[ MANAGING MARKETS ]
ost people know of the black market—the illicit clearinghouse for stolen goods and pirated merchandise. But they may not be aware of its distant gray-market cousin, even though they may routinely buy from it. The gray market is generally legal, though many manufacturers condemn it and in extreme cases have gone to court to try to shut it down. It operates on the wellknown principles of arbitrage—the practice of buying legitimate, branded goods cheaply in one market and reselling them in another market where they can get a better price. In the United States, the gray market exceeds $50 billion per year in the information technology sector alone, according to data from AGMA, an alliance of intellectual property-rights owners. “The gray market is a sort of aberration in the supply chain,” says Udatta Palekar, associate professor of business administration and director of the Supply Chain Management Program at the College of Business. “It takes advantage of price imbalances.” In general, manufacturers condemn gray-market sales activity because it cuts into their wholesale profits. For instance, a car made in the United States will carry a higher wholesale and retail price in Canada than in the United States. The retail differential allows gray marketers to buy the car at full price in the United States and then resell it for a higher
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“The gray market is a sort of aberration in the supply chain. It takes advantage of price imbalances.” – Udatta Palekar
• • • • • • • • • • • • price in Canada. The carmaker loses because it gets only the lower U.S. wholesale price instead of the higher Canadian wholesale price, says Romana Autrey, assistant professor of accountancy. Manufacturers also contend that gray-market operations undermine their networks of authorized distributors because they must compete with the cheaper gray-market price. Numerous factors create the pricing imbalances that spur graymarket sales. Overstock and promotional sales are two examples. So are fluctuations in currency rates. But the gray market thrives in particular on the growth of global commerce, as multinational corporations attempt to sell their goods in more and
more countries. They usually follow a multi-tier pricing strategy designed to boost corporate profits and unit sales, says Autrey, a former senior manager at KPMG, where she conducted gray-market investigations for the firm’s clients. For example, prices are likely to be higher in the affluent United States than in developing nations. But multi-tiered pricing may backfire when the price differential opens the door to arbitrage. “Whenever you have a price difference between markets, you will have gray-market firms which see a profit opportunity,” says Autrey. “They say, ‘I’m going to buy low and sell higher.’” According to Palekar, those gray market firms “may be third-party
firms or authorized distributors who divert their authorized supplies.” Omega watches fell victim to this strategy. Omega charged hundreds of dollars less in some markets than it did in the United States. Enterprising gray marketers spotted the differential, snapped up watches in cheap markets, and then sold them to U.S. discounter Costco. Costco resold them to consumers at far lower prices than Omega’s authorized U.S. distributors could charge. Consumers won; Omega and its distributors lost. Omega fought all the way to the U.S. Supreme Court in an effort to stop the practice, but the court deadlocked 4-4. Justice Elena Kagan abstained because she had previously represented the Obama administration in earlier stages of the case while serving as Solicitor General. The court is set to hear another gray-market case this fall. A Thai businessman bought cheap Englishlanguage textbooks printed for Egyptian users and then resold them in the United States. The textbooks’ publisher, John Wiley & Sons, sued for alleged violations of the company’s copyrights. A jury ordered a $600,000 judgment, but the businessman, Supak Kirtsaeng, appealed. Kagan was not involved in this case and is expected to cast the deciding vote. If the court does act to curb the gray market, it won’t necessarily shut down unauthorized sales, but it could shift the venue in which they are sold, says Autrey. Gray-market
THE TRANSITION FROM OFFICIAL TO UNOFFICIAL
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The gray market operates on the well-known principles of arbitrage—the practice of buying legitimate, branded goods cheaply in one market and reselling them in another market where they can get a better price. While legal, the market is unofficial, unauthorized, or unintended by the original manufacturer.
Perspectives FALL 2012
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IS GRAY HERE TO STAY?
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