Digital platforms and E-commerce in India - Challenges and Opportunities

Devanshu Gupta1

ABSTRACT

The laws regulating an e-commerce entity have been completely reluctant in India and; are at a
very nascent stage. The fast growth of e-commerce has played a significant role in increasing
market competitiveness and; today, e-commerce has connected the rural economies to integrate
faster with the national economy. The reach of e-commerce in the sub-rural and rural areas (around
100-200 million Indians) has provided multiple choices and e-commerce has granted distinctive
expansion prospects to the retail industry from an earlier completely diverse industry – the brick-
and-mortar physical stores. Today, sellers have reached around 22,000 PIN codes to the oddest of
places. The Indian retail industry (brick-and-mortar stores) accounts for over 10% of the country’s
GDP and around 8% of the employment, which may be a threat of loss if unable to shift to an e-
commerce model. With the emerging e-commerce growth, where on one side, buyers and local
sellers have benefited from the easy purchase and sell facilities, on the other side, offline market
players have faced a setback. In this paper, we have talked about legal technicalities involved in
regulating an e-commerce entity in the relevant market. The present market condition has later
been discussed which has become a battleground, where not only the players of the offline retailers
are against the e-commerce entities, but e-commerce entities are competing amongst themselves,
at the cost of violating laws through the innovative ‘two-way companies model’. In the end, few
observations and key takeaways have been jotted down for the kind consideration of the
Competition Commission of India (CCI).

INTRODUCTION

The turning point for the arrival and acceptance of e-commerce in India is the competitive forces
and non-transparency that existed between numerous offline retailers. Through the growth of e-
commerce, global choices are now available to the consumer at doorsteps with effective price
competitiveness, utmost options, and quick delivery - e-commerce has renovated the Indian retail
sector. Pre-liberalization in India, only limited entities having the support of the Government were
able to list in top 25 organizations in India and; post-liberalization in 1991, players from nowhere
had entered the Indian market with their innovative product (goods/services) that drew the
interest of the investors globally, and as a result of the combination, these companies have become
the top companies in India and the world.

As India becomes the top market in the world with its 1.3 billion consumers, investment is
inevitable in India. Investment has, in turn, led the entry of superior innovation into the Indian
market, which has further increased the competition amongst players. The sector has majorly been

1 Devanshu Gupta is a graduate of National Law University, Lucknow currently associated with Competition Advisory Services (I) LLP
(COMPAD)

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driven by the fast-expanding internet ecosystem and the massive number of internet users - India
became second in terms of the number of internet users in the world.

The online retail sector in India has been nearly valued at $23 billion up from only $35 million in
2014 and is expected to be at par with the physical stores in the next few years2. India tops the
Global Retail Development Index 20173, released by AT Kearney. The change is an outcome of four
factors including ‘consumption boom, deep mobile and internet penetration, favorable foreign
investment climate and strong economic growth’. The Government observes that e-commerce has
the potential to contribute more than 4% to India‘s GDP by 2020. Today, e-commerce has covered
almost all sectors in India and players like Amazon, Flipkart, etc have taken an edge over the offline
players. E-Commerce has allowed the local businesses to sell their products online, on one hand,
and on the other, it is a major threat and challenge for the offline retailers to survive, which
employs around 8% of the population in India.

The significant rise of the e-commerce sector in India started in mid-2014 when e-tailers went
through the heavy discounting phase - buying goods as wholesalers and in turn selling them to end
customers directly. Even though according to recently released statistics, despite the massive jump
in retail consumer spending and internet penetration, the e-commerce sector saw a minimal
growth of 12% in 2016-17, compared to growth of above 100% in 2015-16, the major reason being
the model shifting these e-commerce entities have to adapt to comply with the FDI policy 2016 and
FEMA regulations.

The DIPP in March 2016 had restricted i) 100% FDI inflow through automatic route in B2C and
inventory-based model, ii) price manipulation and iii) maximum 25% outsourcing from a single
entity/group company. Therefore, to correct the existing market practices where e-commerce
entities were acting like an organized retailer, influencing from the price of the product to the
delivery and returns, the entities ended up lowering their growth to comply4.

