Last week, the Department of Industrial Policy and Promotion (DIPP) laid down a series of guidelines that have had an immediate effect on online retail. It has defined what a marketplace is and how it is different from an inventory-led model. It has expressly forbidden FDI in inventory-based ecommerce models. And only manufacturer-sellers have been given the right to sell their goods at a discount; also, no seller can sell more than 25 percent of goods on a particular site that follows a marketplace model. Further, site owners shall also not own sellers.
Offline players say the rules will go a long way in creating a level-playing field. Their argument is simple: If FDI to offline players is restricted, the same should apply to online players. Online discounting had meant that they were unable to compete in several categories, the most prominent being cellphones.
In the absence of a policy for online retail, several models had developed with the marketplace model being the most prominent—take Snapdeal, Flipkart. Here, sellers would list their wares on ecommerce sites in exchange for a fee. Online retail thought of this as a good workaround. Other models evolved—some held inventory while others focussed on private labels. In some cases, the retail sites owned the inventory through associate companies. This has also been forbidden. The notification clearly lays down that anything other than a pure-play marketplace model cannot attract foreign investment—as per the definition.
Forbes India invited views from K Ganesh, an investor in BigBasket, and Kishore Biyani of the Future Group on the guidelines.
‘All we want is a level-playing field’
Founder and CEO, Future Group
The recent guidelines issued by the DIPP are defining a marketplace and an inventory-based model. The definitions were required as too many issues were coming up that had to be clarified in the form of legislation or a notification: The issues related to the payment of VAT, the movement of goods across states, clarity on who the sender is and, most importantly, who is paying the taxes. The government wanted a level-playing field while the states were crying foul as they were not generating any revenues from sales [of goods through the online marketplaces]. So what the government has done is clarified the issues in a rightful manner.
Let’s take the VAT issue first. Once you have defined a marketplace model, the law makes it very clear that the seller is responsible for everything. In an inventory-based model, the owner of the inventory is responsible as the marketplace becomes just a technology provider.
With regard to FDI, in an inventory-based model, it has been expressly prohibited; for offline players too. So what the law has done is create a level-playing field. People laugh at me when I say Bigbasket is doing business illegally but the point is how can you do a kirana shop business in this country with foreign money?
When we opened Big Bazaar and sold items on discounts, the difference was that we did it with our (Indian) money. The argument for stopping FDI in offline retail has been that we need to protect the kirana shop. But here Bigbasket was competing against the kirana shop with foreign money. I am not stopping anyone, but don’t do it with foreign money.
Going forward, online retailers will have to follow the law in letter and spirit.
People have misunderstood the online channel. We have also tried to run viable businesses by selling online but the unit economics just doesn’t work. The fact is that the online channel is a very expensive business.
My cost of doing business is 12-18 percent of sales. In online, it is 45-50 percent of sales. Sellers’ commission is 15 percent when you sell through a marketplace. Delivery cost is 11-13 percent. The rest is the cost of managing the business. Even the cost of creating and running a website (all those top dollar techie salaries) is 8 percent. Sellers will eventually sell what [product] has margin. To do business legally online is not easy unless you manufacture yourself or have private labels.
We are not able to sell a lot of our brands online due to the lack of margins. For example, we have a fantastic electronics brand in Koryo that sells about Rs 200 crore a year but we can’t sell it online as the electronics category has low margins. And if we at Future Group can’t get margins, how can anyone get them is beyond my understanding. I expect the online business in a lot of categories to reduce.
At the same time, online has three big advantages. Velocity of sales is much faster, the tail of products that can be sold is much more and the geographical reach is far better. We have to see how we can make each of these work to our advantage.
As a result of these guidelines, actual business will start happening. Today Ram is selling to Shyam and Shyam is returning to Mohan —30 percent of business online is now B2B to push up GMVs (gross merchandise values). They might find workarounds like credit card cashbacks, but now unit economics has to work.
[For instance], for me to make FabFurnish profitable in the third month is easy (Future Group acquired FabFurnish on April 6). It is hardly losing money as they had stripped it down. Their monthly costs of running it are Rs 1.2 crore and I need to do Rs 4 crore of business a month to make it profitable. I feel offline will acquire online. We have the products, the brands, the distribution and the customers—then the unit economics works.
(As told to Samar Srivastava)
‘It’s all about customer service’
Recent developments in India’s ecommerce sector have triggered a flurry of debates pertaining to the companies there.
It began with Morgan Stanley’s markdown of its holdings in Flipkart, leading to a debate among industry watchers on the valuations of ecommerce companies, especially the Indian unicorns. The latest piece of action is the guidelines issued by the DIPP on March 29 that allow 100 percent FDI in marketplace models.
These developments come against the backdrop of a run-up in valuations in early 2015 and a subsequent tightening during the later part of that year. Given this scenario, there’s a fair bit of buzz that the devaluation will have a cascading effect on ecommerce and will curtail the industry’s growth.
I am of the opinion that the exuberance around ecommerce, as well as other business models which leverage the internet, will be tempered with realism. At the same time, the overt negativity and ‘doom-and-gloom’ scenario that have been portrayed are unwarranted.
Firstly, there’s just too much significance that has been attached to the markdowns by Morgan Stanley and Fidelity in their holdings in various private companies. The reality is that Morgan Stanley and Fidelity (as well as every investor worth its salt), present a net asset value (NAV) of their investments and come to a conclusion on what is, in their minds, the right price.
Unless there is a market transaction like an external fund raising, there’s no way of determining the right price. Till then, this type of devaluation is fund-specific and not a reflection of fair value. It is important to understand that this does not reflect the market value as an actual transaction is not taking place at that price.
As far as valuations are concerned, let’s also consider the success achieved by technology disruptors, the market share they command and their power of scale. They shake the traditional ways of doing business. By having the potential to become a dominant player in a large sector in a large economy, they command huge valuations. Take Airbnb, which sells more room nights than any hotel that has been around for decades. The company has the potential to scale globally and has become a dominant force. Is that not worth more than any other hotel chain or even the combined valuation of the top 10 hotel chains?
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(This story appears in the 29 April, 2016 issue of Forbes India. To visit our Archives, click here.)