CIRCUIT BREAKER. The real issue with Flipkart

It is ironic that the very same businessmen who complain of stifling laws that make it difficult to do business in India, should cry out for regulatory intervention the moment a competitor appears on the horizon. The latest instance is the fervent appeals by the Confederation of All India Traders and a few manufacturers of white goods to the Government and the competition regulator to investigate, of all things, Flipkart’s recent festival discount sale.

Even without investigation, it is apparent that accusations of ‘predatory pricing’ against Flipkart and other online retailers stand on weak ground. Competition law lays down two necessary conditions for a firm to be guilty of ‘predatory pricing’. It should hold a dominant position in its market and it should be selling products below cost to fortify this monopoly and decimate competition.

Popular as Flipkart is today, it would take a great deal of imagination to view it as a ‘predator’ in the vast Indian retail market. The traditional retail industry is valued at $500 billion, while online retailers have barely scratched the surface of this market, with combined sales of $3 billion or so.

The fear that these players, given their furious growth rates, will completely take over the retail sector in short order is far-fetched. There are structural constraints to Indian e-commerce. Unlike China or the developed world, only 15 per cent of Indians have internet access. And given dodgy net connectivity and high transaction failure rates, only a tenth of them are willing to buy or sell anything online. It is to overcome such consumer resistance and chip away at the behemoth brick-and-mortar retail model, that online retailers such as Flipkart are going to such irrational lengths to drive traffic to their sites — steep discounts, no-questions-asked return policies and free shipping services, no matter how small the order.

Manufacturers such as Samsung and LG seem enraged that Flipkart should sell their brands below list prices. If Flipkart is willing to sacrifice its own retail margins to offer a better deal to consumers, why not?

If it is actually undercutting manufacturers by selling below their costs, they are free not to fill those orders. Given that online retailers operate on the marketplace model and don’t manufacture anything, they cannot ‘offer’ large inventories of fridges, televisions or mobile phones on sale, without manufacturers agreeing to fulfil those orders.

In fact, this is probably why Flipkart’s ‘steal deal’ offers were such ‘limited stock, limited period’ offers, earning it brickbats from thwarted shoppers.

In any case, it is highly unlikely that Flipkart or any other e-tailer can continue to so heavily subsidise their merchandise through such sales, for perpetuity. When you are a $1 billion firm in a $500 billion market, venture capitalists may be willing to fund your losses in the hope that you will turn profitable as you scale up. But the same venture capitalists are unlikely to keep pumping money into a black hole once you grow into a $20 billion enterprise. The moment online retailers attain scale, you can be sure that there will be pressure on them to rationalise their discounts and come up with a more sustainable and profitable business model.

While the ‘predatory pricing’ issue is best sorted by activist consumers and private equity funds, it is perhaps time for the Government to look into more substantive issues surrounding e-commerce. There are presently a few aspects on which online retailers seem to enjoy an unfair advantage over traditional retailers.

For one, there is the ownership issue. Though FDI in all forms of multi-brand retail is frowned upon by the Centre, there is no gainsaying that Flipkart, Snapdeal and many other e-commerce players are increasingly being funded by foreign private equity investors. The key issue for policymakers here is this. If online ‘marketplaces’ can be allowed to tap into the deep pockets of foreign capital to jostle with tiny mom-and-pop stores in apparel, fashion accessories, shoes and cell phones, why not brick-and-mortar retailers?

Firms such as Flipkart have essentially managed to sidestep the no-FDI stipulation by transitioning their operations from a traditional inventory-led model to the so-called ‘managed marketplace’ model. Flipkart undertook an elaborate restructuring of its operations a couple of years ago to separate its ‘marketplace’ business, from its warehousing, digital, cash-and-carry and other businesses. WS Retail, which used to be a Flipkart entity, now acts as a seller for many of the products on the platform.

As a result, the Flipkart portal that Indian consumers transact with is today backed by a complex web of seven private companies, each handling a different facet of the operation. Three of these firms and the holding company itself are domiciled in Singapore. This structure makes Flipkart a far more opaque entity than, say, a listed Future Retail or a Shoppers Stop. It is also exceedingly difficult for any Indian consumer or regulator to decipher what the retailer’s exact financials or funding sources are.

There is the taxation issue too. With most Indian e-commerce firms preferring to remain unlisted and some domiciled in tax havens, it isn’t clear if these firms suffer the same incidence of income tax, service tax and VAT as domestic brick-and-mortar retailers do.

A recent Business Line story highlighted a claim by online retailers that they are not liable for VAT because they aren’t owners of the goods that they sell.

If differential tax treatment is responsible for online retailers gaining an unfair cost advantage over traditional retailers, then this is certainly a loophole to be plugged.

Finally, there is the sourcing issue. By offering electronic goods and a host of other consumer items at rock-bottom prices, online retailers essentially fuel consumer demand for entirely new categories of products. Such a boom, if it gains enough traction, can have implications for India’s trade balance.

The seemingly insatiable appetite for smartphones and other electronic gizmos, for instance, has already bloated India’s import bill (we made electronics imports to the tune of $30 billion annually in recent years). This may, at some point, call for sourcing regulations that require online retailers to procure a certain proportion of their merchandise from local suppliers. Foreign-owned single brand retailers are already subject to such sourcing norms.

Ironing out these issues will ensure that the new breed of online retailers don’t enjoy any unfair advantages over the traditional stores that make up the bulk of India’s retailing sector. The rest can safely be left to the market to decide.