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Will This Regulation Derail Amazon in India?

Harsh Chauhan, The Motley Fool

Amazon.com (NASDAQ: AMZN) stock took a haircut after the company's fourth-quarter results were released. Wall Street was disappointed with the e-commerce giant's guidance as it calls for first-quarter sales growth of 14% at the midpoint, while analysts were looking for a 19% jump. But that was not the only bad news for shareholders on earnings day.

This is definitely not what Amazon wanted

Amazon has been hit hard by a change in e-commerce regulations in India that came into effect Feb. 1. According to a note issued by India's Department of Industrial Policy and Promotion, e-commerce players with foreign investments cannot hold stakes in wholesale companies that sell on their marketplaces. Additionally, retail companies cannot get more than 25% of sales from just one platform.  

Unnamed sources told the Economic Times that sales via Amazon and Flipkart dropped by a third following the policy changes.

Amazon has been forced to pull product listings from its Indian site as it relied on two sellers -- Cloudtail and Appario Retail -- for the majority of its sales. Amazon holds a 49% stake in both of these entities, which means that it cannot sell inventory owned by them anymore. As Cloudtail was reportedly supplying around 40% of Amazon's sales, the e-commerce giant's India sales are surely taking a massive hit right now.

Man with head down on the table as he sits in front of a hand-dawn chart that shows a red arrow plunging down.

Image source: Getty Images.

The implications

India's fast-growing smartphone and internet penetration have been driving rapid e-commerce growth in the country, and the market is expected to reach $200 billion in sales by 2026. Amazon didn't want to miss this gravy train so it committed billions of dollars to make a mark in India's e-commerce space.

More importantly, the company's investments were paying off nicely, and by the end of 2017 it had nearly tripled its share of India's e-commerce market in just three years. But the latest regulations are expected to put the brakes on India's e-commerce growth story. Consulting giant PricewaterhouseCoopers estimates that the regulatory changes could lead to a $46 billion drop in online sales in India by 2022.

That could knock the wind out of Amazon's India sales and hurt the company in the long run as it now gets 30% of its revenue from international operations. Amazon doesn't explicitly mention how much revenue it gets from India, but it can be safe to assume that this market would have been a solid long-term growth driver.

Amazon's international revenue increased 15% year over year during the final quarter of 2018, down from the 29% growth it had clocked in the year-ago period.

What next?

But all is not lost for Amazon as it's looking to find a way out of this mess by restructuring its India operations. The company is reportedly exploring a conversion of Cloudtail and Appario into wholesale entities that will be engaged in business-to-business transactions, selling their goods to other third-party sellers that will then make the final sale to consumers.

People with knowledge of the matter, as reported by the Economic Times, have said that category managers at Amazon are already in the process of looking for preferred sellers who will buy goods from Appario and Cloudtail. Alternatively, reports suggest that Amazon could offload its stake in both these entities so that it can continue selling through them.

In all, Amazon seems to be confident that the change won't affect its India operations as Cloudtail and Appario haven't canceled any purchase orders just yet. However, it remains to be seen how Amazon copes with the latest regulatory challenge thrown its way by the Indian government.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.