Jurisdiction - India
Reports and Analysis
India – FDI Multi Brand Retailing And Competition Concerns.

12 April, 2013

 

The Government of India’s (‘GoI’s’) recent decision to permit foreign direct investment (‘FDI’) in multi-brand product retail trading (‘MBRT’) has attracted varied reactions from different quarters. Part of the opposition to GoI’s decision is based on competitive concerns. The opponents have argued that GoI’s decision will make way for the entry of mega retail stores such as Wal-Mart, Tesco and Carrefour, who will distort the competitive conditions in the market by driving away smaller Indian retailers – the corner kirana shops. The fear is that once the mega retail stores succeed in replacing the local corner stores, they will start imposing unfair terms on their suppliers (lower purchase prices), not pass the benefits on to consumers (increase the prices of end products), and ultimately distort the competitive conditions in the market. GoI has sought to allay these concerns by two different means.

 

At the policy level, GoI has introduced several safeguards which are aimed at promoting competition at each stage of the goods production and supply chain, which are sold via retail outlets. These include the requirement to spend 50% of the total investment amount in back-end infrastructure, local sourcing requirements and prohibition on e-commerce. Further, GoI has emphasized the role of the competition regulator, CCI, in protecting and promoting competitive conditions should they get distorted post the entry of big retailers. CCI’s chairperson, Mr. Ashok Chawla, has publicly endorsed GoI’s decision to allow FDI in MBRT by stating that GoI’s policy will promote competition and CCI will step in, if need be, to pre-empt or remedy situations of market distortions. This article seeks to briefly highlight the possible competition concerns that may arise due to the entry of large multi brand retailers and analyze whether the Competition Act may provide adequate means to address the concerns.

 

The first key fear amongst the cynics is that the large retailers will underprice their products to wean away customers from smaller Indian retailers, ultimately leading to the exit of smaller retailers from the Indian market. Lower prices benefit consumers and are generally considered pro-competitive. In limited situations, where the retailer, being in a dominant position, sets its prices intentionally below its average variable cost of making the products, with the aim of driving away the retailer’s competitors, these lower prices may be problematic. The rationale being that once all the competitors are driven out of the market, the retailer which was earlier selling at lower prices will increase its prices to recoup its losses and make monopoly profits. In most markets, and in particular, product markets for daily use consumer goods which are typically sold through retail outlets, such a possibility is minimal. Price increase by the monopolist retailer will immediately attract new retailers and help bring down the prices. Moreover, the Competition Act specifically prohibits firms from imposing unfair prices, including prices below average variable cost or predatory prices. If a large retailer indulges in such a practice, CCI may step in and remedy the situation.

 

Linked to the concern about lower (predatory) prices is the concern that local retailers may not be able to match the rebates and discounts offered by large retailers, which may lead to their ouster from the market. GoI has sought to address this concern by mandating that foreign retailers cannot set up shops in cities which have a population of less than one million. This would automatically safeguard the local retailers in most Indian cities. In larger cities, where the foreign retailers would set up shop, their practice of offering rebates and discounts may be examined by CCI and prohibited if they are considered ‘unfair’ or ‘discriminatory’. For instance, if the effect of a rebate scheme offered by a large retailer is loyalty inducing and may lead to competitors being driven out of the market, it may be considered ‘unfair’ and accordingly prohibited by CCI.

 

Lower prices and better terms of sale, including by way of rebate and discount schemes have had little impact on smaller retailers in countries which have allowed FDI in MBRT. On the contrary, increased competition and best practices introduced by large foreign retailers have spurred innovation and competition in retail trade. For instance, there is clear evidence to suggest that permitting FDI up to 51% in MBRT has increased efficiency in retail supply chain in China and has led to an overall increase in productivity. The evidence from Russia and Indonesia indicates that despite permitting 100% FDI in MBRT, local retailers continue to enjoy significant market share. Clearly, lower prices do not seem to pose significant threat to such local retailers. The experience from within India too shows a similar trend. The entry of relatively large Indian multi brand retailers, such as Pantaloons, Shopper’s Stop, Westside and Reliance, which routinely offer rebates and discounts, do not appear to have adversely affected the competitive conditions in the market.

