How Multinationals Can CounterGray Market Imports

S. Tamer CavusgilEd Sikora

Gray or parallel import marketing has always concernedmultinational companies and their dealer networks. Thisarticle proposes a range of both reactive and proactivestrategies that companies can adopt to counter gray marketchannels. Each strategy is illustrated by actual manage-ment responses. The principal thesis is that long-termand assured resolution of gray market problems canresult from deliberate management planning and action.Such a response is made imperative in light of the May1988 US Supreme Court decision upholding the legalityof gray market imports.

GRAY MARKET ACTIVITY—par-allel distribution of genuine goodsby intermediaries other than author-ized channel members—has alwaysconcerned companies.'̂ In the inter-national context, gray marketingrefers to the legal importation of

S. Tamer Cavusgil is Professor of Market-ing and International Business at theGraduate School of Business, MichiganState University. He serves as the Direc-tor of the International Business Develop-ment Program at MSU. He also servesas the Editor of International MarketingReview, and Advances in InternationalMarketing.

Ed Sikora is a Senior Marketing Analystwith Caterpillar Inc., Peoria, Illinois.Sikora's nine-year career with Caterpillartook him to Canada and several LatinAmerican countries where he had an op-portunity to work directly with Caterpillardealers and customers. Sikora holds aB.S. degree in engineering and an M.B.A.from Bradley University.

WINTER 1988

genuine goods into a country by inter-mediaries other than the authorizeddistributors. Gray marketers aretypically brokers who buy goodsoverseas, either from manufacturersor authorized dealers, at relativelylow prices and import them into acountry where prevailing prices arehigher. Because the activity of graymarketers parallels authorized distri-butors, gray marketers are said to beengaged in "parallel importation."

Gray marketers appeal to theircustomers with lower prices. For ex-ample, if purchased on the graymarket, a $54,000 Mercedes 500SEL, which meets all the US safetyand pollution-control requirements,can be bought for about 20%less than the price charged by thelocal authorized dealer. Althoughgray market goods look similar totheir domestic counterparts, they may

not be identical and may not carryfull warranties. For these reasons,purchasers of gray market goodsaccept higher risks that are oftenoverlooked.

The volume of gray market activ-ity is significant. This is especiallytrue in the case of premium brandsof automobiles, cameras, watches,computers, perfumes, wine, cham-pagne, glassware, tires and construc-tion equipment.

For example, industry sourcesestimate that about 10% of IBM'sPC sales and 20% of Sharp Elec-tronics' copier sales are accountedfor by unauthorized channels. Tak-ing again the example of Mercedes-Benz, it is estimated that about 22%of the automobiles this German carmaker sold in the US in 1984 weresupplied by gray marketers. Autho-rized dealers accounted for the re-

75

maining 78%. In 1986, the totalvalue of products distributed in theUS through gray market channelswas estimated to be $10 billion.

The Coalition to Preserve the In-tegrity of American Trademarks(COPIAT) has estimated that atypical member company lost morethan $4 million in sales to the graymarket in 1984. Average sales lossreached $7.4 million per company inthe camera industry and $6.5 millionin the watch industry.

What has been the response ofmultinational corporations to graymarkets? Despite the widespreadand persistent nature of the problem,companies have been slow to respondwith innovative measures. Typicalresponses have included lobbying andcourt battles to seek US Customs' pro-tection from gray market imports.As the discussion later in this articlewill illustrate, such efforts have largelyfailed.

Yet, multinational companies arenot helpless in combatting gray mar-ket imports. Indeed, a small numberof companies are beginning to for-mulate and implement creative strate-gies that have proven to be effective.This article explores both reactiveand proactive strategies managers canemploy to combat the detrimentalimpact of the gray market. Theunderlying premise of the article isthat deliberate and carefully designedresponses can be more effective thanprotectionist trade measures.

WHY SHOULDMANAGERS CARE?

Multinational company executiveshave reason to be concerned. Grow-ing gray markets complicate atleast four aspects of their businessoperations.

Erosion of Trademark Image

Manufacturers whose products aresold on the gray market risk atarnishing of brand image when cus-tomers realize that the product issold at a lower price through alter-nate channels. This is especially trueof products that have "prestige ap-peal"—established by a premium

price and exclusive distributionchannels (i.e., perfume, cosmetics,watches, etc.). Gray marketers,therefore, are getting a free ride onthe brand image created by themanufacturer.

