Flipkart, Amazon could consider franchise pacts with domestic retail firms to meet new FDI norms

E-commerce companies having foreign direct investment, like Flipkart and Amazon, will now have to look for ways to restructure their businesses so as to obviate the curbs on selling products of companies in which they have an equity stake. The government’s new FDI guidelines also restrict them from selling exclusive-only products on their platforms.

The jury, however, is still out on how easy or difficult it would be for e-retailers to carry on with their model of discounting after engineering structural changes.

Analysts FE spoke to said both Flipkart and Amazon will have to disband their current structures of doing business wherein they hold equity stakes in companies which sell products on their platforms.

“E-commerce players need to relook their operating strategies in India on account of the new rule on cap on equity participation by them in their suppliers entities. Going forward, suppliers will not be permitted to sell their products on the platform run by such marketplace entity. This will impact back-end related wholesale group entities and need to remove them from the e-commerce value chain. Time has come to look at franchise channels, rather than equity investments channels to do business in India,” said Rajiv Chugh, national leader, policy advisory & speciality services, EY India.

Franchise model means companies like Flipkart and Amazon need to enter into re-seller agreements with Indian companies and sell their products. Since these companies will store and sell multiple brands they won’t come under the clause which restricts these platforms from selling exclusive-only products. Further, online players will have to enter into such franchise agreements with multiple players because the guidelines prohibit from purchasing more than 25% from a single vendor. The moment the 25% cap is breached the vendor would deemed to be a group company of the e-commerce platform.

Chugh said the new guidelines will see Indian retail firms like Reliance Retail, Pantaloons, Big Bazaar, etc deriving immense advantage.

For Flipkart and Amazon, the other option according to some analysts, is lowering their equity in the supplier companies to below 26%. Chugh said the FDI guidelines define group companies as ones having 26% or more equity by the parent firm. If, for instance Amazon reduces its stake below 26% in its supplier firms, the current selling arrangement can carry on.

Yet another option could be restructuring the equity in supplier firms in such a manner that the equity becomes indirect rather than direct.

According to an analyst with a law firm, the parent firm can create an Indian controlled firm which can then have a subsidiary firm, which can have vendors which supply to the parent firm. In such a scenario, the parent will not have a direct equity in the vendor firm and can obviate the guidelines.

Arvind Singhal, managing director of Technopak, a management consulting firm, said that such equity restructuring may not work. “Since the guidelines are aimed at the two companies (Flipkart and Amazon), it would be very difficult for them to indulge in this kind of exercise. The better option for them would be to challenge this policy as it is discriminatory. Both the companies have made huge investments in the country (Amazon $5 billion, Flipkart $16 billion) and created jobs. It is unfair to target them,” he said.

On revised FDI gui delines, Flipkart in a statement said: “Government policy changes will have long-term implications for the evolution of the promising sector and whole ecosystem. It is important that a broad market-driven framework through right consultative process be put in place in order to drive the industry forward”.

Amazon India only said that it is still evaluating them.

The government tightened norms for online retailers, making it more difficult for the ones having large FDI to offer high discounts – something which was being opposed for long by the offline traders.

The new guidelines, which will come into effect from February 1, says that e-commerce entities, which operate a marketplace, will not be allowed to exercise ownership or control over their inventories. Any ownership or control over the inventory will convert the business into an inventory-based model. The rules further state that the inventory of a vendor will be deemed to be controlled by an e-commerce marketplace entity if more than 25% of the vendor’s purchases are made through the marketplace or its group entities. Any outright equity investment in the vendor will also bar the entity from selling on the marketplace.

Leading online players own or have invested in companies that procure goods in bulk from companies and sell them to their “preferred vendors”, which would list the same products at cheap prices.