Amazon Launches In India But Don’t Get Too Excited Yet

Amazon (NASDAQ:AMZN) has finally launched its website in India. The retailer is currently offering books, movies and TV shows and plans to expand its merchandise to include electronic items such as mobile phones and cameras in the next few weeks. ^[1] India offers a tremendous growth opportunity but government restrictions on foreign online retailers may not allow the company to provide a service similar to that in the U.S. anytime soon. Nevertheless, it needs to jump on the bandwagon as the e-commerce market in the country is expected to grow rapidly over the next few years. This fits in perfectly with Amazon’s broader strategy of expanding its cash profits at the expense of margins. Let’s take a brief look at what India holds for Amazon.

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Why Is India Important For Amazon?

According to research conducted by PricewaterhouseCoopers (PwC) in 2012, the retail market in India stands at over $350 billion and is growing at a healthy compounded annual growth rate (CAGR) of 15-20%. Foreign retailers are showing interest due to a large market, a growing number of aspirational buyers, increasing personal income and the lack of organized retail penetration. As far as the online retail market is concerned, it is still at a nascent stage but seems to have picked up significantly in the last couple of years. Consulting firm McKinsey expects India’s e-commerce market to grow at a rapid pace for the next few years amounting to $2 billion by 2015. ^[2] The firm also estimates that the country will have roughly 38 million active online shoppers by then. ^[2]

There is clear evidence that the explosive growth in India’s online retail market is likely to continue and clearly Amazon wants to be a part of it. This fits in well into the retailer’s broader strategy of focusing on cash profit growth rather than margins. The company, which is in the middle of setting up a number of fulfillment centers to roll out same day delivery, is battling growing competition in the cloud/web services front and is spending heavily towards the development of its content library. All of these activities are cost-intensive and will negatively impact its already thin margins.

However, it appears that Amazon is not much concerned about that and will continue to invest in growth opportunities. In an interview with The Harvard Business Review earlier this year, Amazon’s CEO stated: “Percentage margins are not one of the things we are seeking to optimize, it’s the absolute dollar free cash flow per share that you want to maximize. If you can do that by lowering margins, we would do that. Free cash flow, that’s something investors can spend.”

Potential Hurdles

Looking at the long-term potential and current growth in India’s e-commerce market, it appears that there may be enough room for several retailers, and competition shouldn’t be a big concern. However, the restriction on foreign retailers is likely to limit Amazon’s service in the country. Indian regulations do not allow foreign online retailers to have a fully-owned Indian arm that sells merchandise directly in the region. This is why Amazon cannot sell the merchandise that it owns, but can essentially act as an aggregator for other retailers. This can limit the company’s control over its profits and supply chain. According to a well-known Indian law firm, J Sagar Associates, foreign direct investment (FDI) for online retail will not open up anytime soon in India as it is of low priority on the government’s agenda. This will continue to limit Amazon’s capabilities in the region and hinder its growth. ^[3]

In addition to this, the company will have to battle against unpredictable logistics, the general consumer preference for cash transactions (accounting for over 90% of all retail transactions) and competition from physical retail stores that have strong relationships with their customers. ^[2]

Our price estimate for Amazon stands at $241, implying a discount of 10% to the market.

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1. Amazon Launches Website in India, The Wall Street Journal, June 5 2013 [↩]
2. E-commerce in India: Early birds, expensive worms, McKinsey [↩] [↩] [↩]
3. Amazon debuts in India with ‘marketplace’ model, fierce competition ahead, The Economic Times, June 6 2012 [↩]