Strained Manufacturer-Dealer-Customer Relations

Furthermore, many manufacturersrely heavily on the expertise of theirdealer network. A strong networkis built on a track record of trustingrelationships between top manage-ment of the dealerships and themanufacturer. Such is the case withCaterpillar Inc., whose 200-plusdealers constitute one of the strong-est industrial distribution networks inthe world. But even Caterpillar isnot immune to the gray market. In1984, an estimated $600 million ofgray market construction equipmentflooded US borders. Many coastaldealers were losing sales to graymarketers who were buying European-built Caterpillar equipment at pricessubstantially below US list price.Many became frustrated with thissituation, and some dealers were con-sidering entering the gray marketunless some relief was provided.

The gray market, therefore, canstrain manufacturer-dealer relationsand threaten long-term relationshipsthat support the foundation of astrong distribution system. Fortu-nately, Caterpillar acted quickly toassist its dealers and engaged in somelong-term measures to combat graymarket activity at its source.

On a similar note, dealer-customerrelations become tarnished when thegray market gets out of control. Ascustomers become more comfortablewith gray market prices, their percep-tion of authorized dealers may be oneof skepticism and distrust. Dealersrisk losing the respect of loyal cus-tomers and do not gain the neededtrust to win new ones.

Legal Liabilities

Aside from tarnishing companyimage and relationships, the graymarket may cause complications inthe legal arena. When a foreign-

built product is produced for a de-veloping country, it may lack certainsafety features required in the UnitedStates or Europe. If a fatal accidentoccurs in the United States, forexample, with a piece of equipmentthat was built for another country,would the manufacturer be liable?Fortunately, such an incident has notyet happened.

Disruption of MarketingStrategy and Profits

Finally, a company's marketingstrategy and overall profit performancecan be adversely affected by graymarket activities. Forecasting accu-racy, pricing strategies, merchandisingplans, and other marketing efforts canbe disrupted by an unexpected expan-sion of gray market imports. There-fore, the movement of the gray mar-ket should be anticipated when thefirm develops its marketing strategy.Indicators such as an increasingprice differential between countries,growing inventories, sharp changes inexchange rates and slowing foreigneconomies are all signals of probablegray market expansion.

An important point to recognize isthat gray markets can result from amultinational company's deliberatestrategy to remain competitive in aparticular market. This is often ac-complished through aggressive pricingand by trading off market share forshort-term profits. In this situation,the manufacturer may tolerate theexistence of gray market activity asan outcome of a global marketingstrategy.

HOW GRAY MARKETSDEVELOP

Gray markets, at the internationallevel, develop when there are sub-stantial differences in the prevailingprices of the same product betweentwo national markets. As long asthe price differential is wide enoughto allow gray market brokers an at-tractive return, they are likely to re-spond to demand and supply imbal-ances between the two markets. Thus,the two fundamental factors motivat-ing entrepreneurs to engage in parallelimportation are:

76 COLUMBIA JOURNAL OF WORLD BUSINESS

• substantial price differences be-tween national markets, and

• the opportunity to offset supplyshortages in the importing countryat below-market prices.

While these factors pave the way forgray market activity, the followingconditions also encourage its pres-ence:

• competitive pricing strategies by amultinational firm leading to dif-ferential prices for the same prod-uct in different markets (typicallybetween home and host markets);

• substantial fiuctuations in exchangerates which tend to widen profitmargins for gray market brokers;

• inability of a multinational firm tosynchronize demand and supply invarious national markets (leadingto relative shortages of a productin some markets);

• unavailability in a market of for-eign-made products with desiredexclusives (e.g., unavailability ofcertain Mercedes-Benz and Porschemodels in the US); and

• relative ease with which productscan be moved across countriesand adapted for local use. (Mostconsumer products present no spe-cial difficulties here, while someindustrial equipment may not besold in certain markets withoutmeeting local requirements.)

Typically, a combination of thesefactors leads to the development ofparallel import channels. Managersmust monitor these conditions as "tell-tale" signs of gray market troubles.

WHEN TO RESPOND TOGRAY MARKET PROBLEMS

But how large can the gray marketbe allowed to grow before it poses athreat to manufacturer's profitability?Multinationals have a difficult timeassessing this point, which we will callthe threshold level of gray marketactivity. It is at this level that anincremental increase in gray marketshare will substantially reduce thecompany's overall profits.

Intuitively, we know that the thresh-old level of gray market activity isa function of: (1) gross margin dif-

ferentials between two national mar-kets, and (2) the relative distributionof company sales between the twomarkets.