OVERVIEW OF THE MARKET

The e-commerce sector today is majorly owned by big players like Flipkart, Amazon, etc.
Flipkart took approx 10 years and $3.5 billion to grow, whereas Amazon took approx. $3 billion in
approx. 4 years to reach the same status in India. Amazon has initially entered India in 2012 with
the launch of Junglee.com, which was a price comparative website meant to gain an understanding
of the market and customer behavior, and Amazon.in was launched in 2013. Similarly, Ola raised
$1.3 billion and Uber spent around $500 million to operate the same business model in India in less
time and money than Ola. It is imperative to note that MNCs like Amazon and Uber have taken less
time and cost to set up a larger business in India than Indian companies, mainly through their
innovative models.

2 https://www.ibef.org/industry/retail-india.aspx
3https://www.atkearney.com/documents/10192/12766530/The+Age+of+Focus%E2%80%93The+2017+Global+Retail+Development+

Index.pdf/770c5a53-d656-4b14-bc6c-b0db5e48fdc1
4 Redseer report titled ‘The Indian E-tailing Market in 2017’

Electronic copy available at: https://ssrn.com/abstract=3577285

Amazon has 21 and Flipkart has approx. 17 operational warehouses also known as ‘Fulfillment
Centers’ (FCs) with more than 5 million cubic feet of storage space across India in major cities. In
these FCs, sellers store their products, while packing and delivery to the buyer are done by a
subsidiary of these e-commerce companies. Massive investments have been made in physical
facilities such as warehouses and logistics to source and deliver, even though e-commerce entities
are calling them nothing more than mere software platform is highly tricky.

The big Indian e-commerce entities are now calling for the need for a "level playing field" and
protection against "capital dumping" from MNCs, on allegations of selling at negative gross margins
and burning cash to derive other players out of the market. A similar situation was evident when
Flipkart took over Snapdeal, Myntra out of business and when Ola took Meru, Taxi for Sure out of
the market with the massive foreign funding and predatory pricing, before the entry of the foreign
e-commerce entities like Amazon and Uber in India. The emerging dominance of Flipkart and
Amazon has disrupted the e-commerce start-ups ecosystem and today investors even see genuine
and innovative e-commerce start-ups as an unrealistic investment.

RELEVANT INDIAN LAWS

E-commerce entity has been defined to mean ‘any Indian company or a foreign company in terms
of the Indian Companies Act, 1956 or 2013, or office, branch or agency in India as provided in
Section 2 (v) (iii) of FEMA 19995’ providing the service of an online platform to connect buyers and
sellers.

FDI is allowed in India as provided in the table below:

Sector FDI Entry Route

Limit
E-commerce activities (e-commerce entities would engage only 100% Automatic
in Business to Business (B2B) e-commerce and not in Business
to Consumer (B2C) e-commerce.) 6
Marketplace model of e-commerce (the marketplace model 100 % Automatic
translates into smaller margins, and less control over the quality
of service, product description, and speed of delivery.)

The DIPP had earlier through Press Note 3 of 2016 series mandated two conditions, that restricted
e-commerce companies to limit to 25% maximum sales from a single vendor/ group, directly or
indirectly not influencing the pricing of the product and maintain a level playing field 7. It has been
recently clarified through the FDI policy 2017 that 25% maximum sales shall be calculated based on
value (not volume) of items sold on a financial year basis. The provisions encourage e-commerce

5 http://www.ey.com/Publication/vwLUAssets/FDI_E_Commerce/$FILE/FDI_E_Commerce.pdf
6 http://pib.nic.in/newsite/PrintRelease.aspx?relid=158262
7 http://dipp.nic.in/sites/default/files/pn3_2016_0.pdf

Electronic copy available at: https://ssrn.com/abstract=3577285

players to sell goods from different vendors8. With the new FDI policy 2017 in place, RBI has
inserted similar provisions in the Foreign Exchange Management (Transfer or Issue of Security by a
Person Resident outside India) (Fourth Amendment) Regulations, 2017.

It has been done to increase the visibility of MSMEs in the marketplace and helps them to
overcome barriers of time, communication and geography9, and therefore, FDI has only been
allowed in the B2B model to accelerate the growth of local manufacturers. FDI in B2C e-retail has
been anticipated to result in loss of employment and the creation of an oligopoly/monopoly
situation in the Indian market.

