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India's E-Commerce 'Gold Rush' Fraught With Risks

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India was home to the fastest growing online market among the BRIC (Brazil, Russia, India and China) nations last year, growth that is fueling a booming e-commerce market.

The number of unique online visitors in India grew 50 percent in the 12 months to November 2012, according to internet analytics firm comScore, outpacing the likes of China and Brazil, which grew just 2 to 3 percent each.

And with an estimated three out of five Indians online visiting retail websites during that period, analysts say India is well on its way to becoming one of the world's biggest online retail markets.

But there are also some major challenges ahead. Low internet penetration, the lack of profitability among online retailers, means it could be up to another five years before online retail truly takes off and commands a larger slice of the country's $450 billion retail market, experts say.

"[There are] 110 million people who have access to the internet of any sort, and not all of them are keen on participating in e-commerce - so the space that you're playing in is still very, very small," said Dheeraj Sinha, author of the book "Consumer India: Inside the Indian Mind and Wallet." "The population that you have online has built up over a period of five years."

According to Mumbai-based Sinha, the "big jump" among India's billion-plus consumers, from surfing the internet to becoming keen online shoppers, will take time, and retailers considering entering the online market should have at least a five-year horizon in mind.

Right now, online retail makes up less than 1 percent of India's retail market, according to Euromonitor, but it is expected to reach up to 8 percent by 2020.

Some of the big players in India's online retail market include the U.S.'s Amazon.com, which also runs Indian website Junglee.com, book-seller Flipkart.com, online marketplace Snapdeal.com and apparel retailer Jabong.com.

(Read more: What Slowdown? Indian Consumers Are Still Spending)

Saloni Nangia, president of management consulting firm Technopak, which focuses on the consumer goods industry, says it could be another three to four years before a dramatic shift in shopping habits takes place.

"The number of (online) transactions have increased, the number of people who are more comfortable shopping online has increased, but in terms of the businesses which are in e-commerce - there has been a slowdown overall from earlier growth," Nangia said.

Biggest Challenge: Profitability

The cost of attracting consumers to shop online in India has come at a very high price for online retailers, according to Nangia, who says developing the country's e-commerce ecosystem is impacting their bottom line.

"E-commerce companies have spent a lot of money, so they have ended up with a very high activation cost and the cost of acquisition at times is much higher than the average purchase or business that is generated from that customer," Nangia said. "The first few years have been good to develop the base for the industry, but it's increasingly becoming important that companies look at the profitability of the business as well."

Manu Jain, co-founder of Jabong.com, a leading Indian online apparel retailer that entered the market just over a year ago says that while he expects year-on-year growth for his business to be on track with industry estimates of a 300-350 percent rise in revenue, the company is not making profits yet.

"I think we're moving in the right direction towards the path to profitability and we hope that we should be able to achieve it faster than anybody else in India. We still require investor money, but we hope to become profitable soon," Jain said.

(Read more: Imported Fruits Juice Up Indian Markets)

Snapdeal.com, India's leading business-to-consumer or B2C website, which has over 20 million registered users is also yet to make a profit despite seeing the cost of purchases more than triple over the past year.

"Our cost base is very, very low given that we don't hold any inventory, we don't have any warehouses, we don't own delivery vans and all those things," Kunal Bahl, co-founder and CEO of Snapdeal.com said, when asked about profitability. "We're still in the early days, investments have to be made in driving consumers and brands to digital commerce."

Unique Shoppers

To attract consumers to online shopping, retailers have used tactics such as payment by cash or credit card on delivery and no-questions-asked return policies.

Technopak's Nangia expects retailers to increasingly pull back on these offers as they try to rationalize costs in 2013. "We should see much emphasis on profitability-per-shipment than we have seen till now," she said.

Shabori Das, research analyst at Euromonitor in Bangalore, however, says that if online retailers take back offers like cash on delivery (COD), they'll lose out on big segment of the Indian consumer base: those who do not have bank accounts or debit and credit cards.

"India is an extremely price-sensitive market and if someone is taking back the offer and the other one is still offering, it's bound to happen that the one who's offering COD will get more sales," Das said.

(Read more: Why Are India's Retailers Afraid of Wal-Mart?)

Bahl of Snapdeal.com said he has no plans to change options like COD, because India is an 85 percent cash economy and people will not make a "significant behavioral change overnight."

"While cash on delivery may create 3 percent more returns, I see it as a small price given the market expansion that it facilitates," he said.

Mumbai resident Surova Kar opts more for COD than paying directly online when she's not sure of the fit of items like shoes or clothing or even the reputation of the retailer.

"It feels like the product comes faster for cash of delivery – delivery is very fast, within 24 hours sometimes," Kar, 34, said.

The stay-at-home mom says she orders everything from diapers to clothing up to twice a month for her 15-month old baby online and is now very comfortable with the retailer she uses.

"Since I use this one website, they are extremely good, and now I can order completely blindly with them – that's the level of trust I have got now," Kar said.

And building trust is a big part of how India's online retailers plan to keep their businesses growing.

"The overall acceptability and willingness to buy online has increased tremendously and we see a huge amount of orders coming from not only bigger metros, but also from smaller cities," said Jabong.com's Jain.

Consumers are buying more now, because there's more trust in the system, Bahl of Snapdeal.com added.

"We're making sure he's [the customer's] giving you a dollar very quickly then coming back again and again to give you more dollars," Bahl said.

By CNBC.com's Rajeshni Naidu-Ghelani; Follow her on Twitter @RajeshniNaidu

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