Why Walmart needed to bag Flipkart

It has been more than 25 years since India threw open its economic doors and stepped on the road to reform. Over these years, several global brands from Coca-Cola and Pepsi to Apple and Levi’s have entered the country and the lives of the teeming middle class. But, through all this, one U.S. giant consistently failed to make it into the Indian retail market because of rules on foreign investment: Walmart.

The world’s biggest retailer’s wait finally came to an end in early May. Walmart stormed into the country by buying a 77% stake in India’s largest e-commerce company, Flipkart, for a whopping $16 billion. It was the world’s biggest e-commerce deal and gave the U.S. giant access to one of the biggest markets in the world. But its decision still made many wonder if it was worth it. Even for a corporation that clocked revenues of about half a trillion dollars in 2017-18, the acquisition was an expensive one. The amount Walmart shelled out for the acquisition was also significantly higher than the $9.8 billion net profit it made in 2017-18.

What was even more baffling to analysts was that barely weeks before signing on the dotted line to acquire Flipkart, Walmart decided to sell a majority stake in Asda, a British retail chain it had owned for nearly 20 years, and merged it with competitor Sainsbury’s. Asda, despite being No. 3 in U.K.’s retail market, was generating cash even though its profit was declining while Flipkart was burning cash at a rapid rate and was likely to continue to do in the foreseeable future.

However, Walmart president and chief executive officer Doug McMillon was convinced about the acquisition in India. A week after the announcement of the Flipkart deal, he told journalists at a media call the stake sale in Asda and the investment in Flipkart were part of Walmart’s strategic actions to increase the corporation’s portfolio for long-term growth.“E-commerce in India is growing rapidly, and we expect it to grow at four times the rate of overall retail. Flipkart is already capturing a large portion of this growth and is well positioned to accelerate into the future,” he said. “So, this is an investment in a large, fast-growing country with an innovative business positioned in the growth area of e-commerce, and with an opportunity to be a positive force for good as we create shared value for years to come. We are excited by what the future holds.”

Walmart simply had to take a chance on India’s potential because of the rapidly changing global environment for retail. Basically, the U.S. market is saturated and Walmart doesn't have a choice but to turn to other fast-growing markets such as India and China. “We are focussed on markets with significant long-term opportunity, like India and China. The investment in Flipkart is a sign of the depth of our commitment to India,” says a Walmart International spokesperson.

But it won’t be easy. Even though India lives and breathes Walmart’s corporate slogan and founder Sam Walton’s ideology, ‘Save Money. Live Better’, the U.S. retailer’s experience in the country hasn’t been so happy until now. Its first attempt at cracking the Indian market nearly a decade ago in partnership with Bharti Enterprises fizzled out as India’s restrictive regulations for foreign direct investment in multi-brand retail came in the way of its plans. It is now confined to a ‘cash-and-carry’ wholesale business and runs 21 stores across the country. Ironically, as its partnership with Bharti folded up nearly five years ago, its fiercest competitor in its home market, Amazon, entered India.

In the last five years, Amazon has ramped up its presence in India and, according to industry estimates, is a close second to Flipkart in the e-commerce space. Amazon has grown to offer the largest selection on an e-commerce platform in the country with over 170 million products. It is also home to 300,000 sellers and has built 67 fulfilment centres in 13 states with close to 20 million cubic feet of storage space. Despite the scale, the India operations still account for a large chunk of global losses. But the company is unfazed and is gung-ho about the potential of the Indian market. “India continues to be one of our fastest-growing regions, and we remain focussed on investing and innovating here to transform how India buys and sells, and enhance the daily lives of our customers,” says Amit Agarwal, senior vice president and country head, Amazon India.

Taking on Amazon is, obviously, Walmart’s biggest challenge in India. So, joining forces with a big company like Flipkart, which includes online fashion retailers Myntra and Jabong, was clearly its best bet to gain an edge in the country. Flipkart was set up by two former Amazon employees, Sachin Bansal and Binny Bansal (not related), in the tech capital of Bengaluru in 2007. Since then, the startup’s rise has been nothing short of phenomenal: It says it has 54 million active users and sold 261 million products last year. It has also built 21 fulfilment centres with a storage capacity of 12 million cubic feet; its supply chain arm, eKart, serves more than 800 cities, making 500,000 deliveries daily. “The Flipkart acquisition effectively prevents Amazon from gaining an insurmountable advantage in this important market for now,” Morgan Stanley analysts wrote in a note.

