India: Choosing The Right Expansion Model; E-Commerce Restrictions On Foreign Brands Operating In India

Last Updated: 13 August 2013
Article by Gordon Drakes, Lisa Sen and Chris Wormald

Introduction

Businesses are increasingly looking to expand into farther flung overseas markets like India, expecting to achieve rates of growth which are rarely achieved in saturated and depressed Western markets. However, it is important that businesses consider carefully the different types of expansion models available to them and are prepared to take a flexible approach to their international expansion strategy, taking account of local legal restrictions and fast changing consumer habits and expectations. As this briefing note explains, the choice of a corporate expansion model or an arm's length expansion model such as franchising can have a direct impact on a business's ability to engage in e-commerce within the local market.

India is a case in point, where, despite the recent growth in online sales, the Indian Government has reaffirmed its policy on e-commerce in the retail sector, which restricts foreign brands from participating in local e-commerce if they hold shares in the Indian operating company.

The Need for a Consistent Approach to Multi-Channel Retailing

Historically, the majority of brands expanding internationally have been preoccupied with the "bricks and mortar" channel of distribution, based upon an assumption that the target local market is less technologically mature.

This may have been a fair assumption as recently as three to five years ago, and it is still holds true in an increasingly limited number of countries. However, improvements in access to debit/credit cards, digital infrastructure and the growth of technology enablers, such as tablets and smart phones, means that the buying habits and expectations of the burgeoning middle classes in emerging markets such as India are much closer than ever before to the typical consumer in more developed economies. This, coupled with the challenges of setting up physical store expansion programmes and fragmented traditional distribution channels in some markets presents an opportunity whose time has come. Locally developed brands are increasingly techsavy and to survive and prosper in these markets, foreign brands need to ensure that these new customers can access and experience the brand and the related products and services in the same way that consumers do in their home markets. Businesses which use e-commerce as a channel of distribution (and that is now surely the vast majority) therefore need to deploy an expansion model which facilitates this multi-channel approach.

Growth of Retail and E-Commerce in India

India has seen a surge in the presence of Western brands since 2000, when the Indian Government started liberalising its foreign investment regulations and easing foreign exchange restrictions allowing foreign parties to repatriate their income from India.

A recent study entitled "E-tailing in India: Unlocking the Potential" stated that the total size of the business of e-commerce retail sales is set to reach $76 billion by 2021. In 2012, "e-tailing" comprised around 6 per cent of total e-commerce sales, and was estimated to be approximately $0.6 billion. Most of India's $10 billion e-commerce business last year was in other products and services especially travel and financial services. The study added that "The country's growing internethabituated consumer base, which will comprise 180 million broadband users by 2020, along with a burgeoning class of mobile internet users, will drive the e-tailing story".

Current Restrictions on E-Commerce in India

Businesses tend to expand into India either through foreign direct investment (FDI), which involves holding shares in an Indian company, or through an arms length relationship with an independent local franchisee or licensee.

The latest Consolidated Foreign Direct Investment Policy Circular ("the Circular") issued by the Ministry of Commerce and Industry on April 5 2012 has reaffirmed the earlier policy that "retail trading in any form, by means of e-commerce would not be permissible for companies with FDI engaged in the activity of single brand retail trading or multi-brand trading". Currently, foreign investors can hold up to 100% of the shares in an Indian company selling goods of a single brand, subject to a number of conditions. In relation to the multi-brand retail sector, which primarily refers to the supermarkets, a foreign retailer is restricted to holding up to 51% shares in an Indian company.

The FDI model requires the prior consent of the India Government, which can be a lengthy and costly process, and the effect of the Circular means that single-brand or multi-brand retailers who choose to expand into India through a corporately-owned model are not able to sell to their customers via e‑commerce. Single-brand or multi-brand retailers who choose to use the FDI model and still operate an e-commerce business within India run the risk of violating their hard earned FDI approval from the Indian Government. This could result in the approval being rescinded and/or an investigation by the Reserve Bank of India ("RBI") which reinforces the FDI regulations.

This restriction does not prohibit businesses selling the goods into India via an e-commerce site operated outside of India. However, foreign on-line transactional websites are, in practice, not readily accessible to all in India as the Indian Rupee is not fully convertible and cannot be taken out of India. It is possible for a customer in India to purchase goods on-line from foreign websites if they have an international credit card or foreign currency account debit card. There are restrictions on how much foreign currency is available for each Indian customer which depends upon an annual limit prescribed by foreign exchange laws and the limit imposed by the card company. This therefore represents a serious bar to mass market online trading into India.

The Franchising Option

Franchising is an alternative model of expansion which should be considered as part of a business's international and multichannel expansion strategy. Its principal advantages include the ability to expand the brand rapidly and efficiently in new territories by using the capital resources and local market knowledge of experienced operators. In India, the added advantage of franchising is that there are no restrictions on an Indian owned franchisee's ability to engage in e-commerce activities. However, problems may arise, under the current rules, if the foreign franchisor or other foreign investor ever sought to acquire shares or buy out the franchisee's business.

The franchising model could be used to develop "bricks and mortar" sites in key metropolitan areas and, in conjunction with an effective e-commerce operation, the franchisee could then drive business in the "tier 2" and "tier 3" cities, where a bricks and mortar investment is not yet appropriate. Market analysts in India have reported that citizens in tier 2 and tier 3 cities are increasingly using ecommerce websites to purchase goods and services and this type of approach should enable an optimal market penetration.

Watch this Space

For those who wish to penetrate the Indian market, and for whom e-commerce is an important component in the overall commercial strategy, the franchising option currently presents, along with independent wholesale and distribution alternatives, the only available option.

The rules and regulations in relation to FDI or participation in various types of businesses or sectors in India are in a permanent state of flux. The good news is that the various changes in law point to an overall trend of gradual liberation. Many foreign investors have been lobbying for change and the hope is that the Indian Government will strike a fair balance between the interests of all stakeholders, including the Indian interest groups and foreign investors. Retail has been the most sensitive and politically charged of all sectors in India as it affects the small family businesses and middlemen which form a substantial part of that sector. The current Government nearly fell over the efforts to liberalise the multi-brand sector. As a result, liberalisation in relation to ecommerce in the retail sector has also suffered.

It is necessary to watch this space and see how things progress. Much will also depend upon the results of the elections next year as some political parties champion protection of domestic interests while others would like to open India to international players.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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