processing data from its customers and operating in India will need to store the data in India only. A sunset period of 2 years will be given to the industry to adjust to this localisation, making this step a mandatory one instead of a mere idea or suggestion. Plans are set in motion to provide incentives to develop infrastructural advances towards this goal such as direct and indirect tax-benefits and customs duty rebates, and according infrastructure status to data centres
and server farms. Only certain categories of data will not be subject to any restrictions on cross-border data flow. This includes data not collected in India, B2B data sent to India as part of commercial contracts between a business entity located outside India and an Indian entity,
among others.

Personal Data Protection Bill 2018:

Recently, Justice Sri Krishna Committee has submitted its report and recommendations to protect the data privacy of Indian users, which is in lines with EU’s GDPR Regulations. It upholds the primacy of data protection and will extend to data fiduciaries or data processors who operate outside the country, if they carry out processing of personal data in connection either with any business carried on in India, systematic offering of good and services to data principles in India, or any activity which involves profiling of data principals (individual users) within of India and adds limitations to cross-border transfer of data.

Harmonious linking of the draft E-commerce policy and Data protection bill:

Subject to this bill read with the draft policy, the government will have access to such data for national security and public policy objectives. There is a clear sync between the policy and the bill which is a refreshing change altogether. The bill suggests changes to section 43A of the IT
Act as well as Aadhar Act to bring this harmonious construction to life.

With the threat looming after the Cambridge Analytics and Facebook case, protecting the data of Indian users was the need of the hour. The individual’s data generated by activity in one area can provide a competitive edge for a new business in another area which not only leads to new revenue streams but can also be sold from one entity to another. Thus, making threats eminent and ubiquitous and this move is undoubtedly a stride towards a stronger armoured shield against it with IT infrastructural feats and data centres reigning economic development along with advanced innovative Patents and other Intellectual Property accumulation in India. The entire IT market in India has been a desolate, barren land with no vital Indian players in it, and this will mark the new ethos making us worthy of the so-called IT supremoes as we call ourselves.

C. Pricing Regulations/Anti-competitive measures

Influencing the price of goods:

Targeting massive JVs and M&A ventures in e-commerce the Policy aims at curbing out any direct or indirect influencing of the price of goods and services sold by the e-commerce, especially their group companies through which they procured vast portions of goods and surreptitiously replaced market model with inventory model.

Differential Pricing:

To resolve the deep discounts and differential pricing issues a sunset clause will be mandated upon E-commerce entities which gives a maximum duration only during which such discounts can be offered. To me this clause is overly protective in nature and unwarranted which would eventually deter healthy competition amongst players. To add to this deterrent factor, bulk purchases from related party sellers will be prohibited. This is a major shortcoming as even the brick and mortar entities acquires bulk products on heavy discounts, chop out huge chunks of margins before sell it to the customers. By this logic, even they should be prohibited from doing so and not just the e-commerce players. Eventually, the customers will suffer for this tassel between online and offline businesses.

Stricter vigilance of Mergers causing price distortions:

CCI will be amending the thresholds to potentially detect competition distorting M&A deals, such as the Walmart-Flipkart deal. A separate wing will be created in ED to handle grievances related to the implementation of FDI norms. This was the nudge in the head is what gets the
machinery working better, and so this was needed by CCI for performing better in future.

D. Consumer Protection

The major change they have introduced is the establishment of the Central Consumer Protection Authority (CCPA) as the nodal agency for inter-governmental coordination, mandatory registration of all e-commerce entities and provide platforms for customer redressal.

The task force has also recommended amending Section 79 of the IT Act to modify the liability of intermediaries. Also, the government will have more grounds to seek disclosure of source code of the entities to monitor unfair trade practices and fraudulent methods. This might lead to higher compliances for the e-commerce entity in order to ensure that they don’t commit any act attracting liability, but in the long run, it would protect the interest of the consumer on online shopping.

E. Payment Regulation

The policy recommends mandatory routing of electronic payments on e-commerce websites through RuPay, which is the Indian solution to Mastercard and Visa. Further, to secure payment transactions strong authentication mechanisms such as biometric information authentication, tokenisation and fraud detection intelligence mechanism for early detection of frauds, will be introduced. RuPay has been used in the recent past by a few small ecommerce websites and all government websites and till date, no fallacies have been reported, at least to the best of my knowledge and research thus making it a safe bet for now. Thus, an Indian substitute to compete with Mastercard, Visa and Amex International is indeed a positive way forward for digital self-sufficiency.

F. Promotion of MSMEs

The policy provides for special e-commerce platforms for MSME’s on PPP model basis with collateral-free funding, P2P funding and crowdsourcing. Besides it includes MSME clusters and enhancement of technical capabilities to include digital sales and analytics, GST relaxations, incentivising e-commerce to engage such MSME’s through these measures to reach out to Tier II and III cities and towns and other rural areas.

Statistically speaking, e-commerce industry is expected to grow by $200 billion within the next 10 years which can only be achieved by tapping the massive sub-urban and rural sectors of India. Promoting MSME industries towards digital growth, especially towards logistics sector, is going be the bridge between the gaps and lead to employment generation of around 40 Billion. This will also help the unorganised industries of art and handicrafts reach far out parts of the world and create a massive Indian brand.

Conclusion

The Indian e-commerce market is dominated and controlled by foreign entities which are a deepseated fault of our own. Despite having the resources and means to achieve the digital excellence we have lagged behind the western giants of this industry against which the very few existing smaller players are struggling to compete with a negligible market share.

This policy, even though assumed and declared to be ‘protectionist’ in nature by the top legal astute of the Industry, aims at a larger objective, i.e. welfare of the Indian industry as a whole. Surely, the policy is ‘unsettling’ for the ecommerce giants as it ties their hands with multiple knots but the policy aims at bringing about a constructive change through causing unsettling disruption to aid the smaller Indian players reach digital self-sufficiency, excellence and create global dominance.

The concerns of the well-read and analytical minds should not be about ‘ what is going to happen to the major e-commerce giants?’. The concern should be about, ‘how will the small players reach the level of these giants and dominate the Indian e-commerce market through sale of domestic products and brands?’

Of course, the policy suffers from some grey areas and flawed analogies which ought to be worked on by the government before passing the bill to create a more balanced approach towards e-commerce development in India.

The author is an advocate with in-house experience as a corporate lawyer having keen interest in E-commerce, FinTech, Media and Entertainment industry. 

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