Analysis of the Grey Market

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  1. 1. Author: Wilson, Ryan Session: Fall 2014 Subject: MKT_101_05 Due: 12/15/14 Word Count: Professor: Dr. Barry Berman Principles of Marketing Analysis of the Grey Market, its Activates, and its Evolution
  2. 2. Abstract In this paper, I will illustrate how grey markets operate in domestic and international settings, apply these concepts towards the structure of several large and active grey markets currently in operation, demonstrate the effect of these unauthorized vendors upon manufacturers and retailers in operation within said markets, discuss how these white market operators have attempted to counteract these effects, and conclude by suggesting further actions these companies may implement to work with and around unauthorized resellers. Introduction Grey markets or parallel imports are unauthorized channels through which a firms product is sold and resold via unapproved dealers (Anita, & Bergen & Dutta, 2004, p. 63). This is done in order to take advantage of price arbitrage, whereby parallel importers gain profit by buying legitimate products in low-cost areas and selling in regions where the price for these products are higher in either domestic or foreign markets. (Rai & Jagannathan, 2012, p. 53). In both of these markets, parallel imports have remained legal. Domestically, grey market vendors are protected by the first sales doctrine, introduced under section 109 of the Copyright Act of 1976, which states that once the copyright owner of a US-made product sells their good to a consumer, the manufacturer no longer holds the right to control the distribution of that item (U.S Copyright Office, 2001). Therefore the buyer may actively trade that item as they please. The first sale doctrine also served to protect grey marketers who buy US- manufactured items from foreign markets. In the 1998 Quality King v. Lanza Supreme Court case, copyright holders were restricted from regulating the importation of copyrighted goods into the United States, thus allowing grey marketers to import US-made items from foreign markets for resale (Berman, 2004, p. 52). Grey market vendors thus have incentive to purchase U.S made items in foreign markets in which the product is sold at a cheaper price, and then reimport those products into the country in order to sell at comparatively higher prices (Berman, 2004, p. 52). In 2013, this liberty was extended due to the decision of Kirtsaeng v. John Wiley, in which foreign editions of textbooks were imported into the United States and sold via eBay (Albanese, 2013). Although these books were manufactured outside of the U.S, the Supreme Court ruled that Kirtsaengs sale of lawfully-made copies purchased overseas was protected under the first-sale doctrine, claiming that the law applies to all goods sold in the U.S and does not restrict third parties from selling products based upon that products area of manufacture (Albanese 2013). Therefore, patent holders are unable to regulate the sale of any grey market product sold in the United States regardless of its geographic origin once an authorized sale is made (Albanese 2013). The European Union also applies a form of the First Sale Doctrine within their legal system known as the Exhaustion Principle. According to Article 30 of the Treaty of Rome, a patent holders IP rights are exhausted after the corresponding product is sold, thus allowing for the sale/redistribution of that product (Gudigantala & Bicen, 2011, p. 191). This was originally put into law in order to
  3. 3. allow the free flow of goods between EU member nations, though grey market operators have utilized the principle to extend business (Rai & Jagannathan, 2012, p. 53). However, the Treaty of Rome specifically prohibits the redistribution of goods into international markets, thus grey market vendors operating within Europe must sell between EU nations (Gudigantala & Bicen, 2011, p. 191). Other foreign markets such as Russia, China, and Japan have loose regulation in place to protect IP rights, however these countries ultimately support international exhaustion, which allows for goods to be resold across the world after the initial purchase of a good (Gudigantala & Bicen, 2011, p. 191). Grey market vendors however can present an advantage to authorized retailers. Retailers will often sell knowingly to the grey market in order to relieve itself from excess inventory or seasonal/fashion items that are entering the end of their product lifespan and therefore will offer limited profits (Hu & Pavlin & Shi, 2013, p. 3). In some cases, manufacturers will offer discounted prices to retailers that purchase large amounts of their product for redistribution, however this amount will often be larger than the retailers expected sales for that item (Dasu & Ahmadi & Carr, 2012, p. 1102-1103). In order to limit excess inventory while simultaneously enjoying a manufacturer discount, the authorized