Introduction

CHAPTER 5

Small Businesses and Online Sales in India

MARTIN KANZ AND ROMINA QUAGLIOTTI

Introduction

Over the past decade, e-commerce has grown exponentially in India and many other emerging markets. This growth has opened up new sales channels for many small and medium enterprises that were previously confined to their local markets. This development may be especially beneficial for small and informal firms that would not otherwise have the resources to reach customers in a wider geographical market.

The overall effect of e-commerce on the growth prospects of small and informal businesses is, however, ambiguous. On the one hand, access to e-commerce could relax growth constraints for small businesses by allowing them to reach a larger market and increase sales revenues without incurring additional fixed costs. On the other hand, it is possible that the rise of e-commerce reduces the local market power of small businesses, shrinks profit margins, and generates disadvantages for businesses that are less experienced in using the technology. Another open question is whether e-commerce sales are sufficiently stable to serve as a reliable source of revenue and as a potential engine of business growth. It therefore remains unclear whether the rise of e-commerce merely exacerbates existing inequalities, or whether it represents a development that can effectively level the playing field and generate new growth opportunities for small and informal businesses.

Studying the impacts of e-commerce is difficult for a number of reasons. Information on e-commerce transactions is generally proprietary and not available to researchers. Even where such data are available, it is not usually possible to link data

on e-commerce transactions to data on the characteristics of the firms or entrepreneurs using e-commerce sales channels. As a result, little is currently known about the characteristics of businesses that select into the use of e-commerce sales channels, how these businesses transact once they are signed up on an e-commerce platform, and which types of businesses manage to use e-commerce to grow their sales revenues. This also makes it difficult to assess whether businesses are able to generate sufficiently stable revenue streams for e-commerce to serve as a realistic source of longer-term revenue and business growth.

The analysis in this chapter overcomes these challenges by using new and previously unexplored data from a large e-commerce platform in India. It combines data on the universe of transactions from a leading Indian e-commerce platform that traces individual sales over a period of four years with data from a survey that captures the characteristics of the businesses and entrepreneurs transacting on the platform. This dataset is especially well suited to tracking the behavior of small and informal firms that are not covered in standard databases: the median firm in the dataset has three employees and an estimated annual revenue of about Rs 3 million (US$40,000). The analysis uses this dataset to follow the transactions of small businesses on the platform and examine, in particular, the extent to which sales and revenue outcomes differ between formal and informal firms, as well as firms with greater experience on the platform.

Although the firms represented in the data are diverse and range from large multiproduct firms to small single-product firms with no employees, the analysis places special emphasis on small and informal firms, which one might expect to experience the largest gains from adopting online sales channels. Because no universally accepted definition of business formality exists, the analysis follows the standard approach in the literature and defines a business as “informal” based on its size measured as the number of employees. In particular, a size cutoff is used that is roughly similar to that used in Indian official statistics. A business is defined as informal if it has fewer than five employees. To assess the robustness of the results, the analysis also applies alternative size cutoffs and definitions of informality (for example, definitions based on sales revenue) and finds that these do not materially change the results.

The chapter shows that both formal and informal businesses are able to grow sales and the geographical size of their markets steadily through the use of online sales channels. However, the benefits of online sales channels are larger among small informal firms, which attain higher online sales per employee and more online revenue per employee relative to formal firms. Businesses that are new to online sales experience a more rapid expansion in the size of the markets they serve; however, there is no evidence that the increase in geographical market size served differs between formal and informal businesses.

Aside from business size, the most important determinant of sales growth is experience using online sales channels, as measured by the number of months a business has been using the e-commerce platform. This is the combined effect of two channels: first, businesses that have been active on the platform for longer may be better at pricing

to market and using the advertising tools available on the platform. Second, there is significant attrition; firms that are unsuccessful at growing their sales become inactive on the platform. This is a form of survival bias that gives rise to a mechanical relationship between experience and sales outcomes—a pattern that is similar to that observed in other online markets, such as online trading by retail investors in the stock market (Campbell, Ramadorai, and Ranish 2014).

The analysis additionally examines whether online sales are a sufficiently stable source of income to contribute plausibly to business growth. It finds that online sales are relatively stable and also become more stable over time. The probability that a business experiences a month with no online sales is 19 percent among businesses that have been active for less than six months and 5 percent among businesses that have been active on the e-commerce platform for more than one year. This finding suggests that adopting online sales channels is especially useful for small and informal businesses and can plausibly serve as an engine of sales and revenue growth.

This study is related to several strands of research. First, it contributes to a small but growing literature on e-commerce. Much of this work has studied price setting (Cavallo and Rigobon 2016; Gorodnichenko and Talavera 2017) and reputation (Fan, Ju, and Xiao 2016; Li, Tadelis, and Zhou 2016; Tadelis 2016) in online markets, but has found it difficult to link behavior in online markets to the characteristics of entrepreneurs because the data that online marketplaces collect about such characteristics are typically limited. One study that makes progress on this dimension is Cavallo (2018), who uses microprice data from multichannel retailers (see also Cavallo and Rigobon 2016), combined with scraped product descriptions from Amazon.com to examine how online competition has changed the pricing behavior of firms. The study finds that online competition has changed the frequency of price changes and the degree of uniform pricing across locations in the United States over the past decade.

Second, this study is related to research on the impacts of improved business practices. Studies in this literature have looked at the effects of consulting services, business training, and technology adoption on the performance of small businesses (Anderson and McKenzie 2021; Bloom et al. 2020). Although there is much survey evidence, to date no rigorous evaluations have measured the impact of e-commerce adoption on small businesses. While this study is not designed to identify the causal impact of e-commerce on business performance, one advantage of the setting is that the analysis can match self-reported data on business characteristics to data on actual transactions, which are observed free of measurement error.

Third, this study contributes to a literature on business informality and the benefits of formalization (Bruhn 2011, 2013; Kanbur 2017) and the impact of digitization on business informality (Klapper, Miller, and Hess 2019). One effect of small businesses shifting their sales transactions to online markets is that these transactions become more transparent. This improved transparency makes sales revenue easier to tax, but it also unlocks some benefits of formality to businesses. For example, it enables them to use these documented income streams as collateral for formal credit that can support