E-tailers' shift to marketplace model hurting service quality

Restrictions on foreign direct investment (FDI) and insufficient means of raising capital has forced online retailers to change their business models from inventory-based to marketplace, resulting in lesser control over service quality, say experts.

This has also led to huge reduction in the profit margins for e-retailers as commissions are much lower than the dealer margins, according to experts.

Under the marketplace model, the vendor sells the product, while the e-tailer gets a commission for the platform use.
Naveen Aggarwal, partner, KPMG in India, said while the marketplace model still needs to be tested under the Foreign Exchange Management Act policy, it does not seem to have approval from state value-added tax (VAT) authorities.
This is evident from the recent controversy around levy of state specific VAT on e-tail companies, operating under marketplace model, alleging them as 'trader/ dealer' of goods and asking the third-party vendors to stop supplying goods to e-retailer's warehouses.

The Indian e-commerce industry presently is caught between the devil and the deep blue sea, feels, Shashishekhar Chaugule, director, Walker Chandiok & Co LLP. "The 'devil' in their case is the regulatory restriction imposed by the central government's FDI policy, the 'deep blue sea' is the recent activism on part of the state governments who have issued instructions to goods dealers (the sellers using the e-retailer's platform) to not stock their merchandise in warehouses operated by the e-retailers to streamline procurement and deliveries," said Chaugule.
The state governments are doing this because they fear loss of VAT revenues involved in the sale of goods, he said.

The outcome on this issue may have far reaching ramifications for the e-retailers even on their being compliant with FDI norms as VAT is usually applicable on sale of goods by seller having ownership / possession of goods. Adding to the woes, are other tax hurdles including VAT obligation on transactions where consideration is on 'cash-on-delivery' basis, requirement of road permits (way bill) for entry and exit of goods from/ into the state and so on.

"While this is just a beginning of the tussle between the tax and regulatory authorities and e-retail companies, one needs to be mindful of the fact that the sector is growing at estimated compound annual growth rate (CAGR) of 34% and can grow even faster. All it would take to enable the growth is to have adequate sector policies and a definitive tax regime for the virtual world by the Indian government," said Aggarwal.
Also, as e-commerce transactions gain momentum, the brick and mortar segment are waking up to a feeling that e-retailers are somehow getting around the rules and have become an existential threat.
"Today, with players battling it out for leadership slots, specialist players finding their groove, ecosystem elements starting to fall into place, and investors reaffirming their faith in the sector, the market is at an inflection point," a recent report by consultant Technopak said.

Meanwhile, the e-commerce opportunity is growing.

Technopak projects the $2.3 billion Indian e-tailing market in 2014 to reach 3% i.e. $32 billion by 2020. The brick and mortar retailers are likely to grow to $150 billion and the overall retail industry is likely to grow at $1,040 billion in the same timeframe.
Currently, e-tailing is just 0.4% of the $525 billion domestic retail sector, while brick & mortar sector is around 8%.

Despite the growth, e-commerce will still be insignificant versus physical retail, says Harish H V, partner, Grant Thornton. "The primary reason for physical retailers jumping the e-commerce bandwagon is that most are currently struggling to grow for various reasons. And partnerships with e-commerce portals are being forged in their search for newer business generating avenues," Harish said in earlier interaction.

Among factors for this disruptive growth in e-tailing, Technopak experts Ankur Bisen, Pragya Singh and Prachi Madan feel, are aspects like increased adoption of mobile devices like smartphones, tablets, and laptops in addition to increased access to internet via broadband, 3G and 4G services. The internet users base in India which currently is at 243 million is set to cross 550 million by 2020 primarily on the back of 3G and 4G which will further drive the growth of e-tailing in the country.

With one of the youngest online demographics globally, 75% of India's internet audience (people over 15 years age accessing internet from home or work) falls in the age bracket of 15-34 years of which about 60% visit e-tailing websites. This age segment, industry experts say, forms the core customer base for e-tailing in India as they are aspirational, well-connected, tech-savvy, and mobile and have high spending power. "They are not only internet-habituated but also comfortable with making online transactions. Such favourable young demographics will continue to drive the growth of e-tailing in India," the Technopak experts said.

However, the e-tailing market, characterised by its young demographics, is also expected to reach a tipping point in 5-10 years when the currently young population would have crossed the age of 35 years but will continue to transact online. "This expected demographic shift will make it important for e-tailers to maintain their relevance for the young generation as well as for the consumers who would have grown older shopping online. This approach will help in retaining these customers when they become a part of the next age group," the experts said.
Looking beyond top 10 cities

Faced with various structural issues, majority of the B&M brands/ retailers are still concentrated in the larger cities despite being present for several years. Thus, the market beyond the metros becomes important for e-tailers, both in terms of lower competition from brick & mortar retailers and also as a growth driver for the future. E-tailers will, therefore, have to remain relevant to consumers from both larger and smaller cities and towns.

Interestingly, nearly two-thirds of the urban Indian internet user base is in cities and towns beyond the top eight cities with several e-tailers deriving nearly 50% of their sales from beyond the top 10 cities.

"The sheer ability to be able to access such aspirational products, irrespective of whether they are being sold at market price or at discounted rates, is a bliss for people housed beyond these top metros. The demand from customers beyond the top 10 cities is on the rise and we see these shoppers contributing significantly to the e-commerce growth story in the coming years," said Arun Chandra Mohan, founder and CEO, Jabong.com in an earlier interaction.

With the e-commerce market gradually maturing, the market is seeing significant investments from players like Flipkart, Amazon India, Snapdeal and Jabong towards building out their platforms and those in adjacent areas, such as search, order management and marketing. This is being done using both organic and inorganic strategy, the recent Flipkart-Myntra strategic merger being the biggest consolidation move in the Indian e-commerce industry.

"Vendors are increasingly focused on execution and winning new customers, sometimes at the expense of articulating future vision," said Praveen Sengar, research director, Gartner. "Merger and acquisition activity is increasing, resulting in fewer digital commerce platform options in the market, but also serving to extend the commerce platforms of the established vendors," he said.