Net tightens gray-market retail vise

Manufacturers step up fight against unauthorized dealers muddying their brands, as increasingly popular technologies globalize the problem.

Paul Festa Staff Writer, CNET News.com
Paul Festa
covers browser development and Web standards.
Paul Festa
7 min read
The order seemed innocent enough--1,000 Hewlett-Packard computers and monitors to be shipped to a charitable foundation for underprivileged youth.

But when HP sleuths paid visits to the addresses where the deeply discounted computers were supposed to go, they didn't find underprivileged youth or classrooms. They found warehouses.

Welcome to the gray market, a realm between the legitimate market and the black market where distribution channels evade manufacturers' control, consumers get bargain basement prices, profit margins and customer service suffer, and brands take a beating. The cost to IT on a yearly basis? A hard-to-ignore $5 billion.


What's new:
Manufacturers have long had to contend with unauthorized dealers muddying their brands, but increasingly popular technologies have globalized the problem.

Bottom line:
Illegal imports and other so-called gray-market goods may have put electronics makers on a potential collision course with online retailers.

More stories on this topic

"If you look on eBay, you'll see so many products sold at cost," said Joseph Loomis, vice president of sales and marketing for Net Enforcers, which helps companies combat gray-market distribution of their wares. "The whole gap between retail and wholesale has been eliminated with the Internet. That's a major problem for storefront retailers and manufacturers, because they're competing with at-cost sales and manufacturers are losing their margin."

Bargain shoppers love the Internet because it offers an easy way to troll for the lowest prices. But it's playing havoc with companies that price goods differently around the globe.

Byzantine trade rules are meant to ensure that importers can't pocket the difference. But manufacturers are increasingly in danger of losing momentum in the fight, thanks to the growing popularity of technologies that connect sellers and buyers across borders with scant oversight.

The problem mirrors disruptive online economic effects playing out more visibly in the media industry, where unauthorized distribution channels have made products widely available for free, threatening profits. Just like the media industry, electronics manufacturers are combating the problem both with private police forces, wielding copyright law as their primary weapon, and with lawsuits.

Illegal imports and other gray-market goods may have put electronics makers on a potential collision course with online retailers.

Take eBay. The company provides some recourse for businesses whose goods are being auctioned off illegitimately. eBay's VeRO (Verified Rights Owner) program helps manufacturers remove eBay listings that improperly use logos and other intellectual property.

And the auction giant insists that its Web site is the perfect place for manufacturers to dispose of their refurbished and excess inventory. eBay doesn't pose a challenge, the company insists, but offers a complement to manufacturers' existing channels.

Still, eBay is unapologetic about the Internet's capacity to facilitate sales to the United States of cheaper products intended for foreign markets.

"That's exactly what eBay is designed to do--remove inefficiencies in

markets," company spokesman Hanni Durzi said. "And there are inefficiencies in geographical differences. Ultimately, it's the consumer's decision."

That's cold comfort to companies like HP, which has been at the forefront of organizing a response to the gray market. Last week, the company sponsored a meeting in the United Kingdom aimed at educating companies and drumming up support for industrywide countermeasures through the Alliance for Gray Market and Counterfeit Abatement (AGMA), a trade group formed in 2001 to combat the problem.

"The Internet is where the gray-market problem really exploded," said Marla Briscoe, a member of HP's brand protection team and vice president of AGMA. "With the Internet, we virtually created a borderless distribution system that makes it a lot easier for unauthorized dealers to advertise products, to buy and resell, and makes it more difficult for manufacturers to track down who exactly is selling these products. This is a worldwide issue."

The problem of gray-market goods is hardly new for manufacturers. Urban commercial strips like Canal Street in New York have long been famous for their storefronts crammed with low-price consumer electronics and other products with reputable brands that have strayed from normal distribution channels.

"The Internet is where the gray-market problem really exploded."
--Marla Briscoe, AGMA, vice president

But online bargain hunting, fueled by increasingly sophisticated price comparison sites, has turned the whole Internet into Canal Street writ large.

According to a KPMG study commissioned by AGMA, the IT industry loses $5 billion annually to the $40 billion gray-market economy. Gray-market watchers estimate that the problem has only worsened in the two years since the study.

Products reach the gray market through a variety of channels, some grayer than others.

