Articles

Going Gray? How Businesses Can Put an End to the Unwanted and Illegal Gray Marketing of its Products

Originally Published September 6, 2007 in IP Law 360

INTRODUCTION

Coming out of the box, it looks like a brand new computer in perfect condition. When the buyer has some questions and calls the manufacturer for technical support, however, he is frustrated to learn that the manufacturer will not support the product because it was sold without its knowledge or authorization. The customer is certain that there must be some mistake. After all, the computer was not bought from some covert computer peddler doing business out of his van in a dark alley; the customer bought it from a retail establishment that was openly advertising and selling all types of computers and hardware for the whole world to see. How can the manufacturer possibly claim that this computer was sold without its knowledge or permission?

After some further investigation, it turns out that the computer was indeed sold without the manufacturer’s authorization.

The computer was sold on the “gray market.”

WHAT IS THE GRAY MARKET?

A large part of many businesses’ success today is their ability to distribute products all over the world through authorized distribution channels. The price at which products are sold to distributors often depends on the location of the distributor and intended end user. For example, prices for products in developing countries are invariably less expensive than developed countries. Unfortunately, a destructive market exists where products are diverted from the authorized channels and imported into the United States without a business’ knowledge or consent. These “gray market” products end up being sold at lower prices than those offered by domestic distributors. Unsuspecting customers purchase these branded products at greatly discounted prices. Meanwhile, authorized domestic distributors have difficulty legitimately competing with these “gray marketers” because of the dramatic price disparity.

When manufacturers learn that domestic customers purchased products intended for developing countries, they face a difficult dilemma when asked for warranty support. On the one hand, they can provide support for a product that did not generate one penny’s worth of domestic revenue. On the other hand, they can refuse to provide support and suffer the intangible consequences of a disgruntled customer.

HOW TO STOP THE GRAY MARKET?

One school of thought naively instructs businesses to eliminate the gray market by simply selling its products for the same price all over the world. See e.g., NEC Electronics v. CAL Circuit Abco, 810 F. 2d 1506 (9th Cir. 1987) (“If [the plaintiff] chooses to sell abroad at lower prices than those it could obtain for the identical product here, that is its business. In doing so, however, it cannot look to the United States trademark law to insulate the American market or to vitiate the effects of international trade. This country’s trademark law does not offer [the plaintiff] a vehicle for establishing a worldwide discriminatory pricing scheme . . ..”).

Axiomatically, the economic realities of the global marketplace will not sustain a manufacturer selling its laptop computers to retailers for the same price in Manhattan as Macau. A company ambitious to have an international presence understands it is imperative to price its products in relevant relation to the geographic region. If this same company wants to stop its products returning to the United States through the gray market, therefore, it must take action.

Too often, companies mistakenly believe the gray market is sufficiently addressed by dedicating its sales and marketing group to enforce the problem. Since they are the “boots on the ground,” the theory goes, they are best suited for identifying and reporting suspected gray market activity. The problem with this ostensible solution lies with how most sales and marketing employees are compensated. The vast majority of companies pay their sales employees a base salary with added commissions for sales made. With no economic incentive for catching gray marketers, time spent policing the gray market is time that could otherwise be spent making a sale and making more money. Gray market enforcement becomes a low priority or no priority at all.

Instead, companies that are serious about protecting the integrity of their brand should designate a group of employees to be dedicated to gray market prevention. Unlike a company’s sales force, the income and incentives for this group must be aligned with the goal of stopping gray market transactions.

Authorized distributors must likewise be encouraged to (1) avoid the temptation of participating in the gray market, and (2) report those suspected of gray market activity. With respect to the first item, the authorized distributorship agreement should clearly articulate the manufacturer’s right to periodically inspect and audit the distributor’s inventory to ensure that all products are legitimate. In the event that gray market products are discovered, the penalties should be severe and strictly enforced. Encouraging authorized distributors to report suspected gray market activity through economic incentives will give a company an added weapon in the fight against the gray market.

When suspicious products are examined, the manufacturer must also be able to trace the product backwards through the distribution chain and identify with precision where the gray market leak occurred. For example, product codes that are not easy to remove or deface can identify that a product was manufactured for sale in China and shipped to an authorized distributor in Beijing. If this product was instead discovered in a retail store in Boston, the manufacturer can contact the distributor in Beijing; unless the distributor can accurately account for the product’s sale to a bona fide end user in China, that distributor has violated its distributorship agreement and should be appropriately sanctioned.

Finally, manufacturers should publicize their efforts and enforcement of gray market activity. “Cease and desist” letters should be sent to those suspected of gray market transactions. When litigation becomes necessary, the lawsuit and its subsequent settlement or trial victory should be circulated within the appropriate industry. Gray marketers invade industries and companies where they believe their activities can proceed without consequence. By making public a company’s efforts to stop and punish those who engage in this unlawful activity, gray marketers will be deterred from engaging in transactions with respect to that particular company and prey on others easier targets.

CONCLUSION

The gray market is a significant problem that is growing worse at an alarming rate. Companies committed to selling their products in the global marketplace will inevitably face the gray market challenge. In order to maintain profitability, brand integrity, and legitimate competition, companies must take adequate measures to discourage gray market activity and punish those who are unjustly enriching themselves doing so.

For more info contact David R. Sugden