 

The second big concern pertains to the unequal purchasing power enjoyed by large retailers. Presently, the Indian retail trade market appears highly fragmented, with the presence of thousands of small, medium and large retail stores. Similarly, the market on the supply side is also fragmented. This level of fragmentation means that the commercial relationship between retailers and their suppliers is equipoised, with no one side enjoying the ability to act independently of the other. The opponents of FDI in MBRT fear that the entry of large foreign retailers will change this state of relative competitive equilibrium, and large retailers will start abusing their position by imposing unfair purchase terms on their relatively smaller suppliers. While this concern may have some merit, the Competition Act appears well suited to address such situations.

 

There are possibly two ways in which a large retailer’s practice of imposing unfair purchase terms, including exclusive dealing requirements, or purchase at very low prices from its suppliers, may affect the competitive conditions in India. First, low purchase prices may cut down the suppliers’ margins, possibly putting many of them out of business. Second, the ability of large retailers to procure supplies at low prices may increase their smaller competitors’ cost of doing business. It is possible that smaller retailers may not be able to extract the same or similar terms from suppliers that a large foreign retailer may. Increased procurement costs would lead to higher sale prices and, consequently, a loss of market share to large retailers who may offer the products at relatively lower prices, ultimately leading to the exit of small retailers from the market.

 

The above mentioned concerns may also be addressed under the Competition Act. Section 4 of the Competition Act specifically permits CCI to examine whether the business practices or prices imposed by a dominant enterprise are ‘unfair’ or ‘discriminatory’. CCI is empowered to examine whether lower prices offered by large retailers to relatively smaller suppliers are such that they may lead to the exit of suppliers from the market. Equally, the Competition Act empowers CCI to examine any conduct of a dominant enterprise if it is such that it may drive its competitors out of the market and result in market foreclosure. Hence, if a dominant retailer’s purchasing policies result in raising its rivals’ (smaller retailers) cost so much so that they are forced to exit the market, CCI may intervene and remedy the situation.

 

Similar concerns have arisen in foreign jurisdictions and competition regulators appear to have promptly stepped in. For instance, the Office of Fair Trade – U.K. Competition Regulator (‘OFT’) was called upon to examine whether the purchase terms offered by large UK retailers such as Asda and Tesco to their suppliers resulted in higher costs for smaller retailers and ef- fectively created entry barriers for newer and smaller retailers. The OFT was also required to examine whether the significantly higher buying power enabled large retailers to extract lower prices from suppliers than would otherwise be possible. With respect to the effect on smaller retailers and their inability to offer purchase terms similar to those offered by Asda and Tesco, the OFT held that they have ample room to improve their purchasing conditions, including by joining larger buying groups. Further, it suggested the introduction of a strengthened Code of Conduct for large retailers, to prevent practices that may lead to an unjustified exercise of buyer power against suppliers.

 

The solutions proposed by OFT may not be easily applicable in India. The Competition Act prohibits all forms of co-operation amongst competitors which have the effect of determining purchase or sale price. Consequently, if the smaller retailers were to organize themselves into a joint buyers’ group and negotiate purchase price from their suppliers, CCI may consider their action to be in the nature of an anti-competitive cartel agreement. This risk will also apply to suppliers if they were to organize themselves into a joint sellers’ group to negotiate prices with large retailers. Thus far, CCI has not had the opportunity to examine the legality of joint buyer or purchaser groups. However, in a case concerning motion picture producers, it observed that coming together of firms for ‘collective bargaining’ purposes may not per se be illegal and may be permissible depending upon their economic effects.

 

In light of the above discussion, it may be argued that the concerns voiced against the GoI’s permission to allow FDI up to 50% in MBRT are no different from the concerns that may arise in any other industry where foreign participation is allowed. Reduction of prices because of the en- try of a retailer who enjoys higher economies of scale and hence benefits consumers is generally pro-competitive. In limited situations, where the reduced prices may force suppliers or competi- tors out of the market, CCI may step in and take corrective measures.

 

AZB

 

For further information, please contact:

 

Rahul Rai, AZB & Partners
rahul.rai@azbpartners.com
 
Hemangini Dadwal, AZB & Partners
hemangini.dadwal@azbpartners.com
 

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