To illustrate, let's assume that anAmerican multinational corporationrealizes far lower profit margins forits product in Europe as a result ofan aggressive marketing strategy. How-ever in the US, much higher marginsare maintained due to greater demandand competitive considerations. Froma strict profitability viewpoint, themultinational can overlook gray mar-ket imports of its European productinto the US os long as a substantialproportion of its total sales are gen-erated from the more lucrative USmarket. However, as gray marketsales grow in the US, they will"choke off" the higher profit marginsachieved from authorized-channel USsales and jeopardize the company'sglobal profits. At this point, themanufacturer wiU be forced to re-spond to the fundamental factorcausing the gray market activity (i.e.,substantial price differential betweenthe two markets), or accept lowerglobal profitability for the company.^

Unfortunately, the recognition thatthe gray market has become a realproblem for the company often comestoo late—after it has reached intoler-able levels for the company and itsdealers. Thus, some managementswill only have the opportunity to re-act to gray markets. Other forward-looking managers will implementstrategies to prevent and minimizethe adverse effects of gray marketactivity.

Tables 1 and 2 present reactiveand proactive measures, respectively,that companies can employ to copewith gray market imports. As can beseen, many trade-offs exist among thestrategies in terms of implementationcosts, long-term effectiveness, legalrisks and other relevant criteria. Inthe next two sections, we will elabo-rate on each strategy.

REACTIVE STRATEGIES TOCOMBAT GRAY MARKETS

Often gray market imports growunexpectedly to levels that requireimmediate attention. In this situation.

a company can choose from amongseven creative strategies to reduce theadverse impact of gray market activ-ity. These are: strategic confrontation,participation, price cutting, supplyinterference, promotional bursts, col-laboration and acquisition.

Strategic Confrontation

Strategic confrontation requires theauthorized dealer take on the graymarket broker head-on. The manu-facturer's role with this strategy isone of support. The degree and typeof support depend upon the strengthsand weaknesses of the victimizeddealer. Strategic confrontation canbe carried out in the following ways:

Dealer Education

Many weaker, non-aggressivedealers are prime targets for agray market attack. When underattack, their first reaction maybe an outburst of anger towardthe manufacturer for allowingthe gray market to exist. Theymay cry out for lower pricesand complain that the manufac-turer's profit is being made attheir expense.

Such dealers may benefit froma broad understanding of graymarket dynamics, including whyit exists, where it exists, andwhat they can do about it. Theyalso need to understand that thepotential for gray market activ-ity has always existed in theirterritory.

Dealers that are more sophisti-cated may require only trainingon additional ways to counterexpanding gray market activi-ties. More-informed dealershave usually accepted the exis-tence of this threat and focustheir energies on keeping theactivity down to tolerable levels.

Analysis of Strengths and WeaknessesManufacturers can also helpdealers identify their strengthsand weaknesses. Strategies canbe developed that identify whatdealer strengths can best be usedagainst the gray market brokers.The analysis includes both thetangible product and the intan-

WlNTER 1988 77

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78 COLUMBIA JOURNAL OF WORLD BUSINESS

gible dealer support-type ser-vices. Both must be consideredfor the analysis to be complete.

Promotion of Dealer Strengths andCompetitive Weaknesses

Advertising, direct mail and tele-marketing are effective ways topromote the selected dealerstrengths against particular brokerweaknesses. Advertising alsocan promote dealer strengthswhOe, at the same time, builddoubt in the customers' mindsabout broker warranties andguarantees. Manufacturers cansupport this effort by sharing inthe dealer's expenses.

Creative MerchandisingPlans that provide options tocustomers is another way to ac-cent intangible product differen-tiation. Short-term rentals,leases, special financing (skip orballoon payments), guaranteedservice and maintenance con-tracts, guaranteed buy-backs, andguaranteed availability are onlya few of the ways dealers cancreate a market niche in theirterritory. In addition, manufac-turers can participate by provid-ing either financial assistance orfree training for dealers who areinterested in offering variousmerchandising packages.

One East Coast Caterpillar dealerconfronted the gray market importersby expanding its short-term rentalfleet, keeping a close ear to the mar-ketplace and by modifying certainproducts to differentiate them fromtheir European counterparts. Oneexample is the modification of aD6D Track-Type Tractor with higherhorsepower and longer track. Themodified tractor appealed to a certainmarket segment that could not betouched by gray market brokers.

In addition. Caterpillar sponsoreda "PLUS 3" warranty ofler that pro-vided customers with a three-yearguarantee on the powertrain, 48-hourparts availability and 48-hour serviceturnaround in most countries. Cus-tomers could also design their ownwarranty package "cafeteria style"through Caterpillar's Value AssuranceProgram. This program allowed cus-

tomers to pick the warranty packagesthey liked best. By aggressively mar-keting these programs, many Cater-pillar dealers have curtailed the graymarket in their territories.

Participation

This reactive strategy requires deal-ers to purchase machines on the graymarket. A formal or informal un-derstanding with the manufacturer isstrongly recommended. This strategyis often used by smaller dealers whodo not have the financial muscle toimplement a confrontation strategy.