OVERVIEW OF THE MODEL

In response to the DIPP and FEMA regulations, e-commerce entities have devised a corporate
structure to circumvent the law. The ‘two-company route’ has been adopted by the big e-tailers, in
which the foreign-funded firm carries the entire inventory process as an entity in B2B wholesale
operations (in which 100% FDI is allowed). But as this entity cannot legally sell directly to the
consumer, therefore, another B2C entity acts as a ‘front’ for the B2B firm, as a packaging and
logistics entity. Some examples of this two-company format are Flipkart - WS Retail and Amazon –
Cloudtail. The details have been provided below -

Cloudtail is a 49:51 ratio Joint Venture (JV) between Amazon and Infosys's Catamaran Ltd. It can be
anticipated that Amazon has not invested in Cloudtail but holds full control over the operations
10.There are situations where a foreign company can exercise management control even though it

is not investing in the JV Company, typically, when the foreign company provides technology and
other knowledge-based inputs, the foreign company may retain an option to invest in the JV
Company at a future date11. Such a structure is used by a foreign company to create a foothold for
itself in a sector where FDI is not allowed. Cloudtail has been the largest seller on Amazon India
generating as much as 40% of the company’s sales. A similar approach is being followed by Flipkart.

One of the reasons why Cloudtail and WS retail (B2C) has become the biggest seller on their
respective platforms is their ability to offer additional discounts on goods procured at a discounted
rate from its B2B wholesale entity. The B2B Company can absorb FDI and deals directly with the
manufacturer to procure the huge amount of goods at lesser prices as compared to other sellers. In
turn, it sells the procured goods at discounted rates to Cloudtail/WS retail (B2C) that sells directly
to the end consumer. This way the big e-commerce players can sell at massive discounts, being
operational as a B2C e-commerce entity owning the absolute inventory, even when receiving FDI.

8 http://dipp.nic.in/sites/default/files/CFPC_2017_FINAL_RELEASED_28.8.17.pdf
9 E-Commerce Growth and Opportunities in Indian Scenario - A Survey on Ecommerce Eco System, Roshni Upasna, Santhosh
Rebello
10 http://www.ey.com/Publication/vwLUAssets/FDI_E_Commerce/$FILE/FDI_E_Commerce.pdf
11 http://psalegal.com/wp-content/uploads/2017/01/ENewslineJune2014.pdf

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They are even able to manipulate prices of the products of many sellers as it helps their sales and
the discounts get compensated by the company12.

Essentially, the two-way entity structure adopted by the e-commerce entities boils down the aim of
the Government. Each big e-retail firm is not only a retailer in every sense of the word but a very
active retailer at that, one which decides everything from pricing to delivery and returns policy.
Recently, on March 29, 2017, the DIPP had replied to All India Online Vendors Association’s (AIOVA)
concerns over aggressive discount strategies and violation of FDI policy by e-retailers and had
forwarded the grievances to the RBI. The Directorate of Enforcement (ED) has been reported to
start the investigation. It has been reported recently, that Amazon and Flipkart are reducing the
sale of mobile phones from Cloudtail/WS retail to comply with the 25% sale restriction from single
vendor/ Group Company by DIPP13.

E-COMMERCE AND CCI

E-Commerce involvement in each sector of the market gives a massive impact on market
competition. Though healthy competition is the need of the present market, there is a superior
need for maintaining equilibrium and protecting the interest of all the members of the market, how
big or small. Major concerns that had arisen in CCI have been majorly related to Exclusive
Supply/Distribution Agreements and Predatory Pricing. CCI has passed orders in the case of
SanDisk, Kaff Appliances14 and Mohit Manglani15, wherein the activities of Online Retail Portals
were in question. However, it has been observed that online and brick and mortar are separate
channels of the same relevant market, as the customer has the option to shift16, and the retail
market as a whole is considered the relevant market for deciding whether the e-commerce entities
have been dominating and giving an adverse effect on competition. Fortunately, the CCI, for now,
has believed that these alleged activities are not anti-competitive as the e-commerce sector is still
growing and does not have a significant presence in the retail sector in India. It was noted by the
Commission in its order that 93% of the retail market in India falls under the unorganized sector.

Similarly, the major allegations in the cab sector relate to the Predatory Pricing. It has been noted
by the Commission in its recent order that "The Commission does not fully disagree that the low
prices of OP are not because of cost efficiency, but because of the funding, it has received from the
private equity funds. But as discussed above, there is no evidence that the access to such funding
was inequitable and that the market for financing was not competitive and had aberrations.
Moreover, it was their penetrative pricing strategy that facilitated them to garner high market
shares in a short period as well as develop the networks to a size that could provide sufficient
positive externalities to the participants of the network. At this stage, it is difficult to determine with

12 http://economictimes.indiatimes.com/small-biz/startups/to-comply-with-foreign-investment-norms-amazon-indias-cloudtail-to-
stop-selling-mobile-phones/articleshow/54203261.cms
13 http://economictimes.indiatimes.com/small-biz/startups/to-comply-with-foreign-investment-norms-amazon-indias-cloudtail-to-

stop-selling-mobile-phones/articleshow/54203261.cms
14 Case No. 61/2014 CCI
15 Case No. 80/2014 CCI
16 Ashish Ahuja Vs Snapdeal Case No. 17/2014 CCI

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certainty the long-term impact of this pricing strategy as the market is yet to mature17”. The
Commission is of the view that the evidence on record does not establish the dominance of the
online cab aggregators, thereby; the matter was closed.

