In the early 2010s, I was studying to be a doctor in a remote town in Gujarat. Back then, crazy hours aside, my biggest frustration was that a lot of the textbooks that I wanted to purchase weren’t in stock at the only bookstore selling medical textbooks in town... until one day, someone suggested that I checkout a website that sold books online called Flipkart. All my instincts indicated that this was a scam, but I was desperate enough to give this wacky idea a shot. I hit buy and prepared for the worst until one day, a smiling delivery person turned up at my door, book in hand! Fast forward a few years and I buy everything online: mobile phones, clothes and even drinking water. How I shop has changed too - I now browse on multiple sites, return goods that I don’t like and pay online instead of on delivery.
Lots of forces have been responsible for this phenomenon, most of which have been cheered on universally - smartphone penetration, cheap internet access, maturing supply chains and trusted payment networks. But the one that draws the most ire is the practice of providing massive discounts and cashbacks, which has made buying online cheaper than nearly all other alternatives. This has driven margins to the ground, causing several traditional retailers to go bankrupt, and led retail unions to complain to the government about predatory pricing.
In response, in 2016, the Department of Industrial Policy and Promotion (DIPP) introduced a host of regulations in the ecommerce sector. Notably, it allowed 100% foreign direct investment (FDI) in B2B companies. It also allowed 100% FDI in B2C ecommerce companies that did not control the inventory sold on their platforms (marketplace model). At the same time, it disallowed FDI in ecommerce companies that control the inventory sold on their platforms (inventory model). Crucially, it also added that foreign B2C marketplace entities were not allowed to have more than 25% of their sales originate from a single seller. The purpose of this was to discourage large players from controlling prices through discounts, cashbacks and offers.
In practice though, these rules were very easy to circumvent. We put together a simple model to show how key players did this. Let’s consider a simple ecosystem in which total demand of goods and services via online marketplaces is 100 units. Let’s assume that this in an oligopolistic ecosystem with just two ecommerce marketplace entities, E1 and E2, both with equal market share and both with a supply 50 units of goods and services.
To get over the 25% restriction, the entities could just spawn multiple vendors (V1, V2 … V8), and divide the inventory supply such that no single vendor has more than a 25% impact on aggregate sales.
This is exactly what happened on the ground. Amazon India and Flipkart, both foreign owned “marketplace” entities operating in B2C space, formed joint ventures with Indian entities to stay compliant. As a result, while they passed as marketplaces in theory, in practice they were able to exert control on the inventory sold on their platforms.
Another round of regulations
In December 2018, the DIPP introduced a new set of conditions that would come into effect on 1st February 2019.
First, marketplace entities and their group companies were not allowed to own more than 26% equity in their sellers. As per the RBI, a “group company” means two or more enterprises which, directly or indirectly, are in a position to:
- exercise twenty-six per cent, or more of voting rights in other enterprise; or
- appoint more than fifty per cent, of members of board of directors in the other enterprise.
This would directly impact companies like Flipkart and Amazon India which held 49% equity stakes in many of the sellers on their platforms.
Second, marketplaces were not allowed to control the inventory of their sellers. They were not allowed to supply more than 25% of the inventory of any of their sellers, either directly or indirectly through group companies. The earlier restrictions on aggregate sales were dropped in favor of this change. The spirit of these alterations was to close the loopholes that key players had managed to exploit, and enforce the spirit of restrictions in FDI.
Third, marketplaces were not allowed to give preferential treatment to any of their sellers. All cashbacks and discounts would have to be applied in a non-discriminatory manner to all sellers. Ancillary services like IT infrastructure, delivery logistics and customer support would have to be extended equally to all sellers.
Interestingly, the policy note gave informal approval to cashbacks and discounts; rather than seeking to stop these practices, its focus was on encouraging marketplaces to give them out in non-discriminatory manner.
How did the market react to this? The new 25% regulation resulting in significant restructuring in the market. Whereas previously E1 and E2 were allowed to supply 50 units each, they now had to reduce their control to 12.5 units (25% of 50). This opened up a large supply gap in the market that could be filled by domestic MSMEs. It also pushed vendors like V1 and V2, who previously sourced exclusively from E1 and E2 to look elsewhere to keep their supply channels afloat.
What really happened?
Theoretical analysis aside, what really happened though?
We tried to track these changes by selectively crawling web pages from the two largest foreign marketplaces, Flipkart and Amazon India. Over a period of two weeks, we regularly crawled the best seller lists on each of these websites, and looked at which products, brands and sellers featured the most.
First up, sellers.
Both marketplaces seemed to have approximately 40% of the products supplied by sellers associated with them. Do note though that we’re looking at just a sample of products here, and tracking number of products, not volume of sales.
How would we track sales? Without access to detailed financial reports from the companies themselves, we had to be creative with our indicators. We chose to track the rate of change of reviews on the top selling products on these sites, with the assumption that number of reviews of a product is positively correlated with its volume of sales.
In the graphs below, we made an assumption that it takes 10 days on an average between a product being purchased and review for it being submitted on the site. The data that you see has been left-shifted by 10 days.
But what REALLY happened?
It’s difficult to tell. The onus of monitoring policy compliance has been put on the marketplace entities themselves. This is difficult and expensive because marketplace entities don’t have access to operational information and the books of the thousands of vendors on their platforms. And self-certification or declaration by vendors does not alone suffice.
What’s more, there are many aspects of these regulations that are subject to interpretation, and could potentially be exploited for further loopholes. For example, many arguments assert that joint-ventures between:
- marketplace entities (like Amazon India) and
- subsidiaries of joint-ventures between the marketplace entity and an Indian partner (like Cloudtail India)
may be exempt from these policy restrictions.
Where does all of this leave us?
Theoretically at least, the latest regulations should prevent small and medium retail businesses from being stifled. While also allowing consumers to enjoy the discounts that the ecommerce boom affords. Whether this results in a thriving and sustainable ecosystem in the long-run remains to be seen.
The government does seem to be willing to actively shape what course the ecommerce industry takes. The next frontier seems to be technology. It’s no secret that one of the most potent weapons that ecommerce players have is behavioral data about consumers, something that allows them to stay one step ahead of everyone else. Newer drafts reveal that government agencies are keen on keeping data-related advantages of foreign players at check, and transferring some of the benefits to Indian SMEs. We’ll look into how these forces play out in subsequent articles.
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