Some gray-market distributors fraudulently obtain charitable or educational discounts from companies like HP, then sell the goods below market price. Some legitimate distributors illegitimately hand off inventory to friends and associates, who sell it on the gray market.

Manufacturers routinely sell products for cheap in countries where there is no service infrastructure to support warranties, and the gray-market steers that merchandise back to the United States at bargain basement prices.

Sometimes gray-market goods, sold as new, are used or reconditioned. Sometimes they've fallen off a truck.

In addition to evaporating margins, the gray market potentially poses even more vexing problems for manufacturers.

Take that camera sold without a warranty in Mexico, where the manufacturer doesn't have a widespread service network. When the camera pops up on Canal Street, eBay or a fly-by-night Internet storefront, the buyer may not realize that the product has no warranty. If the

product malfunctions, the manufacturer is faced with two bad options: honoring a nonexistent warranty on a product sold at or below cost, or wrecking a customer relationship.

Because so many gray-market products are in fact reconditioned or used, they're more likely to fail, gray-market watchers say. To keep customers who stand to make more expensive purchases in the future, manufacturers often wind up providing full-year warranty service on products that would only have been warranted for 90 days, or not at all.

"The value of that consumer to a company like Pioneer (Electronics) is high," Loomis said. "What happens when that consumer goes out to buy a $3,000 TV? In reality, the manufacturer is still having to service and support the (gray-market) product even though they didn't factor that into the price. The value of the consumer is too high to say, 'Go fly a kite.'"

So what can manufacturers do to combat the problem? AGMA--which this year expanded its mandate to combat counterfeiting in addition to the gray market--establishes brand protection guidelines for members to follow. The goal, according to the group's Web site, is to "render the movement of unauthorized technology products difficult, undesirable and unprofitable."

"We're the plumbers, finding the leaks in the pipes through sophisticated methods of investigation."
--Joseph Loomis
Vice president, Net Enforcers

Two of the group's members, HP and 3Com, have attempted to achieve that goal by suing gray marketers.

Other AGMA members include Cisco Systems, Lexmark International, Western Digital, Nortel Networks, American Power Conversion, Maxtor, Hitachi Global Storage Technologies and Seagate Technology.

But the Internet, which has fueled the gray-market problem, also has offered up a crop of companies like Net Enforcers that promise to track and help eliminate illegitimate distribution of goods.

GenuOne, for example, sells software that monitors Net auctions for counterfeit or gray-market goods. Pretection International, based in the Hague of the Netherlands, offers an array of brand protection and law enforcement services to manufacturers battling the gray market.

Incorporated in 2002, Coral Springs, Fla.-based Net Enforcers and its 35 employees inspect auctions to make sure that unauthorized dealers aren't using a manufacturer's intellectual property to pass themselves off as authorized dealers.

"We're the plumbers, finding the leaks in the pipes through sophisticated methods of investigation," said Net Enforcers' Loomis. "It's a slowly progressing flood that we're maintaining control of. When we come on board with a manufacturer, we're slowly helping solve the problem and rebuilding their channel."

When the inspectors find auctions they suspect are illegitimate, they

issue take-down notices, a method of copyright enforcement established under the federal Digital Millennium Copyright Act that compels Internet service providers to pull suspected copyright infringements.

Net Enforcers, whose 105 clients include JVC, Pioneer and Kenwood, will also procure gray-market products and then trace their distribution using serial numbers. If a particular distributor is parting with a lot of product "sideways," he or she may get a reminder from the company about what constitutes legitimate distribution.

The start-up denies that it's playing a never-ending game of gray-market whack-a-mole, and it claims that education provides a more lasting solution among the less malicious gray marketers.

"The majority of the people out there aren't trying to commit a conspiracy," said Adam Cohen, the company's vice president of business development. "In 70 percent to 80 percent of the cases, the dealer is not sophisticated--he's been taken advantage of. He's bought the product under the precept that he would be able to resell it. We wind up educating the mole so we don't wind up whacking him over and over. Then we take the information we gain, and try to find out where the problem lies upstream."

One manufacturer credited Net Enforcers with some improvement in its gray-market problem but cautioned that the industry has its work cut out for it.

"These gray-market dealers harm the brand, and they harm the industry by giving the customer a bad experience," said Keith Lehmann, vice president of Kenwood USA's electronics division. "It's a moving target. It will never be stamped out, only suppressed. It's impossible to stop it all."