By participating in the gray mar-ket, dealers are able to selectivelymatch broker prices and thus preventa dilution in their market share. Thedealers can maintain their normaltransaction price with most customersbut have the flexibility to providepreferential treatment to customerswho are opinion leaders in theircommunity.

Participation requires sound dealer-manufacturer communications. Themanufacturer should understand thatthis strategy, if used properly, caneffectively control gray market activ-ity and lead to higher profit margins.On the other hand, dealers must notabuse this privilege by using the graymarket as their primary source ofequipment. One possible arrange-ment would be an informal short-termagreement specifying the number ofgray market products a dealer wouldpurchase in a twelve-month period.This can be seen as a form of theone-time price discount.

Participation should only be usedas a short-term strategy to "sting" thegray market brokers until a morecomprehensive strategy can be de-veloped. The primary risk in long-term participation is that the customerperceives this as an endorsement ofthe quality and reliability in graymarket products. The dealer thenwould nullify any effort to createdoubt or uncertainty about thebroker and his products.

Aggressive Confrontation:Price Cutting

Aggressive confrontation is com-prised of precise and deliberate

maneuvers to quickly reduce localgray market activities through priceadjustments. This approach is riskierthan strategic confrontation, and spe-cific actions should be carefullyassessed to identify if they fall withinthe company's range of comfortablebusiness practice.

A common mode of aggressiveconfrontation is selective temporaryprice cutting. A financially strongauthorized dealer can identify those"bread-and-butter" models of thegray market broker and either matchor beat the gray market price. Themanufacturer may even participateby offering the dealer a one-time pricediscount on selected models. The keyto a successful price-cutting strategylies in the dealer's ability to sustainthe low price long enough to effec-tively reduce gray market activity.This strategy may carry two primarydangers:

• Irreversible profit loss mayresult if the broker survives theattack or the attack lasts solong that customers begin toperceive the low price asnormal.

• Legal action may be taken bythe broker if he can prove thatthe price cuts were designed andimplemented for the sole pur-pose of eliminating competition.

Multinationals with foreign manu-facturing facilities are in a betterposition to assist their distributorswith temporary price cutting. Thesemanufacturers can simply step upproduction of their lower-cost foreignplants to create a finite, one-timepool of equipment that could be al-located to dealers on a "need" basis.Each distributor could then selectivelyprice its product at or below that ofthe gray market broker. If a ma-chine would be sold at a normalprice, the distributors could place theexcess profit in a pool to provideadditional discounts later.

This strategy was used successfullyby some US equipment manufacturersin early 1985, and in less than twelvemonths the first gray market brokersstarted trading foreign-manufacturedequipment with higher price differen-tials. Other brokers shifted their

WINTER 1988 79

trading focus to less competitive in-dustries. As one distributor's salesmanager said, "When we were cer-tain that we would lose the deal, wewould pull out a new, fully warranted"pool" machine priced 5% underthe broker's price and pull the rugright out from underneath his feet."Such a strategy refiects the carefulassessment of the manufacturer'sstrengths and weaknesses. In thiscase, a global manufacturing networkprovided a definite advantage.

Aggressive Confrontation:Supply Interference

A second aggressive confrontationtechnique is supply interference. Ifa financially strong dealer can identifythe source of gray market importation,he may be able to bid up the priceof these goods to a level where thegray market broker cannot sustain aprofit.

Manufacturers also can participatein supply interference. Channels ofsupply can be interrupted at thewholesale or retail level with varyingdegrees of effectiveness. IBM usedinterference at the wholesale level in1984 when it canceled several dozenof its 2,200 microcomputer dealersfor participating in gray market ac-tivities.

Sometimes the mere threat of can-cellation is enough to limit gray mar-ket activity. Hewlett-Packard, NECElectronics, Leitz Inc., and Charlesof the Ritz Group are among thecompanies that used announcementsto discourage sales to unauthorizedchannels. On the domestic scene,Lotus Development Corporation statedthat it intends to terminate anyone inits distribution network who was sup-plying its products to unauthorizeddealers. TTie strategy was used tostop dealers from ordering large quan-tities of software at volume discountsand then selling the excess on thegray market.

Swatch Watch USA used retail in-terference when it purchased 70,000watches from brokers selling on theretail market. The retailers includedmass merchandisers such as K-Mart,deep discount brokers sueh as 47thStreet Photo and numerous catalogshowrooms. As a result, Swatch

80

watches have remained scarce amongthe discount stores—possibly influenc-ing consumers' choice of stores forpurchasing the produet. Althoughthis strategy may be effective intargeted areas in the short term, theinability to attack the source of thegray market imports may not justifyits high cost.

