Why Amazon is considering buying a stake in India's Reliance Retail

Amazon has a huge market opportunity in India.

But government regulations and customer familiarity is favoring local giant Reliance Retail to take hold of the still-fragmented e-commerce market in the massive country.

That's why Amazon is reportedly in talks to buy a stake in Reliance.

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Amazon is reportedly in talks to buy a 26% stake in Reliance Retail, India's largest brick-and-mortar retailer.

Reliance Retail is rolling out an e-commerce service, and that could seriously threaten Amazon's growing presence in what's on track to become the second-largest e-commerce market in the world. Neither Amazon nor Reliance commented for this story.

India is a massive business opportunity — particularly in e-commerce. The e-retail market in India is only worth $38.5 billion now, but it's slated to become an even larger online shopping market than the US by 2034.

And, perhaps more importantly, Indians haven't determined their e-retailer of choice. It's still a fragmented marketplace with Amazon, Walmart-owned Flipkart, and local giants like Reliance and Paytm Mall all claiming some of the pie.

With 10,000-plus physical locations, five million customers a week, and the blessing of the Narendra Modi administration, Reliance Retail has a serious potential to become India's Alibaba — a domestic retail giant that fends off Amazon from gaining serious market share.

And Amazon, which has already lost out on China and spent billions in India, can't afford to fall behind in this region of the world.

Modi is fighting the threat of 'data colonialism'

The Modi government is making it challenging for companies outside of India to take advantage of the explosive growth in consumer spending, with a slew of new laws that restrict foreign direct investment in e-commerce.

Several other rules, like barring companies from offering special prices on certain websites, are intended to keep brick-and-mortar healthy as e-commerce booms.

These laws are aimed at fighting what Indians are calling “data colonialism” — the fear that American tech giants will reap profits from Indian consumers and their data. “As a country, we have to all grow up and say that, you know, enough of this,” Vinit Goenka, an official in the Modi government, said last year.

American retailers have balked at the rules, particularly Walmart, which owns a $16 billion majority stake in retailer Flipkart. “This is a major change and a regressive policy shift,” a senior director in government affairs at Walmart told the Office of the United States Trade Representative in an e-mail on Jan. 7, Reuters reported.

Those roadblocks are bad news for Amazon

Growth at Amazon Web Services — the company's cash cow — has slowed, so investors are hoping that Amazon can dominate in new international markets like India to boost revenues.

“Amazon has several drivers that should yield robust global revenue growth with rising margins the next several years, namely ... significant opportunity in existing and newer international markets like India, Mexico, and Australia,” Cowen analysts wrote to investors in July.

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Amazon has been rolling out in new markets around the world for years, but the payoff hasn't established itself yet. Amazon loses money when it comes to the international sector — to the tune of $690 million in 2019 and $1.1 billion for the first six months of 2018.

Growth in sales abroad is also slowing in 2019. In the first half of 2019, Amazon saw 10% year-over-year growth in net sales outside of North America, compared to a 31% net sale boost during the same period last year.

Those pressures to actually turn a profit abroad are only further challenged when the foreign government doesn't look kindly upon outside businesses attempting to gobble up market share.

Amazon recently reported its Prime subscription base in India has doubled over the past 18 months. But the Modi government's interest in protecting domestic, traditional retail channels will likely disrupt Amazon's further attempts to expand meaningfully in India. Analysts like Jason Helfstein of Oppenheimer have warned that those regulations will put a damper on revenues for 2019 and 2020.

The legal roadblocks are so intense, in fact, that Amazon grouped India in with famously-restrictive China in its most recent quarterly statement under the “Risk Factors” header of “Our International Operations Expose Us to a Number of Risks.”

But local players are set to flourish — and Amazon is likely to drop coin on them

The Modi rules are creating winners and losers. Analysts say Reliance Retail, India's largest retailer which is now opening an e-commerce service, is a definite winner from the new laws.

Two senior executives told The Economic Times on Thursday that Amazon is in talks to purchase a 26% stake in Reliance. That would allow Reliance to become a Marketplace seller on Amazon, and would give Amazon an instant logistics and fulfillment network across India. However, the talks might not lead to a deal.

Read more: Amazon is reportedly in talks to acquire a 26% stake in a huge Indian retailer, meaning it will dominate a $200 billion market

Reliance is India's biggest industrial conglomerate, and it has its fingers in oil, textiles, telecommunications, consumer electronics, and just about everything else. With $87 billion in revenue, it's one of India's most well-known corporations — lending it a name brand across India that's recognized more widely than Amazon.

Along with a home-court advantage, Reliance is established on the brick-and-mortar side of India. There are already 10,000 Reliance Retail outlets nationwide. Some 97% of retail in India occurs in store.

“In retail/e-commerce, despite competition from well-funded global companies, RIL's wide footprint of physical stores along with its omnichannel focus, subscriber reach and regulations governing foreign e-commerce entities could help it gain a 300 basis point market share in high-growth, modern retail,” UBS analysts wrote in a January note.

But for Amazon, losing out on India would be very costly. Amazon has already invested at least $5 billion in India. The company fumbled in establishing a meaningful presence in China, so losing out on India means that the retailer would not sell to roughly 37% of the world's population.

And as for Reliance, UBS analysts asked in their January report, “Can RIL evolve into India's Amazon/Alibaba/Walmart？” It then followed up: “Yes.”

Do you have an opinion on where e-commerce in India is heading？ Do you work for Amazon India, Flipkart, or Reliance Retail？ Send the author a note at rpremack@businessinsider.com.