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Watch out for riders as the government mulls FDI in e-commerce

09 January, 2014

Late last month, we had writte about how the Indian government is planning to open the e-commerce sector to foreign direct investment (FDI) by the end of the current financial year or by March 2014 end. Now there’s some concrete developments which suggest this may indeed be implemented soon. 

The Department of Industrial Policy and Promotion (DIPP), which is part of the Ministry of Commerce and Industry, has put together a discussion paper on e-commerce, asking stakeholders their views on whether FDI should be allowed at all in B2C e-commerce besides other nuances.

Besides putting across the basic question whether FDI should be allowed in e-commerce in the country, the DIPP has posed certain questions which sound trivial but may end up being critical for attracting foreign investment in inventory-led B2C e-commerce firms in India. 

Mind you, B2C e-com via marketplaces such as eBay, Snapdeal and the like are already open to foreign investment and so are firms which are essentially back end or wholesale suppliers to actual B2C e-com ventures (like most other e-tailers in the country including Flipkart which turned into a marketplace last year). 

Here’s a look at some of the points which are worth watching out for: 

Should it be open for all products or only for non-food products? 

This is one of the questions on which the DIPP has sought views. This essentially means the government is wondering whether to allow FDI in Indian grocery e-tailers. This is a legacy issue from the offline retail sector which faced mass protests in the past and is a political hot potato. The grocery e-tailers include names like BigBasket, EkStop and ZopNow. Some of these firms already count PE/VC firms as shareholders. If the proposed relaxation in e-commerce excludes food products, these firms may have to continue with their existing ownership structures which legally bypasses the ban on foreign investment in the sector.

Should a limit for minimum capitalisation be laid down? 

The discussion paper also poses this question which follows a similar norm for offline retail ventures. However, this could be a self-defeating proposition as many ventures in e-commerce are essentially bootstrapped startups with minimal capital infusion. Many of these startups are struggling to survive with the lack of investors willing to back them. Unless the minimum capitalisation is set at a bare-bone level to attract early stage foreign investors, such ventures may not get an opportunity to raise capital to grow which would effectively allow foreign investment in only larger firms. 

Should a limit for percentage of sourcing from domestic manufacturers be prescribed? If yes, what should be the limit? 

This has been a dampening clause for offline retailers and has been a bone of contention for foreign retail giants to rush to set up physical outlets in India more than a year after the government opened the multi-brand retail sector to FDI. This is because, large global retailers prefer to source products globally (read China) to bring down the cost of procurement. However, this may be less of an issue for e-commerce firms as most of them already source a large chunk of fast moving products locally—for instance, apparel in lifestyle e-commerce, books and even locally assembled mobile handsets. However, this may affect some vertical e-com players whose product lines may expose them to a clamp on such retail trade, dependent on imports. 

How will retail sale under multi-brand retail trade be restricted to states that have agreed to open front-end stores? 

The discussion paper has opened a pandora’s box with this poser and justifiably so. As of now, multi-brand retail has been opened to FDI in the country but with a rider that it is subject to approval by the states where such stores are proposed to be opened. Though many state governments have said they have no objection to such outlets, some including Delhi could be a no-go area (the new Delhi government is opposed to FDI in retail). If FDI in e-commerce is allowed and it carries a clause that such firms cannot sell or ship products to states which do not allow multi-brand retail outlets with foreign shareholders, it would be an operational issue for such e-com players. 

What should the entry routes and caps be in FDI in B2C e-commerce companies? Should it be automatic up to 50 per cent? 

This signals that there could be a ceiling on the stake to be held by foreign investors. At present FDI up to 51 per cent is allowed for offline retailers and the government may look at parity while opening FDI in e-commerce. However, this could affect PE/VC funding structures in such e-commerce ventures. As firms attract larger funding in Series C, D and rounds thereafter it is common for capital-intensive ventures such as e-commerce to be majority owned by such foreign investors. A clause that FDI in such ventures would be restricted to 51 per cent would mean such firms may have to look for a funding cycle where local investors, including PE/VC firms operating domestic funds, pick a significant amount of stake and bring in a chunk of capital. This may force such e-commerce firms to have local investors with sizeable stake in early stages and also that foreign investors come with a distinguishable premium valuation. Such a structure would allow foreign investors to own a minority stake at a later stage to confirm to FDI ceiling. On the flip side, it also means a giant like Amazon, which already operates a marketplace in India, may have to bring in a local partner for the Indian venture if it wants to sell goods on its own. Moreover, the entry route could dictate whether say an Amazon can buy (hypothetically 51 per cent stake) a local e-com firm. If such a relaxation is not include then consolidation in the sector would continue in the form of shutdowns.

Will the proposed policy relaxation be a non-starter like physical retail or aids local e-com players? We will know soon.


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Watch out for riders as the government mulls FDI in e-commerce

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