100 million dollars in 10 hours–that’s the revenue which Flipkart generated on its Big Billion Day sale on October 6th, 2014, envious for any company. The revenues were generated twice as fast as the company itself estimated. Apart from a lot of limelight, the event attracted some regulatory attention as well. There were reports that the Ministry of Commerce and Industry received complaints from traditional brick and mortar traders that Flipkart was trying to sell products below cost price and indulging in unfair competition (under competition law, this is known as ‘predatory pricing’).

This raises a fundamental question which is not limited to Flipkart’s megasale itself, but the entire business model of e-commerce. Unlike other industries, businesses in e-commerce typically have a very long road to profitability. Many e-commerce companies are known to make losses on every sale they make – that is, the cost of each product sold is less than revenues. The immediate goal for them is not to make profits, but to capture market share. It took Amazon 13 years to break-even.

In that case, how is this loss-making activity fuelled so sustainably? While a loss-making business may not seem attractive ordinarily, e-commerce businesses are an exception – they can be very attractive for venture capitalists and private equity investors. For investors, profits need not necessarily be in sight – an increase in market share of the business can lead to a windfall increase in its valuation, and a growth in its investment. Now, let’s understand the competition law problem.

The curious case of ‘Predatory Pricing’

Flipkart, along with other online retail giants like Snapdeal, Amazon etc. has been accused of predatory pricing. Under Indian laws, predatory pricing is defined in the Competition Act, 2002 (“Act”) in Section 4 which states that “predatory price means the sale of goods or provision of services, at a price which is below the cost of production of the goods or provision of services, with a view to reduce competition or eliminate the competitors.”(Cost is determined as per the regulations – it is generally the average variable cost but the Commission has power to use another more appropriate measure of cost keeping in mind the nature of the industry, market and technology used).

Is selling below cost a prohibited or illegal? No, selling products below cost is alright. The issue of predatory pricing arises when the seller (who is selling below cost) is ‘dominant’ in a particular market. If you are not a dominant player, you may sell below cost just to stay competitive or improve your market share – but it will be difficult to establish that you are attempting to eliminate competition.

However, the situation changes completely when you are a dominant player. In that event, selling products below cost can amount to an abuse of dominant position, which has serious consequences – including payment of past 3 years’ average turnover as penalty.

Flipkart’s strategy of selling products online at low prices and offering massive discounts has made traditional brick and mortar retail traders raise the question- whether it is fair, aggressive pricing (a necessary ingredient of competitive markets) or unfair pricing which may slowly eats into the traditional retail system, which consists not only of giants such as Walmart and Pantaloons, but also smaller store owners. These players often have a market limited by geographical restrictions and have limited capacity to bear losses. For consumers, the sale of products below cost now does not mean that this is a sustainable outcome – once these players are eliminated and the fight for market capture is over, e-commerce companies will be free to charge much higher prices than what they are charging now (unless competition with one another keeps price increases in control).

Has Flipkart been involved in predatory pricing? Of course, that will be answered for sure once the Competition Commission initiates an inquiry, but I will try to answer that in light of available information. I argue that it has not been involved.

The test for predatory pricing

In order to be liable for predatory pricing, a firm/company indulging in predatory pricing needs to:
a) Enjoy a dominant position in the relevant market: The first test of determining a firm who indulges in predatory pricing is establishing the dominant position that it occupies in the relevant market. Dominant position as explained under the Act (Explanation II to Section 4) says that a dominant means the position of strength enjoyed by a firm which enables them to operate independently of the competitive forces prevailing in the market and also, affects the consumers, competitors and the market in its favour.

b) Dominate in the “relevant market” which is the market in which a particular product or service is sold:Relevant market can be identified both on the basis of product and geography. A product market is identified on the ease with which consumers can interchange or substitute a product. A geographic market is identified as an area where the supply or demands of goods are distinctly homogenous.

c) Operate independently of competitive forces (read: other players) prevailing in the relevant market

d) Abuse the dominant position by creating barriers for the new entrants or trying to drive them out by selling at a price below the cost of production
Now the question arises- has Flipkart by offering massive discounts on its Big Billion Day engaged in predatory pricing or not.