Aggressive Confrontation:Promotion of Gray MarketProduct Limitations

A third example of aggressive con-frontation, promotional bursts, havebeen a popular gray market strategyamong manufacturers and authorizeddealers. These bursts flood the mediawith messages that identify productdifferences and tactfully build doubtabout gray market goods. Althoughsuch efforts do not curtail gray mar-ket activity at its source, they mayreduce the amount of gray marketimports in targeted areas.

For example, some Komatsu deal-ers in US coastal territories adver-tised that they may not be able tosupply parts for gray market con-struction equipment. Mercedes-Benzof North America mailed hundreds ofletters to insurance companies, banks,and leasing eompanies warning themof the dangers and inereased risksassociated with gray market automo-biles. Seiko and Rolxe used radioand newspaper ads, respectively, towarn consumers that the manufac-turer's warranty may not apply toproduets purchased through unautho-rized channels.

Most reeently, IBM has chosen todeter gray market activity by warningend-users it would not accept war-ranty claims for its PCs purehasedfrom unauthorized dealers. In addi-tion to newspaper advertisements ap-prising customers of the warrantypolicies, IBM now places such noticeson PC shipping cartons " . . . to helpensure end-users' satisfaction and toprotect IBM's channels of distribu-tion."

Collahoration

This strategy ean be summarizedwith "if you can't beat them, jointhem." Only a few authorized deal-

ers have negotiated with their localgray market broker. Agreementsusually require the dealer to purchasea fixed amount of gray market goodsin exehange for the exclusive right tosell that particular brand in designatedterritories.

In one industry, a dealer initiatedthis strategy by default. In 1982 themanufacturer's produet was in shortsupply. This was also a peak yearfor gray market activity, and thedealer risked losing his loyal cus-tomers to local brokers. To con-tinue selling the manufacturer's brand,the dealer agreed to buy this brandfrom local gray market brokers inexehange for the exclusive right tosell it in his territory. As a result,the dealer kept his current customers,added some new business, and madea healthy profit off the low-costforeign product.

Collaboration usually is used whenthe dealer believes the gray marketactivity is a short-term problem thatwill disappear, perhaps with changesin the exchange rate. Collaborationallows the dealer to temporarily main-tain his clientele without going towar with his loeal gray market broker.

Collaboration, although efEeetive,does carry some legal risk. Theprimary coneern is restraint of tradeor collusion. In the above example,the dealer could not get the productthrough the manufaeturer so it wasdoubtful that trade was restrained.On the other hand, when two retailersagree to sell only to designated cus-tomers, they effectively agree not tocompete, which may violate antitrustlaws.

Acquisition

A final reactive strategy against athreatening gray market importer isacquisition. Such a strategy can beseriously considered when the brokeroperations are located in a high-opportunity area where the authorizeddealer has limited operations.

Before deciding on acquisition,several faetors should be considered:

• the finaneial ability and potentiallikelihood of the broker to reopenunder a different name after theaequisition is completed;

COLUMBIA JOURNAL OF WORLD BUSINESS

• effect of the acquisition on thedealer's image; and

• cost of the aequisition versus thecost of other alternatives.

Acquisition is probably the mostexpensive strategy and is seldom used.Its large initial cost must be weighedcarefully against long-run benefits.From a legal standpoint, acquisitionsare safe as long as they are not asso-ciated with attempts to monopolize.Nevertheless, the finaneial demandsoften make other strategies more at-tractive.

PROACTIVE STRATEGIES TOPREVENT GRAY MARKETS

While reactive responses may pro-vide relief from parallel imports, noneare designed to address the funda-mental causes of gray markets. There-fore, multinational companies mustdevelop and implement proactivestrategies to protect themselves andtheir authorized dealers from theharmful effects of gray market activitymust be included in developing stra-tegie marketing plans.

Proactive strategies to prevent graymarket imports include product/service differentiation and availability,strategic prieing, dealer development,marketing information systems, long-term image reinforcement, establish-ing of legal precedence, and lobbying.Table 2 provides additional com-ments about each proactive strategy.

Product/Service Differentiationand Availability

Product/service differentiation canbe a very efiective method of stifiingthe gray market. By designing prod-ucts with exclusive features that havestrong appeal to a certedn market,manufacturers can reduce gray mar-ket activity.

Product differentiation may includesafety, luxury, and functional fea-tures. These exclusive features canthen be used to create brand prefer-ence over gray market imports. Forexample, a Canadian contractor mightbe reluctant to purchase gray markettractors from South America becausethey may not have been designed to

WINTER 1988

operate in extremely cold weather(functional feature).

Ford and General Motors, on theother hand, by simply discontinuingthe placement of EPA certificationstickers on their Canadian-built cars,made it more diffieult to import graymarket autos through US Customs(labeling feature).

