The Indian government has recently clarified that 100% foreign investment (without government approval) is permitted in online marketplaces which do not maintain any inventory and merely act as aggregators. This clarification however comes with certain conditions which online marketplaces may find restrictive for a sector which is still nascent in India.

On 29 March 2016, the Department of Industrial Policy and Promotion (DIPP), Government of India has released Press Note 3 of 2016 containing a set of clarificatory guidelines (Guidelines) on foreign investment in the business to consumer (B2C) e-commerce sector.

The Guidelines:

  1. make it explicitly clear that foreign investment up to 100% (without any government approvals) is permitted in online marketplaces, which do not maintain any inventory and only facilitate the sale and purchase of goods and services between third-party sellers and consumers (Online Marketplaces);
  2. reiterate and clarify that foreign investment is not permitted in e-commerce platforms which maintain an inventory of goods and services that are then sold to consumers; and
  3. set out certain operating requirements/ restrictions (Compliance Requirements) that online marketplaces with foreign investment have to comply with.

Prior to the Guidelines, the prevalent view had always been that foreign investment is permitted in Online Marketplaces. However, this was not explicitly clear in the regulations themselves.

Foreign investment laws in India significantly limit or restrict foreign investment in the multi-brand retail sector. Over the course of 2015, several traditional brick-and-mortar retailer associations initiated legal proceedings seeking to enjoin foreign investment into Online Marketplaces on the argument that since regulations did not specifically permit (or regulate) foreign investment into e-commerce websites/ online marketplaces, and regulations expressly limited or restricted foreign investments in physical retailers engaged in the sale of multi-brand goods and services, a discriminatory approach was being adopted between online and offline distribution channels from a foreign investment perspective.

In some of these legal proceedings initiated by physical retailers, Indian courts directed the Government of India to engage with physical retailers and address their concerns with respect to creating a level playing field between online and offline distribution channels, and take those into account while clarifying/ formulating a policy governing foreign investments into the e-commerce sector.

The Guidelines are primarily intended to quell some of the uncertainties that arose following the initiation of legal proceedings by physical retailers, by expressly clarifying that foreign investment of up to 100% is permitted in Online Marketplaces without government approval, and the Compliance Requirements are meant to address some of the concerns raised by physical retailers.

We have analysed the Compliance Requirements below:

  1. No ownership of inventory

The Guidelines make it clear that the Online Marketplace should not exercise any ownership over the inventory of goods. In the event there is any ownership over the goods, it will be deemed to be an inventory based model in which foreign investment is prohibited. The impact of this rule on the current e-commerce market may be minimal as most players operate on zero inventory models.

  1. Influencing sale price of goods and services

Online Marketplaces cannot directly or indirectly influence the sale price of goods and services offered on their website/ platforms, and "shall maintain a level playing field". This requirement addresses one of the central grievances of physical retailers, and makes it much more challenging for Online Marketplaces to continue undertaking promotional activities to attract new customers through discounts or cash-back schemes.

This provision also reinforces the intention of the DIPP to allow only pure Online Marketplaces, and the impact of this rule on the nascent Indian e-commerce market will be significant as they will have to fine tune their business model to comply with this requirement.

  1. Support services to sellers

Currently most e-commerce players offer services to both sellers and buyers on their platforms. Listing, packaging, warehousing services are provided to sellers while expedited delivery, premium membership services, etc. are options offered to buyers. The Guidelines provide that Online Marketplaces are permitted to offer support services to sellers, including warehousing, logistics, order fulfilment, call centres, payment collection, and other services on a B2B basis. While this condition addresses the physical retailers' arguments that Online Marketplaces were acting as end-to-end services providers akin to physical retailers, it remains to be seen whether this condition will affect the services offered to buyers, in which case these services may need to be restructured.

  1. No anchor seller

No single seller (or a group) can account for more than 25% of the sales through an Online Marketplace. This requirement is intended to ensure that Online Marketplaces act as true aggregators, and they are not dominated by a small number of 'super sellers' who may be indirectly supported by, or benefit from preferential trade terms with the Online Marketplace. Many e-commerce players in India currently have super sellers or anchor sellers on their platform, which conduct a large volume of transactions on these marketplaces. Online Marketplaces are likely to find this requirement restrictive as the e-commerce ecosystem is not yet sufficiently developed and lacks a varied body of qualifying sellers.

  1. List contact details

Online Marketplaces have to specifically list the name, address, and contact details of specific sellers, and post-sales delivery and customer satisfaction need to be the responsibility of the seller. This provision is intended to provide more visibility and access to sellers and is beneficial from a customer point of view. However, Online Marketplaces may be concerned with this requirement as it could negate any competitive advantages they enjoy on seller acquisition.

  1. Warranties and guarantees

It has been clarified that the warranties and guarantees relating to goods and services sold on Online Marketplaces are the responsibility of the seller. While most e-commerce players have so far been operating on models where the sellers provide warranties, online marketplaces tend to provide guarantees on the replacement or repair through back-to-back arrangements. Many e-commerce players have their own return or replacement policies, which form the cornerstone of their customer shopping experience, and it is possible that this restriction may impact these arrangements.

This clause must also be understood in the context of certain OEM vendors who have taken a stand that they will not honour warranties for their products sold through e-commerce channels. In light of this, some online marketplaces have entered into agreements with service providers to ensure that consumers buying such products are adequately serviced. This requirement could cast a shadow on such after-sales warranty arrangements entered into with such support service providers.

  1. Inclusion of services

Another interesting aspect of the Guidelines is that the definition of 'e-commerce' has been clarified to mean the "buying and selling of goods and services including digital products over digital and electronic network."

However, Clause 3 of the Guidelines states that the sale of services through e-commerce will fall under the automatic route. It appears that the Government has reiterated the position that provision of services online is not subject to FDI restriction. However, it is not clear whether the Compliance Requirements will also apply to services and digital products.

If the intention of the DIPP is in fact to regulate companies providing online services, this will no doubt lead to disastrous results for many existing operators. Many existing taxi aggregation companies, food delivery services, travel booking websites, ticketing websites etc., will squarely fall under the definition of 'Online Marketplaces' for services. Many of these models specifically rely on surge pricing, which could be argued as influencing prices. It will also mean no discounts for the customers. Similarly, with respect to taxi aggregation services, the Central government and various state Governments have been working on imposing responsibilities on taxi aggregators. The Guidelines seem to suggest a contrary approach.

If the sale of services are also required to satisfy the Compliance Requirements, it could also affect online streaming companies and App stores, and it remains to be seen whether the DIPP will provide clarity on this.

Conclusion

Though the Guidelines have legitimised the existing marketplace model, it has also opened up major compliance issues for most e-commerce players in India. These e-commerce players will have to take another look at their arrangements with anchor/super sellers to ensure compliance with the 25% sales threshold rule. They will also have to restructure their business models in terms of interactions with the sellers. The restriction on price control will most certainly affect their business plans and marketing strategies and will affect the potential growth of the sector in India.

Further, while the clarity provided in terms of the Online Marketplace model is welcome, the Guidelines will significantly impact and at least to some extent restrict the e-commerce industry in India. The Guidelines came into effect on 29 March 2016 simultaneously with its release without giving existing Online Marketplaces time to conform to the Compliance Requirements.

Another significant impact is the applicability of the Compliance Requirements to online services companies. If services are to be regulated, then the current business models of online services sector in India will be impacted. It will also impact inventory based online service providers who are looking to receive foreign capital for expanding their operations.