Unlike black market activity – where counterfeit, refurbished, or stolen goods are resold as genuine brand products – gray market activity involves the unauthorized movement of commerce through various geographies by rogue distributors and trusted channel partners alike. We look at the some of the attendant issues and explore methods for a brand protection strategy
by Graphic Comms Group Kodak
In this rapidly changing global economy, gray market diversion has become an ever-increasing issue facing many brand owners today. It has been estimated that as much as $63 billion per year in revenue is lost to gray market diversion in the U.S.1 Within the IT industry alone, nearly $5 billion in profits is lost to gray market activity each year.
The problem is more prevalent in other countries, potentially costing hundreds of billions of dollars per year in lost revenue to thousands of companies worldwide. Considering that manufacturers could be losing 4.5% of sales or more to gray marketers, it is no wonder that companies are now taking a hard look at their Brand Protection Strategies to combat this ever increasing problem.
More commonly known as ‘product diversion’ or ‘parallel importing’, gray market activity can be considered a fraudulent means of inflating profits for participating distributors, while reducing brand owner revenue. Gray marketers capitalize on surplus inventory, lower manufacturing costs, fluctuating distribution costs, economic conditions, and currency exchange rates, by exporting goods without the permission of brand owners. The gray marketers then undercut the prices of authorized domestic distributors by selling at lower price points, while achieving similar or higher profit margins due to the lower cost of product acquisition in the originating countries. Gray market product diversion can cycle through several brokers and resellers, who look for the lowest prices of products around the world. The net effect of gray market is two-fold. First, the local distributors are forced to compete with artificially lowered prices by the gray market activity, causing significant conflict and supply chain demand issues within the authorized sales channels. Second, product revenue streams for brand owners become unbalanced, causing inflated sales metrics in some regions, while incurring reduced revenues in other regions. In many cases, well-known retail stores may acquire gray market products through non-traditional channels, bypassing the brand owner’s distribution network altogether. Essentially, gray market activity disrupts the invisible hand of competition in a given sales region, by luring purchasers and consumers away from authorized channels, and creating artificial demand for goods imported by unauthorized means.
Brand impact
Gray market product diversion is caused by geographic price disparities within various channel partners, from internal or external distributors, brokers, and resellers. As economic conditions change in various regions of the world on a daily basis, the currency exchange rates are affected. These global factors can be compounded by surplus inventories, as well as domestic rising or falling of manufacturing and distribution costs, creating the perfect storm for gray market diversion. As a result, brand owners may experience channel conflict, inventory issues, wide price fluctuations, reduced margins, brand erosion, and brand equity concerns.
Price impact
Enterprising channel partners and resellers take advantage of global conditions, knowing where they can obtain genuine product at the lowest price, and where they can sell it at the highest price. Without the proper monitoring of product price fluctuations throughout the world, gray market commerce can go undetected by manufacturers and brand owners. Typically, authorized distributors in the localized sales regions will sense gray market activity, as they will see the effect of the artificially increased supply against the unchanged demand from consumers. The laws of economic forces drive prices down as supply 
goes up, causing authorized distributors to slow their order patterns from manufacturers and brand owners. This channel conflict creates inventory planning issues and demand problems within the authorized distribution system, which affects product pricing and availability concerns. It also can reduce the profit and revenue of brand owners impacted by the channel conflict.
Profit impact
Business relationships between manufacturers and their channel partners can also be negatively affected, particularly if the channel partner suspects the manufacturer is involved in the gray market commerce. In the end, authorized distributors may reduce their ordering from manufacturers, which lowers profits for both business entities. In the case of B2B manufacturers, gray market activity can occur within their own walls, creating the illusion that certain sales regions are doing better than others, when in fact, the opposite may be true. When companies fail to respond to this internal problem, conflict can occur at the executive level, particularly when it affects bonuses and compensation plans.
Customer impact
From a customer buying perspective, consumers intuitively seek out lower prices over higher prices. However, consumers also balance product quality, safety, regulatory compliance, and warranty guarantees with advertised pricing, and they may pay more for genuine product over ‘suspect’ product. In the case of gray market sales, consumers are usually not informed that the product has been diverted through unauthorized means, potentially creating issues with warranties and returns. In addition, certain options, accessories, functionality, and documentation intended for different regions may be missing from imported gray market products, creating customer dissatisfaction, brand equity issues, and safety concerns.
Some gray market resellers may change the packaging and instruction manuals to match languages in the affected regions.
However, many of these products may have been designed for use in certain countries and, for safety reasons, should not be used in other countries – such as the case for certain electronics with required matching power supplies. In addition, gray market diverters may remove packaging and instructions, as a means of disguising the origin of the product, depriving customers of potentially vital product information. Once the product is moved outside authorized distribution channels, quality control becomes non-existent, potentially exposing customers to expired or even tampered items, such as diluted fragrances and perfumes. In the case of pharmaceutical drugs, diverted product may not necessarily be approved in certain countries, causing regulatory issues, liability concerns, and legal exposure for brand owners.
Brand protection methods
Brand owners should consider developing a Brand Protection Strategy and Architecture to defend against gray market diversion, as well as black market/counterfeit activity, and infringement of trademark, copyright and intellectual property rights. To maximize the probability of success, brand owners should consider collaborating with brand protection experts, who have broad experience in all types of brand protection problems. Brand protection experts will have a thorough understanding of the technology, capabilities, and cost of available solutions. In addition, they can evaluate possible solutions against best-practices. Kodak’s approach to developing an end-to-end Brand Protection Strategy includes five steps:
- assess – understand current state & quantify the problem
- design – envision future state and design solutions
- protect – pilot and deploy solutions
- monitor – detect, measure, and report
- enforce – develop and implement investigative plan.
Gray market product diversion is costing brand owners hundreds of billions of dollars worldwide. Through fraudulent methods, gray marketers prey on the inability of brand owners to detect product diversion through complex distribution channels around the globe.