INCOME TAX CONCERNS

One reason apart from FDI, e-retailers are keen to be seen as a marketplace and not a retailer is
their ability to avoid tax liability like other retailers. In 2016, an order was passed against the big e-
commerce entities by the Commissioner of Income Tax, Bangalore, which reclassifies marketing
expenditure done through deep discounts as capital expenditure. These entities classify the
discounts as marketing losses and deducting it from revenue, leading to huge losses. The
justification given by the tax department is that marketing costs constitute capital expenditure as
the marketing costs may aid future revenue, which is quite reasonable. If the tax department's
methodology is followed, e-commerce companies could turn profitable and be liable for tax in
India, a suitable option to avoid the price wars. According to a report in Economic Times18, E-
commerce giants have appealed to the Commissioner of Income Tax (Appeals), Bangalore against
this order, however, there were no immediate decisions taken.

However, it is noteworthy that the assessing officer has no say in dictating terms of business to a
taxpayer as what business expenditure to incur and what quantum, it is up to the business to
decide and, even enough judicial decisions support this proposition. The e-tailers also have to
defend these expenses as necessary to run the business every year and create demand for their
services, as currently there is no provision under the tax law under which a company may not be
allowed to deduct genuine marketing expenses incurred for business purposes from total revenues.
The justification provided by the department holds water and, therefore, the effective conclusion
may be expected soon by the Higher Courts. It is noteworthy that US Supreme Court classifies e-
commerce transactions are retail sales and accordingly taxable at the state level.

CHALLENGES FOR CCI

In competition law, freedom is not constitutive of competition but competition is constitutive of

freedom. Competitors must be protected when, and only when, their foreclosure from the market
is detrimental to the objective of competition law, e.g. social/consumer welfare, not when an
entity is excluded from its inability to compete.

The major challenge for the Competition Commission of India (CCI) is the risks of false acquittals
and false convictions - Cost of false acquittals is the welfare loss of the society at large, resulting
from the unlawful practice continuing, whereas the cost of false convictions is the welfare loss,
resulting from the welfare-enhancing practice being prohibited. The CCI accurately has to ascertain

17Para 122 http://www.cci.gov.in/sites/default/files/6%20%26%2074%20of%202015.pdf

18http://economictimes.indiatimes.com/small-biz/startups/e-commerce-cos-face-tax-heat-as-i-t-dept-says-marketing-costs-should-
be-treated-as-capital-spend/articleshow/60330712.cms

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whether the practice is detrimental or beneficial to competition the complexity of market/sector
potential magnitude of welfare benefits or losses.

The ultimate welfare objective of the competition is in an increment inefficiency by an increase in

allocative efficiency, productive efficiency, and dynamic efficiency. Dynamic efficiency is probably
the most important driver of today’s innovation world, economic growth, and productivity –
dynamically efficient conduct should not, by definition, be prohibited even if it harms competitors.
Most importantly, consumer harm resulting from the reduction of rivalry is a plausible cause of
harm to long-term social welfare if not counterbalanced by other factors, e.g. investments likely to
result in innovative production processes or products.

CONCLUSION

In India, everything is nascent, the logistics, the payments, and the overall digital ecosystem. There
is a need to connect the dots on a massive scale, thousands of cities and local sellers, on which e-
commerce has significantly revealed the great scope and, embedding competition assumes critical
importance today. In contrast, India will drive the third great wave of Asia’s growth, in the next 20
years and will hold above that for half a century, the role of CCI as a competition regulator is
significant to ensure a level-playing competitive field, to ensure economic efficiency of Indian
markets, thereby incentivizing innovation, and facilitating foreign investment. Anything which
comes into the way of competition is the enemy of the economy and the economy needs to be
defended from only the anti-competitive practices.

