Modi govt did right thing by legitimising online ‘marketplaces’, but it is courting political risks


The Narendra Modi government’s decision to allow 100 percent foreign direct investment (FDI) in online “marketplace” retailing, subject to some riders, is the right one for India.

What this means is that the future of Indian e-commerce will essentially be foreign ownership, given that very few Indian business groups have the deep pockets needed to sustain such low-margin and fickle customer bases over sustained periods of time.

When customer loyalties can switch the minute they get a better deal elsewhere, you need lots of capital infusions at frequent intervals to sustain a business model.

It is worth noting that Flipkart’s continuing losses after scaling up its volumes is over Rs 2,000 crore (2014-15), and the top three e-tailers (Amazon India and Snapdeal, plus Flipkart) managed to collectively lose over Rs 5,000 crore last year.

The government’s decision has been prompted by four factors.

#1: Online commerce has seen a large inflow of FDI already. It makes no sense to shoo this away when the investment can create thousands of jobs in technology, warehousing, sales, logistics, etc

#2: Online marketplaces had no earlier legality, and it did not make sense to continue with this ambiguity when billions of dollars were already committed. Digital India will be bankrolled by online retailing in substantial measure by building business models for it.

#3: Offline retailers like Kishore Biyani (Big Bazaar) were crying foul, saying online retailers like Flipkart were offering deep discounts even below cost to ruin their businesses. They wanted a level playing field.

#4: Most important, online retailing cannot be sustained by low capital. Giving free play to FDI was unavoidable.

It is worth looking at the huge risks being courted by online marketplaces in trying to build their businesses. In February, Flipkart, which was earlier valued at over $15 billion, saw its valuation plunge 25 percent to $11 billion, as investors saw that it may take longer to turn a profit. Globally, other tech products have also seen such value erosions due to slow profit growth or new competitive threats. According to this Economic Times report, file-sharing platform Dropbox’s valuation has dropped 50 percent, Snapchat’s by 25 percent and Palantir’s by 32 percent.

Even Amazon barely makes a profit globally, as founder Jeff Bezos believes that he has to keep investing revenues to build a customer experience that will sustain profits in future. And remember, Amazon started life in 1995.

Coming to the government’s e-commerce decision allowing 100 percent FDI, what it has essentially done is to grant legitimacy to what is called “the marketplace model,” where the company claims to be a technology platform to facilitate direct interaction between sellers and buyers online. Before this clarification, the likes of Flipkart were essentially operating in quasi-legal territory, as no rule allowed foreign investment in e-commerce.

Worse, the online retailers were using the ruse of “marketplace” to offer deep direct discounts on products to customers, often below cost, by dipping into their private equity-funded corpuses, taking customers away from brick-and-mortar retailers. The government’s decision tries to level the field.

Currently, customers think they are buying from a Flipkart or Amazon or Snapdeal, but the actual transaction is between the product vendor and the buyer. This has now been legitimised by the government, which has, however, added conditions. These conditions prohibit online marketplaces from offering more than 25 percent of their products through one vendor, and also ban them from holding inventories of their own for direct sales to customers. Flipkart uses WS Retail and Amazon India Cloudtail India to generate more than 25 percent of their revenues, according to a Mint story today (30 March).

The NDA move, while assuaging offline retailers, will, however, face political backlash just as the UPA decision to allow 51 percent investment in multi-brand retail. That decision caused a rupture with Mamata Banerjee quitting the government in 2013, and many states banning multi-brand retail. By allowing 100 percent FDI in e-commerce, the NDA could be opening another can of worms for itself.

However, it is the right decision, for online marketplaces are the future of e-commerce, and without strong funding – not possible in the Indian context for most business groups – they cannot sustain long periods of losses in order to build a large enough customer base that will sustain.

The rise of technology companies in the post-1990s period has shown the power of disruption in regular offline business models. Entire businesses – from airline, rail and bus ticketing to media to advertising to retailing to even taxi services – have been impacted by technology platforms that offer better options at the click of a button.

We have moved to “the age of the platform”, as author Phil Simon says in a book with the same title. Technology companies have to build platforms on which other companies and vendors can sell or advertise their products for which the platform provider can charge a fee or toll. But building a platform is not a one-time effort; it is about continuously investing in building more and more products into the platform, so that everyone can hop on to it.

Google is not just about search anymore; it is about mail, maps, browsers, mobile operating systems, desktop productivity software, cloud services, etc. Amazon is no longer just the world’s largest bookstore; it is a veritable Wal-Mart online. Even Wal-Mart is under threat from Amazon. Facebook is not just a place for friends to chat and share; it is becoming an online publishing platform too; Apple is not just about great devices; it is an e-commerce platform for vendors to sell digital products using its iTunes platform.

At home, one can look at the government’s rail ticketing service (IRCTC) as a potential platform where everything can be sold; it is already selling airline tickets and other products, though less successfully than the Flipkarts and Amazons.

The mobile phone companies, Airtel, Vodafone, and, in future, Reliance Jio, will also be seeking to become platforms, using their millions of phone and data customers to sell songs, chat services, photo sharing, banking services, etc. They too will seek to become online financing and trading marketplaces – at least of a limited nature.

The rules of the online game have changed. They are not anymore about developing one great product and making money on it; they are about building a long-term customer base using low margins and easy transactional options where many things can be sold and revenues collected.

The other reality is that this is an expensive business, and risky too. A new smart rival can up-end an existing platform; this is why Facebook quickly saw the potential threat (or opportunity) in Whatsapp and bought it for $19 billion. That’s the value a company with just 50-and-odd engineers could create through a disruptive innovation.

If technology has increased risks, it is best if these risks are borne by people who can handle the high costs of failure. This is why 100 percent FDI in online marketplaces is inevitable. Few Indian companies can take that kind of loss for failures.