How Flipkart dodged India’s e-commerce laws

By Adam B Lerner | 23 June 2014

At the end of May this year, the news broke that Flipkart—India’s largest e-commerce company—had acquired the online apparel store Myntra for between $300 million and $330 million, the largest deal to date in the history of India’s nascent e-commerce sector. Journalists compared the deal to the American e-commerce giant Amazon’s 2009 purchase of clothing and shoe e-retailer Zappos for $1.2 billion. In fact, Flipkart’s founders, Sachin Bansal and Binny Bansal (they are not related), are former Amazon staffers who quit their jobs in 2007 to launch their company.

However, at a press conference announcing the deal, Sachin discounted this comparison with Amazon. “Our role model today is actually the Alibaba Group more than Amazon,” he said, referring to the Chinese internet behemoth, which made business headlines when it filed documents in preparation for its IPO, expected to be in August. Experts have claimed that Alibaba could be worth around $200 billion by the end of the year, far more than Amazon’s current market cap of around $154 billion.

But there is more to the Bansals’ disavowal of Amazon comparisons than their aspirations to Alibaba’s scale. Since Amazon’s India launch in June 2013, the company has become Flipkart’s primary competitor. Many believe the Myntra–Flipkart deal is a sign that the companies are ramping up to hold their own against Amazon. As Abhash Kumar, a writer who covers e-commerce for YourStory.com, a Bangalore-based business website, put it to me: “Rather than have a three-way fight between Flipkart and Myntra and Amazon, why not consolidate both of them, and just fight off Amazon?”

In most countries in which it operates, Amazon runs both an inventory and marketplace model simultaneously—that is, it serves both as a seller of its own product stock and as a platform for other vendors to sell their products. The inventory model allows the company to take advantage of economies of scale, acquiring products in bulk and offering lower prices than competitors. Bejul Somaia, the India managing director of Lightspeed, a venture capital firm that invests in numerous technology companies, explained in a post on VCCircle.com that in India, too, an inventory model could provide Amazon a better post-purchase user experience because it allows “control of the product” and “enables you to deliver faster and with higher accuracy, and respond effectively to customer inquiries about shipping status,” by cutting an additional player out of the sales equation.

Since Amazon entered India in 2013, it has restricted its operations to the marketplace model because Indian laws do not currently permit online retailers with foreign funding to sell directly to consumers. Yet companies like Flipkart seem to sell a range of products to customers while successfully having procured hundreds of millions of dollars in foreign funds over the past few years.

But in fact, Indian e-commerce companies, such as Flipkart, Jabong, Myntra and Snapdeal, have had a tenuous relationship with regulations, as detailed in this September 2012 story in Businessworld. YourStory.com has also outlined how Flipkart circumvented the law in these recent posts.

In 2006, the Indian government eased regulations on foreign direct investment in wholesale businesses (B2B) and single-brand retail, as part of a gradual opening up to FDI in the country. Though multi-brand retail was still closed to FDI, no specific policy had been laid down on online retail. Flipkart, which was incorporated in 2008, had a structure that made the best of this loophole—it was generally known as a retailer, but on paper it resembled a wholesaler, with another company, called WS Retail, functioning as its front-end, selling to customers. With this structure in place, Flipkart received foreign funds, which enabled it to expand operations.

But when Businessworld went to visit WS Retail’s stated headquarters in Bangalore to find its supposed director Tapas Rudrapatna, they found a “small, sleepy house” and were then directed to a Flipkart office 5–7 kilometres away. There, an HR representative said that Rudrapatna worked for Flipkart. Further, WS Retail’s 50 percent shareholder was BK Bansal, Sachin Bansal’s paternal uncle, who told Businessworld that he knew very little about the business and that everything was handled by Sachin. This structure violated, if not the letter, the spirit of the law that was intended to restrict the influence of foreign funds over Indian retail ventures.

In April and September 2012, the Department of Industrial Policy and Promotion released press notes clarifying that FDI in multibrand retail e-commerce was banned entirely. The legality of Flipkart’s regulation-skirting structure now appeared considerably more precarious.

After a 2012 Enforcement Directorate probe into whether Flipkart was violating Indian FDI rules, in February 2013, Flipkart sold WS Retail to a group of high net-worth individual investors led by OnMobile COO Rajiv Kuchhal; in July 2013, it raised a further $200 million in funds. Since then, Flipkart has technically been operating as a marketplace, rather than a B2B venture—i.e., it charges other vendors a commission on each sale on its site.

It is difficult to establish how much influence Flipkart has over WS Retail now, but a casual visit to the site reveals that more often than not, WS Retail features as the first seller on most Flipkart products. This ranking was based on the “number of ratings and feedback, and number of successful deliveries,” Flipkart’s PR manager Payal Banerjee said when I spoke to her last month. Banerjee couldn’t tell me what percentage of products on Flipkart featured WS Retail as the first seller, claiming it was too “dynamic” a process to monitor. She declined to tell me what percentage of Flipkart’s current marketplace business runs through WS Retail.

E-commerce companies’ shifty strategies will alter dramatically if the government decides to allow FDI to any extent in online retail companies. In February 2013, Amazon sent global vice-president Paul E Misener to meet commerce minister Anand Sharma and present what The Telegraph called a “plea” for “relaxation of foreign direct investment norms.” There are indications that this may be in line with the current government’s intentions.

While the government has indicated that limitations to FDI in retail, including e-commerce, will continue, some news reports suggest that the government is likely to ease restrictions in e-commerce from July this year.

Flipkart’s recent expansion could be its latest adaptation to changes in the policy environment, aimed at helping it meet the challenges of a market where FDI boosts the ability of companies like Amazon to sell products directly to consumers. Arvind K Singhal, chairman and managing director of Technopak, a consulting firm that specialises in e-commerce, told me that the Myntra deal and the influx of new funds can be seen as an indication that Flipkart realises it “needs to keep investing in building scale and size, because the barriers to entry are not really there” in the long term. The company may have a head start over Amazon, but if regulations change to allow Amazon to compete as a retailer, the lead Flipkart enjoys will start to look far less comfortable.

Adam B Lerner is a former Henry Luce Scholar at The Caravan.

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One thought on “How Flipkart dodged India’s e-commerce laws”

If customer is gaining by cutting into dealers/traders margins, it could be welcomed; in general traders do not add value to product, other than investing money in stocks.

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