The government’s new restrictions on these firms will hurt both consumers and, in the long run, the industry itself. It is bad economics.
The Department of Industrial Policy and Promotion issued a clarification to the rules on FDI in e-commerce policy in late December that has caused quite a stir and caused e-commerce platforms such as Amazon and Walmart (which has a majority stake in Flipkart) to question their long-term investment strategy in India.
The rules, due to come to effect on February 1, 2019, has three main components that are likely to cause a major disruption to the investment plans of e-commerce platforms:
- Vendors that have any stake owned by an e-commerce company cannot sell their products on that e-commerce company’s portal. This essentially restricts the creation or functioning of private labels from the e-commerce giants to safeguard the high-volume, high-margin areas for themselves.
- Any vendor who purchases 25% or more of its inventory from an e-commerce group company will be considered to be controlled by that e-commerce company, and thereby barred from selling on the platform. This is done to ensure that vendors do not buy all its inventory from Amazon and then, sell on the platform.
- E-Commerce marketplaces will not be allowed to influence the price of a product sold on its platform by providing deep discounts or by giving incentives to particular vendors.
One thing that should be clarified at the outset is that this is not a new policy, but a clarification on the existing policy. The clarification, however, has come a bit too late. The original rules have been circumvented by Amazon and Flipkart. The circumvention starts by marketplaces—through their group entities—buying directly from brands and large manufacturers. These goods are then sold to proxy sellers, such as Cloudtail and WS Retail, who are controlled by the marketplace itself.
Between the two of them, Amazon India and Flipkart have 30 private labels covering 200 different categories. They have together spent $1.5 billion in the country to build their private labels and have major expansion plans in the future that has serious job creation potential. However, for almost two years when the companies have been undertaking such operations, no action was taken. Now, with elections around the corner and in a perceived attempt to woo the small retailers, this clarification has been issued, seemingly out of the blue. It also provides just about a month’s time for the firms to comply with the new regulations.
The problems with vertical integration
This policy of not allowing the e-commerce firms to sell their products on their own platform is a response to an economic practice in platform economics called vertical integration. To be clear, vertical integration in platform businesses does cause some problems related to competition. Vertical integration is the process where the platform, such as Amazon or Flipkart, also acts as a competitor in the same platform. There have been some issues of anti-competitive behaviour elsewhere in the world due to vertical integration. Amazon, for example, has been known to unfairly give preferential treatment to its own retail brand over other products, even when its retail price is higher. It is also known to manipulate its search algorithm to favour its retail brands.
Third-party retailers on Amazon have felt that it has used the marketplace as a lab for its own retail company. It would let retailers innovate and compete against one another, extract this data through the platform, and then cherry-pick the best products for themselves and capture the value.
These are serious issues and can potentially have a negative impact on the third party vendors who want to sell on the e-commerce platform. However, there are two main problems associated with the DIPP’s policy. One, if this policy is constructed in order to discourage anti-competitive practices, there has to be proof of existence of such practices. How did the DIPP conclude that Amazon or Flipkart were engaging in preferential treatment? Were there studies conducted? Are there tools to recognize such practices in India? In the US, there were in-depth academic studies that could conclude that the e-commerce firms were engaging in anti-competitive practices. Only then, did the Federal Trades Commission take cognizance and setup an investigation.
Second, even if it has an intuition that this could potentially lead to harm, shouldn’t such an act fall under the purview of the Competition Commission of India, who are better equipped to detect and take corrective action against such anti-competitive practices? The DIPP could have requested the CCI to undertake a detailed investigation to establish whether e-commerce firms are violating the neutrality of the platform.
The policy was made in order to help the small retailers from getting exploited at the hands of the big e-commerce players. While it may help them in the short run, an atmosphere that is not conducive to investment in this sector is bound to hurt them in the long run.
Both Amazon and Flipkart have planned to approach the government together to reconsider these provisions. If they fail to convince the government, they will shrink the size of their future investments. This can have a significant negative effect on the entire e-commerce sector and can lead to job losses due to the closing of their private labels. Not to mention the loss of the number of jobs they would have created by their extension plans. Cities in the US are fighting with each to provide incentives and attract Amazon’s second headquarters, while the Indian government is driving away the investment.
Finally, the decision is bound to hurt the Indian consumers. By limiting the amount of discounts given by the private labels, the consumers will have to pay a higher price for their purchases. It will also reduce the variety of goods that are available to the consumers for online purchases.
As previously mentioned, vertical integration can have anti-competitive effects. However, it can be dealt with in a far more efficient manner than outright bans on such operations. Antitrust authorities across the world have tools to recognize and prevent practices that can hurt consumers and small retailers. The competition commission can be given the mandate to develop these tools and implement them instead of killing the goose that lays the golden eggs.
Finally, this would also be the right time to revisit the policy of not allowing FDI in multi-brand retail. The parochial fears of potential harm to small retailers is overplayed in the public discourse. All of the small retailers in question have benefited massively from the presence of these platforms. They are now able to reach an unimaginable number of customers because of the platform. Similarly, multi-brand retail can have a massive positive effect on economic growth and job creation.