Serviee differentiation can be justas efiective. Through extended war-ranties or improved parts and servieeavailability, a manufacturer can makeits produet more appealing than thegray market counterpart. Implemen-tation of such strategies may warrantlong-term deeisions on product qualityand parts and service requirements.

Product differentiation efforts canbe enhanced by ensuring the avail-ability of popular models. Becausesome automobile models are not soldin the US, a certain prestige appealmay be built around these models.When gray market sales reachedcritical levels, Porsche responded bymaking all of its models availablein the US.

Strategic Pricing

As a multinational marketer de-velops competitive prieing strategiesin various national markets, largepriee differentials should be expectedto trigger the gray market. Manage-ment may move away from uniformprieing in global markets for a num-ber of reasons: to penetrate a foreignmarket with high sales potentials, toward off a competitive attack on aparticular market, or to lower in-ventory levels of its foreign-manufac-tured products. Whatever the casemay be, the larger the price differen-tial, the higher will be the probabilityof gray market expansion.

Firms, therefore, should carefullyeonsider the gray market implicationsof their pricing strategies. Althoughdifferential pricing may improve prof-itability, increased gray market activ-ity "chokes off" some of thisadditional profit. Beyond the thresh-old level of gray market activity, anyadditional price differential will onlyresult in decreased global profits forthe company.

Porsche has apparently accommo-dated for the gray market in its USpricing strategy. By "holding theline" on US prices, Porsche hopesthat consumers will prefer to gothrough authorized channels ratherthan risk the uncertainty of purchas-ing on the gray market.

Dealer Development

If manufacturers expect to enjoyhigh profitability through differentialpricing, they can reduce resulting graymarket complications by paying at-tention to their dealers' long-termdevelopment needs. Strong dealerswho aggressively and creatively mar-ket their goods have a much higherprobability of warding off a graymarket attack in their territory.

Therefore, it pays for manufac-turers to invest time with their dealersto develop a strong distribution net-work. Caterpillar Inc. has extensivedealer development programs to im-prove dealer skills and expertise inmarketing, finanee, service, parts,data processing and other areas.Human resource development consul-tants of the company provide special-ized training on effective managementtechniques, situational leadership andorganizational development. Further-more, a team of experienced Cater-pillar representatives and managersare available through decentralizeddistrict offices around the woTld.These district teams provide contin-uous support and guidance to thedealer and valuable marketing infor-mation to the manufacturer.

Manufacturers with less extensiveresources may want to consider host-ing gray market informational sem-inars for their dealers. Such aprogram was implemented by CanonUSA's Copier Division. The educa-tion program informed authorizeddealers about the long-term hazardsof participating in the gray market.

Marketing Information Systems

Marketing information systems area "must" in tracking gray marketmovements in the global arena. Themost common method of trackinggray market goods is with warranty

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82 COLUMBIA JOURNAL OF WORLD BUSINESS

registration cards that are secretlycoded to identify the original dealerswho purchased the product. Withthis information, companies can iden-tify where distribution system leakagesare occurring and take the necessarycorrective action.

Caterpillar's Service Information-Management System (SIMS) pro-vides its dealers with worldwide accessto warranty and service infonnationon a particular machine through themachine's serial number. With alittle ingenuity, Cat dealers can findout if their local brokers are sellingused machines as new ones or paint-ing a rosy picture about the machine'sservice history. Furthermore, Cater-pillar can use this information toidentify those dealers who are sourc-ing the gray market products tobrokers.

Similar information systems havebeen implemented by Lotus Develop-ment Corporation and Yamaha toidentify the source of leakage fromtheir distribution channels.

Information can be gathered inother ways. In Japan, both Komatsuand Hitachi used insf>ectors to developblack lists of gray marketers by moni-toring shipyard activities. Similarlists not only identify the brokers, butalso indicate the volume and type ofequipment being imported. Such in-formation is critical to determine thetype of strategy a manufacturer shoulduse in response to movements in thegray market.

Manufacturers can gather a signifi-cant amount of information throughtheir distribution networks. Manydealers have extensive informationsystems on their territory activity andtheir customers. In addition, a largeamount of information is passed byword of mouth. Manufacturers shouldnot overlook this source.

An information system should bedesigned to monitor the followingcritical factors:

• price differentials between author-ized distributor and gray marketchannels;

• threatening levels of gray marketactivity in sales territories;

• sources of leakages in distributionsystem;

• specific product models that be-come the target of gray marketimporters; and

• profile of gray market customers.

Building a reliable information systemmay take time, planning and coordi-nation. However, the pay-off lies inknowing when to react, where to reactand how to react to the gray mar-keters before they cause irreversibledamage to company profits.