Walmart didn’t want to miss out on the enormous potential offered by India’s online retail market. It was estimated at nearly $20 billion in 2017 and is slated to grow to $200 billion by 2026, or nearly 12% of total retail sales in the country, according to a recent Morgan Stanley report. It may be much smaller than China’s $1,070 billion e-commerce market or the $511 billion U.S. market, but it is the fastestgrowing. Walmart’s confidence to invest in India was also reignited because of policy measures such as the implementation of the Goods and Services Tax, according to a company spokesperson.

So, despite the scepticism among some in the industry, there is a sense of calm in Walmart after the deal to acquire Flipkart was announced. Not only will Walmart resume its share buyback programme, which was put on hold in the months leading up to the deal, but even the manner of celebrations at the company reflects the optimism.

On the day of the announcement, McMillon donned a Flipkart T-shirt and shot a social media video with Flipkart employees. Something he did not do when Walmart acquired stakes in U.S. e-commerce company Jet.com in the U.S., JD.com in China, or even after striking a partnership with Japan’s Rakuten. When asked about future investments in global markets, the Walmart International spokesperson said the retailer is now where it wants to be with strong partnerships in India, China, and Japan.

But the question remains: Did Walmart overpay for Flipkart? Going purely by the numbers, it probably did. Less than nine months ago, Japanese investor in Internet startups, SoftBank, bought a 21% stake in Flipkart valuing the Indian firm at $10.2 billion. Walmart’s deal pegs the valuation at a much higher $21 billion. But according to analysts and credit rating agencies, the deal is much better than it looks at first glance for Walmart. “The acquisition [Flipkart] is credit positive because it provides immediate scale in India’s burgeoning retail e-commerce sector,” wrote Charles O’Shea, vice president-senior credit officer at Moody’s, in a note after the deal was announced. “Although we expect that Flipkart will continue to generate losses for the next few years, our credit-positive view is based on India’s compelling features, including its 1.2 billion residents and an economy that generates more than 7% annual GDP growth. India has more than 400 million millennials, a growing middle class and exploding smartphone penetration, all of which are critical as shopping continues to shift online.

At the end of the day, it’s a win-win for both Walmart and Flipkart. The U.S. retail giant will bring in its expertise in supply chains and logistics. “Flipkart currently has quite a lot of investment already in infrastructure. We think that one of the ways that we can help support the business is with our expertise in supply chain and e-commerce supply chains, as well as retail supply chains,” a Walmart spokesperson said in response to a questionnaire sent by Fortune India. “Walmart and [payments company] PhonePe will partner with 5-6 million kirana stores to modernise their business practices and offer affordable, high quality services.” PhonePe is Flipkart’s payments division.

Also, Walmart is strong in the food and grocery space which experts believe will emerge as an area of focus for Flipkart. The Indian e-commerce firm has been running pilots in this segment in Bengaluru for the last three months. “Conversations are definitely on with them [Walmart] on the business of food and grocery. In this business, three things are important–stocking, delivery, and packaging, and they are sharing their learnings with us. We will launch food and grocery in three-four cities by the year-end,” says a Flipkart official who did not wish to be identified .

On paper, it all sounds good. But India is a country which has thrown up some nasty surprises to multinational corporations in the past. Whether Walmart is able to comply with India’s regulations which still prevent foreign multi-brand retailers from setting up brick-and-mortar shops or even sell their own products directly to customers online is one of the big question-marks. Experts say Walmart’s purchase of Flipkart is in some ways a backdoor entry into India. Traders have gone to the Competition Commission of India against the deal, saying it will lead to a monopoly in the sector.

Though the popular narrative is one of Walmart vs Amazon, the Indian e-commerce market could well be a three-way battle between Walmart, Amazon, and the combine of Alibaba Group and SoftBank, whose investments in Paytm Mall, Grofers, and BigBasket make the Indian e-commerce market far from a duopoly. No doubt the risks for Walmart’s largest ever acquisition are huge. But in business the biggest risks are what provide the biggest rewards.

(The article was originally published in June 2018 issue of the magazine.)