Why the FDI Policy’s Price Influence Restrictions on E-Commerce Marketplaces Have Failed

[Mark Papang and Sanchit Varma, 4th year students at NALSAR University of Law]

Introduction

The FDI Policy of India contains a number of provisions to ensure that the employment of foreign capital does not militate against healthy competition in the e-commerce sector. However in practice, many of these provisions have not had a significant impact on the manner in which e-commerce entities operate. Accordingly, this post examines the shortcomings of the present FDI Policy, with particular emphasis on the provisions against price influence, and explores potential solutions to remedy this situation.

Overview

Since the early 2000s, e-commerce entities have only been permitted to engage in business-to-business (‘B2B’) e-commerce and not business-to-customer (‘B2C’) e-commerce. However, a recurrent problem under the older regime was that e-commerce entities were essentially operating as B2C entities under the garb of a B2B framework, and were offering steep discounts to the detriment of other sellers, both in the online and offline market.

To address these concerns, the rather simplistic B2B restriction was bolstered with Press Note 3 of 2016, which imposed several additional conditions on e-commerce entities. An important contribution of the Press Note was the definition of the two models of e-commerce i.e. the marketplace model, and the inventory based model. Under this scheme, e-commerce entities with FDI were only allowed to operate as facilitators between buyers and sellers, and were prohibited from engaging in direct transactions with consumers on the marketplace. In addition, it laid down several restrictions and riders on marketplace entities to safeguard against the multilevel maze structures adopted by e-commerce entities to circumvent the FDI regulations. In this context, the two most important conditions are: first, that no marketplace entity is permitted to allow more than 25% of its sales effected on its site from one vendor or its group companies, and second, that marketplace entities cannot directly, or indirectly, influence the sale price of goods and services sold on their e-commerce platform.

The regulatory shortcoming

The increased regulatory oversight, however, has thus far been unable to prevent heavy discounts on the marketplaces of e-commerce giants like Flipkart and Amazon. The reason for the failure of the changes aimed at preventing price influence by e-commerce entities can be attributed to the fact that most of the discounts on these platforms were not offered by the platforms themselves, but by third party retailers that were in turn financed by foreign investors. These circuitous corporate structures were adopted prior to the introduction of Press Note 3, and remained largely unaffected by its proscriptions since the restriction on price influence was applicable only to the e-commerce entities, and not third parties who might receive foreign investment to finance discounts on these platforms.

The problem can be better understood through the corporate structure employed by Flipkart for its operations in India. The ultimate holding company in this structure is Flipkart Pvt. Ltd., a company incorporated in Singapore, which has a wholly owned subsidiary in India, Flipkart India Pvt. Ltd. Further, Flipkart’s e-commerce platform is owned by Flipkart Internet Pvt. Ltd., which is a wholly owned subsidiary of Flipkart Marketplace Pvt. Ltd., incorporated in Singapore, and is in turn a subsidiary of Flipkart Pvt. Ltd. In this scheme, discounts are funnelled to Flipkart.com using Flipkart India, which operates as a B2B entity and sells merchandise to B2C retailers at heavily discounted prices. The foreign investor, i.e. Flipkart Pvt. Ltd, subsequently compensates or absorbs the discounts so provided to the B2C entity. The discounts provided to the B2C entity are then passed on to consumers when the B2C entity sells the heavily discounted products on the e-commerce marketplace.

A perusal of Flipkart’s corporate structure yields that discounts on products sold on its marketplace are being offered by third party B2C entities such as WS Retail, which are only able to sell products at a low cost due to absorption of the discounts by Flipkart Singapore. Accordingly, discounts offered on the marketplace are being created at the B2B stage and are merely implemented at the B2C stage, with no role for the marketplace itself. However, the prohibition on influencing the price under the FDI Policy is placed only on the e-commerce marketplace, which has a negligible role in giving discounts on its platform. Considering that the stated objective of the restriction on price influence was to ensure a level playing field for all stakeholders, the amended policy fall woefully short of changing the status quo.

Potential solutions

Since the flaw in the proscription on price influence lies in the fact that it is only applicable to e-commerce marketplaces, a possible solution to remedy this shortcoming could be to make the restriction applicable to the group companies of the e-commerce marketplace as well. Under the FDI Policy, the term ‘group company’ means two or more enterprises which, directly or indirectly, are in a position to exercise 26 percent or more of voting rights in another enterprise; or appoint more than 50 percent of members of board of directors in the other enterprise.[i] Applying this definition to Flipkart’s case, both Flipkart Internet Pvt. Ltd. and Flipkart India Pvt. Ltd. will be group companies since Flipkart Pvt. Ltd. exercises direct control over Flipkart India, and indirect control over Flipkart Internet. Accordingly, a restriction against price influence on Flipkart Internet’s group companies will also apply on Flipkart India, i.e. Flipkart’s B2B arm where discounts are initially created.

While the modalities of this approach are likely to be complex, such a proscription would not be entirely unfounded, as a similar restriction has been provided under the FDI policy to prevent more than 25% of the sales value on an e-commerce platform to be affected by a single vendor or their group companies. In this context, another way in which the influence of foreign capital on the e-commerce sector can be mitigated is by stipulating a ceiling limit on the total sales for products sourced from the group companies of the e-commerce marketplace. For instance, in Flipkart’s case such a restriction would operate to limit the sale of products sourced from Flipkart India by any B2C company, to a certain percentage of the Flipkart.com’s total sales. Consequently, this would result in limiting, to a certain extent, the number of heavily discounted products on e-commerce platforms.

Conclusion

The existing FDI framework does little to ensure a level playing field in the e-commerce industry, since marketplace entities are able to circumvent its proscriptions through elaborate corporate structuring, making sure that they are compliant with the letter of the policy, but not its spirit. Further, while the solutions provided in this post may have practical drawbacks, they are important in highlighting that for the FDI policy measures to succeed, it is crucial to take into account the circuitous structures adopted by companies, else the provisions amount to mere eyewash. 

– Mark Papang and Sanchit Varma

[i] Para 2.1.21, Consolidated FDI Policy, Department of Industrial Policy and Promotion, effective from August 28, 2017.

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