Long-Term Image Reinforcement

Long-term image building may bethe most overlooked proactive strategy.Repetitive messages that promote thedealer's image and intangible servicesmay discourage would-be gray mar-ket buyers. Promotion also can beused to reassure current customersthat they made the right choice bybuying from a particular distributor.A targeted direct mail program toexisting customers is one way a dealercan reinforce customer loyalty. Aftera dealer has established a strongimage, promotion can be used to cre-ate anxiety about doing business withother dealers or brokers.

Image building can also revolvearound symbolic intangibles that ap-peal to the customer's need for pres-tige and/or power. A manufactureror a dealer with a strong image mayappeal to customers who have a needto affiliate with that image. Thesecustomers usually build a strongloyalty to a particular distributor ormanufacturer. This loyalty may goundisturbed by low gray market prices.Therefore, it makes sense for manu-facturers and dealers to invest inimage building.

Establishing Legal Precedence

The legality of parallel imports hasnot been clear.̂ As a result, somemanufacturers have attempted toestablish legal precedence by filingmultiple suits against small brokerswho cannot afford a costly defense.Such action was taken by Coleco In-dustries Inc. in an action to stop theparallel importation of CabbagePatch Kids. Other companies havefiled suits against gray market im-porters of such goods as toothbrushes,pain killers and apparel. In settling

cases, importers have agreed to paysome of their profits, to re-exportgoods, to sell them to the trademarkowners or to label them as grayniarket goods.

Lobbying

Lobbying can be thought of as atype of political advertising that pro-motes company's viewpoints and im-proves the chances that favorablelegislation will be passed. With re-gard to gray market imports, lobby-ists can work on three fronts: in-fluencing exchange rate policy; seek-ing protectionism against parallel im-ports; and increasing non-tariff bar-riers through regulatory agencies.

American multinationals have re-sorted to all of these actions withrelatively little success. While mostefforts focused on exchange-ratestabilization during the first half ofthe 1980s, recent attempts have beenin favor of protectionist legislationand non-tariff barriers. Recently, forexample, a proposal has been madefor mandatory theft-marking of luxurygray market autos.

Much of the lobbying effort againstthe unauthorized importers by UStrademark owners has been assumedby the Coalition to Preserve the In-tegrity of American Trademarks(COPIAT). Formed in 1983,COPIAT is now made up of morethan 40 companies that suffered theerosion of product image and mar-keting investment.

A long-awaited Supreme Court rul-ing on the legality of gray marketimports, released on May 31, 1988,came as a major disappointment toCOPIAT members and other manu-facturers of trademark goods.COPIAT had sued to obtain an orderdirecting the Customs Service to ex-clude the importation of gray marketgoods. COPIAT contended that theregulations (19 CFR 133.21 (c)( l)-(3)) that permit entry of suchgoods if the US and foreign trade-marks are owned by the same oraffiliated entities or if the Americantrademark owner has authorized theforeign entity to use the mark areinconsistent with 19 USC 526. Al-though the District Court ruled againstCOPIAT, the D.C. Circuit Court re-

WlNTER 1988 83

versed the ruling on May 6, 1986,claiming that the exclusions were un-reasonable and therefore invalid be-cause they conflict with the statute.

When the COPIAT case reachedthe US Supreme Court's considerationearly in 1988, a five-justice majorityruled that subsections (1) and (2)of the regulation are consistent withthe statute. That is, when there iscommon ownership or control of thetrademark in issue (which representsthe greatest portion of gray marketimports), the US Customs Servicewill continue to allow importation ofgray market goods. The Court ruled,however, that allowing imports underthe "authorized use" exception (sub-section 3) was inconsistent with thelaw.

CONCLUSION: MANAGEMENTACTION IS NEEDED

The Supreme Court decision sendsa clear message to trademark ownersthat they cannot rely on existinglegislation to prevent parallel impor-tation. A better strategy is to pursueefforts to combat gray market activityat its source. As the discussion inthis article clearly demonstrates, man-agers have a variety of strategyoptions to effectively deal with graymarket imports. Rather than brush-ing aside the problem as a temporaryphenomenon or hoping for govern-mental help, multinational companies

are better off implementing their ownmeasures, which should prove morepromising.

Managers should examine each ofthe proposed strategies carefully forpotential implementation. The mea-sures offered differ in terms of costand difficulty of implementation,relief provided to authorized channelmembers, long-term effectiveness andlegal implications. Some requireclose participation of dealers for suc-cessful implementation. Consequently,the most appropriate strategy responsewill vary. It is also important tonote the complementary nature of theproposed strategies; simultaneous im-plementation of several strategies isoften needed. Efforts in the areaof dealer development or marketinginformation systems, for example,will prove effective when used in con-junction with other strategies.