Competition is important but it is not an end in itself, but a means for an end. Therefore, promote
competition shall be an idea but not a mandate. Global Economic Forum in its Global
Competitiveness report believes that there are three major sources of growth i.e. the resources a
country, competition efficiency, and innovative dynamic efficiency (classified 140 economies) -

1. The countries which rely on 60% on resources, 35% of competition and 5% on innovation,
end up with a per capita GDP of less than US$2000.
2. The countries which rely 40% on resources, 50% from the competition, and 10 % from
innovation; end up with per capita GDP from US$3000 – US$10,000.
3. In resources reduces drastically to 20%, competition 50%, and 30% innovation, it gives a per
capita GDP of US$17,000019.

India is listed in the first category. Therefore, move from US$2000 to US$17000 is practically
contributed by competition. Currently, in India, only approx 20% of people are using e-commerce
services, which depict a large scope in the Indian Market. Simultaneously, 93% of the retail market
in India falls under the unorganized sector; therefore scope is inevitable in the scenario post
demonetization, where e-commerce sector has seen a great fall20.

19 http://www3.weforum.org/docs/GCR2016-2017/05FullReport/TheGlobalCompetitivenessReport2016-2017_FINAL.pdf

20 Redseer report titled ‘The Indian E-tailing Market in 2017’

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There are some suggestions/takeaways that may be considered by the Honorable Commission-

• Protection not to a Big, but to a small e-commerce start-up: businesses will have to offer
products that are uniquely customized to attract shoppers in small towns, to the needs of
the next 100-200 million Indians, there is scope for new e-commerce businesses, which
need protection for some time.

As investors have become more careful about putting their money in e-commerce, looking at the
losses they have to bear, smaller firms are increasingly shutting down as of lack of funds and
investment. According to the recent IBM and Oxford study, 90% of the startups in India failed
within the first five years of commencement. Last year, between January and August 2016,
reportedly 29 startups closed their doors in India21. Eight Startup businesses folded in India in 2017
between January and June22. Now, it is going to be even tougher for small players to compete with
big firms as the process of consolidation has begun. There could not be a level playing field for
Indian companies and MNCs, who unlike Indian companies have huge pockets and global
experience.

1. Rule of reason approach: The rule of reason approach shall be used to the necessary
extent, overseeing the prevailing economic and social conditions of the economy.
Competition law is a means to achieve competitiveness in the market and, therefore, is
dynamic in it, where the rule of law plays a great influence. For the analysis of online
platforms, it is particularly important to move away from a purely structuralize approach
that existed earlier. It is now necessary to focus on the harm to the competition and
consumer welfare, in the long run, unlike a structuralize approach. Unnecessary inference in
the market may also pull the existing innovative forces, which would be a greater loss for
the Government’s objective to transform India into a manufacturing hub.

2. Natural Justice and procedural fairness must be protected: Natural justice, linked with
procedures established by courts of law, is preferable when taking an administrative
decision- a must

3. One of the major drawbacks of E-Commerce on Competition is chances of price

obfuscation, in which a seller being adversely affected by price comparison due to e-
commerce advertise low- quality products on a website to attract consumers, which
adversely affect the quality of production in the market. It may also result in lowering the
standards of production in the country for which many countries have suffered; for example
China.

4. Another concern may be a situation where greater price transparency may facilitate
collusion among firms, as monitoring of competitors’ behavior with market data to set

21 https://www.indianweb2.com/2016/08/25/20-indian-startups-shutdown-in-2016/
22 https://inc42.com/buzz/startup-shutdowns-india-2017/

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 prices has become too easy. This includes the network effects through vertical restraints
that may even push the negative impact on the competition existing in the market.

In 2015 and 2014, local and foreign investors rushed to fund start-ups, but, so far this year, no new
e-commerce start-ups have received funding. Big opportunities driving big investment in India is
due to the potentially large e-commerce opportunity, where competitive dynamics and market
share is still in fluctuation.

The benefits of online platforms over the past few years have been enormous for social welfare
and any negative hindrance may result in the speed of growth of the industry and the economy.
Unlike Russia, which is a closed market, or China, where the most non-Chinese Internet companies
are blocked out for political and other reasons struggled to compete with the local players due to
the Government’s aid and support, India has been an open market with limited reasonable
restrictions. Such an approach adopted by India has been a major reason for speedy, sustainable
growth and massive investment upcoming in the market. Today, for gaining a high market share,
more focus on genuine innovation, uniqueness, and consumer-driven approaches shall be the key
to success in the industry’s upcoming big shots.

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Electronic copy available at: https://ssrn.com/abstract=3577285