5 reasons why it may not be a case of predatory pricing

#1 – E-commerce players (at least those which operate through a marketplace model) are merely platforms and not retailers
The Competition Commission of India (“CCI”) itself has given its first word on dominance in the online portals’ market in the matter of Ashish Ahuja vs Snapdeal and Anr (see the order here). The complainant was a merchant who was selling San Disk products through Snapdeal – Snapdeal had banned the sale of his items through the portal saying that he was not an authorized partner of SanDisk. He argued that Snapdeal and SanDisk were collaborating to compel him to become an authorized dealer for SanDisk, which prevented him from offering competitive pricing to the customer.

The CCI rejected that Snapdeal could not be a dominant player in the e-commerce space, because it is not engaged in the purchase or sale of storage devices itself -it is merely an intermediary which owns and manages a web portal, enabling sellers to sell storage devices through the portal for commission.

Of course, this observation is restricted to e-commerce players which use a marketplace model. Flipkart’s model has changed considerably since 2012, after it shifted from its earlier inventory model to the marketplace model- where it became a technology platform allowing small and medium sellers to sell online as well, rather than just being a retailer itself. And this model has been identified by the competition regulator as just being a different platform than offline market for selling the same product. Hence, as long as it is different distributors offering goods on these web portals and not the web portal itself, there may not be a case of predatory pricing against the online retail companies.

#2 – The e-commerce space itself has several competitors, none of whom is clearly dominant
Establishing a dominant position for any one player in the e-commerce space is not easy. Market share (of usually more than 50 percent) is used as an indicator of dominance. In e-commerce, it is not just Flipkart or Amazon or Snapdeal which are dominating the world of online retail to the detriment of other players. The Commission in the Snapdeal order had observed that there are many web portals such as Flipkart, Amazon, eBay, Yebhi and Junglee.com competing with each other. These stores were themselves competing to offer a platform to two kinds of market participants – sellers (to offer products to customers), as well as customers (to select the best deals/prices).

#3 –E-commerce is not a separate market from that of brick and mortar retail stores but just a channel of product delivery – no e-commerce retailer is currently dominant in the combined retail space (including both e-commerce and brick and mortar)
When it comes to violation of competition law norms, a firm/ enterprise needs to be a dominant player in a relevant market. This means establishing whether two or more products can be considered substitute goods and whether they constitute a particular and separate market for competition analysis.

At present, the CCI has not recognized offline and online retail as different markets, but merely as channels of distribution of the same product. In Ashish Ahuja vs. Snapdeal and Anr, CCI observed that “both offline and online markets differ in terms of discounts and shopping experience and buyers weigh the options available in both markets and decides accordingly. If the price in the online market increase significantly, then the consumer is likely to shift towards the offline market and vice versa. Therefore, the Commission is of the view that these two markets are different channels of distribution of the same product and are not two different relevant markets.”

What does this mean for e-commerce players?
This just means that to establish dominance of an e-commerce player such as Amazon or Flipkart, one needs to argue that the player dominates the entire retail space (including online and offline retail), which is a much harder task. Let’s take some estimates to get a reality check here – the current share of e-commerce is USD 13 billion, in comparison to the current retail market size of USD 500 billion (see Economic Times story here and Firstpost data here). By 2021, total retail market size is likely to reach USD 1.3 trillion, of which e-commerce is expected to be far in excess of USD 70 billion. If the Commission continues to use this test, it makes it can be very difficult to establish dominance of an e-commerce player.

#4 – Offering deep discounts is not anti-competitive per se, and is not targeted at hitting out at other competitors
Dominance of one player cannot be established in the online retail segment. There are many players in this emerging space and the market thrives on offering discounts and deals which in effect benefits the consumers. Generally, low pricing is seen as a benefit of successful competition. The deep discounts offered by Flipkart, was in no means, preventing other players to enter the market and not offer similar discounts. Along the same period of time when the Big Billion Day sale happened, Snapdeal and Amazon as marketplaces offered heavy discounts on the goods sold through their web portal.