To date, most multinationals havesimply ignored or resorted to reactiverather than proactive strategies tocope with gray market imports. Thisresults from their failure to considerthe impact of the gray market indeveloping marketing strategies. How-ever, with effective information sys-tems and other proactive measures,gray market movements can beprevented or at least detected beforethey reach critical levels.

Outside of individual companyactions, it would be unrealistic to ex-

pect any sweeping publicly initiatedresolutions to the gray market prob-lem in the near future. Both theCongress and the Treasury Depart-ment have been slow to resolve theissue. The Treasury is consideringaltematives, including mandatorylabeling and mandatory removal ofthe trademark. Mandatory labelingis designed to ensure that customersare aware of risk-price trade-offs whenpurchasing gray market products. Inaddition, misrepresentation of essen-tial product characteristics, such aslimited warranty, potential parts in-compatibility and limited service canbe minimized.

In conclusion, multinational manu-facturers and their authorized dealershave good reasons to be concemedabout the gray market. Failure torespond with creative company strate-gies to expanding parallel importscan result in a tarnished trademarkimage, injured relations with dealersand customers, increased legal prob-lems and impaired implementation ofmarketing strategies. The best solu-tion is prevention, a strong proac-tive strategy. If, however, graymarket activity approaches criticallevels, there will be no choice but toreact quickly. Afterward, when thegray market falls back to tolerablelevels, manufacturers and dealersshould continue to monitor this ac-tivity and acknowledge its existencein their long-term strategies.

NOTES

1. Gray market activity is not encountered in the interna-tional context alone. Conflicts have developed in domes-tic marketing between traditional and newer channelmembers when the latter made the same goods availableto customers at lower prices. The continuing strugglebetween full-price department stores and off-price re-tailers, such as Marshalls, T.J. Maxx and Plums, is acontemporary example. The off-price retailers havetaken sales away from department stores by launchingdesigner apparel at substantially lower prices. An inter-esting twist to parallel distribution problem was encoun-tered by Lotus Development Corp., which found thatits authorized dealers were taking advantage of volumediscounts and selling the surplus to discount houses.Despite the legal battles, manufacturers have not beenable to restrict prices that discounters can charge or tolimit their access to the merchandise.

2. In practice, two problems are encountered with thisanalysis. First, the volume of gray market imports isvery difficult to assess since most manufacturers haveinadequate information on gray markets. Therefore, thequestion of when to act is never clear. Second, apart

from the opportunity costs to the manufacturer, thereare some non-monetary harmful effects of gray marketactivity (e.g., impaired relations with authorized channelmembers) which also need to be considered.

3. See, for example. Dale F. Duhan and Mary Jane Sheffet,"Gray Markets and the Legal Status of Parallel Impor-tation," Journal of Marketing, Vol. 52, No. 3, July 1988,75-83.

Legislative history on gray market importation datesback to a landmark 1923 Supreme Court ruling, A.Bourjois & Co. v. Katzel. The French manufacturer andtrademark owner sold its US business, goodwill andtrademark rights to the American plaintiff, Bourjois.The defendant, Katzel, a foreign importer, lawfully pur-chased a large quantity of the trademarked facial powderin France and sold it in the US under the same marks.Justice Holmes found that the genuineness of goods didnot automatically entitle any seller to market themunder a trademark belonging to another. The Courtnoted that Bourjois had purchased and reregistered themark and had expended considerable sums on the trade-mark's development. Thus, it would be "most unfair"

84 COLUMBIA JOURNAL OF WORLD BUSINESS

to permit Katzel to sell facial powder in the US withoutthe consent of the trademark owner.

The Supreme Court ruling was later formalized inlegislation by Section 526 of the Tariff Act of 1930.Section 526 of the Act makes it "unlawful to importinto the United States any merchandise of foreign manu-facure if such merchandise . . . bears a trademarkowned by a citizen of, or by a corporation or associationcreated or organized within the United States," whenthe trademark is registered with the Patent and Trade-mark Office and the Customs Service, unless consent ofthe trademark owner is obtained.

Although the legislation appeared to be absolute, theCustoms Service identified four exceptions. The restric-tions do not apply to parallel imports when:

(1) both the foreign and the US trademark ortradename are owned by the same person orbusiness entity; or

(2) the foreign and domestic trademark or trade-nanie owners are parent and subsidiary com-panies or are otherwise subject to commonownership or control; or

(3) the articles of foreign manufacture bear arecorded trademark or tradename applied underauthorization of the US owner; or

(4) the objectionable trademark is removed or ob-literated prior to importation.

Because of the Section 526 exclusions, most multina-tional companies have not been able to take advantage ofthe Customs Service protection against unauthorized imports.

WINTER 198885