vendor will calculate the expected excess and then proceed to sell the determined amount to grey market operators (Dasu et al., 2012, p. 1103). While this benefits the retailer in the short term, the sale will serve to cannibalize the demand for their product, and thus result in reduced profit (Hu et al., 2013, p. 3-4). And while cannibalization of demand and reduction of profit are the most cited disadvantages of the grey market, further harm can be done to a firms marketing strategy in terms of brand image and customer loyalty. For example, grey market vendors operating in the international marketplace will sometimes distribute products in regions where the sale of such products has been intentionally limited or untapped due to concerns over the items success in that area (Berman, 2004, p. 54). Some of these products are also manufactured specifically to accommodate a cultural taste or trend, such as Japanese candy or automobiles made to drive on the left or right side of the road, and are not meant for sale outside cultural boundaries. Once the product in question is exposed to these regions, negative customer experiences will reflect back on the brand or firm that manufactured the item even though they did not approve the sale in the first place (Berman, 2004, p.54). Also, since grey market vendors normally do not regulate the storage or handling of their items, product failure may occur for customers who purchase from these dealers (Berman, 2004, p. 54). Once this occurs, the brand will more often than not be unable to extend care services or warranty coverage for these products since the sale originated from a third party, thus the customer will often blame the manufacturing company and cause damage to brand image (Anita et al.,2004, p. 66). This paper will analyze how these concepts translate into major grey markets currently in operation both domestically and worldwide. In this analysis, I consider how these markets have evolved to the point in which they exist today, reference legal doctrines that apply to the operation of these markets, review the impact of these markets in the areas in which they occur, and indicate whether or
  4. 4. not parallel importation within the fields discussed will expand in the future. Following the analysis of these markets, I will discuss what action is currently underway to counteract these grey markets and conclude by proposing what I believe should be further done in these marketplaces to regulate grey market activity. Pharmaceuticals The pharmaceutical grey market has flourished in recent years both in the United States and the European Union. Between 2000 and 2005, the United States experienced prevalent medication shortages, which allowed grey market pharmaceuticals to take root within the country (Mahugh, 2013). These medication shortages have continued to occur in recent years; in a report released by the Food and Drug Administration (FDA) in 2012, the FDA recorded nearly 200 new medication shortages since the beginning of the year (GAO, 2014, p. 13). These new shortages are in addition to the 255 respective medication shortages the FDA reported in the previous year of 2011 (GAO, 2014, p. 13-14). Since many of these medications are life saving and require continuous consumption, the grey market becomes the most attractive alternative for those lacking these drugs, both for individual consumers and health-care providers such as hospitals (Mahugh, 2013). When a grey market company becomes aware of an emerging medication shortage, pharmaceutical products are obtained via wholesale distributors, pharmacies, and other grey market entities (Mahugh, 2013). Although some pharmaceutical manufacturers have admitted to selling products to unauthorized distributors who then sell to grey market entities, the majority of grey medication comes from pharmacies (Rockefeller & Harkin & Cummings, 2012, p. 16). According to a 2011 investigation into grey market pharmaceuticals, 21 of 25 pharmacies claimed to have been contacted by grey market companies asking to have the pharmacy buy medication from manufacturers and wholesale distributors upon their behalf (Mahugh, 2013). When successful, the pharmacy acts as a purchasing agent between the wholesaler and the grey market, acquiring drugs from a list of Figure 1: Active Drug Shortages Source: GAO, 2014
  5. 5. medication in short supply that the wholesaler provides the pharmacy (Mahugh, 2013). These pharmacies then turn over these drugs to grey market companies in large amounts, who pay between 10-15 percent over the invoice amount (Mahugh, 2013). However, grey market operators may also create fake pharmacies in order to create a direct channel to the wholesaler (Rockefeller et al., 2012, p. 21). These shell pharmacies operate by obtaining a temporary license from the state after completing the application forms and applicable fees required under state law (Mahugh, 2013). Though state law often requires pharmacies to undergo i