Can we say that this practice was essentially designed to defeat competition and abuse of dominant position by one player? No. One web portal did not work to the detriment of the other players in the same space. The discount offered by one did not result in an ‘appreciable adverse effect on competition’. On the contrary, the multiple players were offering similar discounts at the same time. The issue of predatory pricing may not arise here since, it is not the case of a dominant player killing competitors and thwarting the entry of new players.

For establishing predatory pricing against online web portals, one also needs to look into the sustainability of the pricing strategies and the funding of the discounts in the long term. For now, the pricing strategy that these online retail companies had adopted was for a limited period, ranging from a day to three days. Even in the physical market, clearance sales and deep discounts on limited occasions is a part of the trade, so it may not be feasible to argue that this is anti-competitive. In fact, in the Snapdeal case above, the Commission had also made an observation that the e-commerce market thrived on special discounts and deals.

#5 –A causal link between incurring short term losses with the intention to subsequently eliminate competitors and charge excessive prices in future is missing
To test predatory behavior of an enterprise, one important criterion that needs to be established is whether the enterprise deliberately incurs short term losses to eliminate competition and be able to charge excessive price in the future. Fortunately for e-commerce stores, it is extremely difficult to establish a causal relationship between the discount and any future increase in price, especially because the road to profitability is also very long. Therefore, initial short term losses faced by the online retail companies may not be classified into losses incurred for engaging in predatory pricing in the longer term.

Further, the online retail business in India is still in the nascent stage, having taken off only in the last 2-3 years. The initial losses could be attributed to these companies’ investment in building brand name, customer loyalty, and relationships with the sellers for their marketplace model. A difference in the economies of scale of the online and offline retail companies show that it is not that online retail companies are deliberately lowering prices of goods to adversely affect offline retailers. Their business model ensures that they could have lower overhead cost structures than the traditional brick and mortal model – leading to the creation of a more efficient market. For example, many reputed US publications and journals are no longer available in the print version and only accessible online – this happened after a realization that the print model may not work as efficiently in light of a changed market reality (i.e. the widespread use of internet). Similarly, brick and mortar businesses also have the option to participate in the e-commerce revolution without undertaking heavy investment themselves (through the market place model), to adapt to new market realities.

Are the e-commerce players completely safe?

The case against the online retail companies look weak from the standpoint of “predatory pricing” – especially where the e-commerce store is following a market place model, or till the time that the Commission considers the entire retail market together to identify a dominant player (it much harder to find a dominant player in a larger market).

However, this does not generalize the verdict for the entire e-commerce sector, as different e-commerce businesses have different operating models, and competition law inquiries are very fact-specific. Apart from that, there is possibility of other anti-competitive malpractices that the Commission can look into (apart from predatory pricing). For example, consider an exclusive deal from Motorola to release all its Android phones exclusively on Flipkart, or a laptop manufacturer insisting that it will only provide warranty and customer support to customers who purchase a product from a specific e-commerce site. These can be a threat to developing a competitive e-commerce market. While the Competition Commission of India has powers to take suomotu action, for now e-commerce companies may be safe, if the CCI chairman Ashok Chawla’s statement can be relied upon (see story here).

The option for brick and mortar stores in this market

The option for brick and mortar stores is very clear – they can’t afford to ignore e-commerce. A more prudent idea would be to participate in the model. For example, Tata’s retail store Croma, for example, sells not only through its own store but also through other portals. E-commerce increases the reach for brick-and-mortar stores without undertaking heavy investment in purchasing distribution outlets. To participate in the model, a brick-and-mortar store owner can identify e-commerce stores with maximum market penetration and sell there. They can also sell on multiple e-commerce sites. They may have to redirect efforts towards pitching their products better online (say, by describing product features better, showing more images, giving faster shipment and showcasing better customer feedback for the product).