How Multinationals Can Counter Gray Market Imports

S. Tamer Cavusgil Ed Sikora

Gray or parallel import marketing has always concerned multinational companies and their dealer networks. This article proposes a range of both reactive and proactive strategies that companies can adopt to counter gray market channels. Each strategy is illustrated by actual management responses. The principal thesis is that long-term and assured resolution of gray market problems can result from deliberate management planning and action. Such a response is made imperative in light of the May 1988 US Supreme Court decision upholding the legality of gray market imports.

GRAY MARKET ACTIVITYparallel distribution of genuine goods by intermediaries other than authorized channel membershas always concerned companies.'^ In the international context, gray marketing refers to the legal importation of
S. Tamer Cavusgil is Professor of Marketing and International Business at the Graduate School of Business, Michigan State University. He serves as the Director of the International Business Development Program at MSU. He also serves as the Editor of International Marketing Review, and Advances in International Marketing. Ed Sikora is a Senior Marketing Analyst with Caterpillar Inc., Peoria, Illinois. Sikora's nine-year career with Caterpillar took him to Canada and several Latin American countries where he had an opportunity to work directly with Caterpillar dealers and customers. Sikora holds a B.S. degree in engineering and an M.B.A. from Bradley University. WINTER 1988

genuine goods into a country by inter- not be identical and may not carry mediaries other than the authorized full warranties. For these reasons, distributors. Gray marketers are purchasers of gray market goods typically brokers who buy goods accept higher risks that are often overseas, either from manufacturers overlooked. or authorized dealers, at relatively The volume of gray market activlow prices and import them into a ity is significant. This is especially country where prevailing prices are true in the case of premium brands higher. Because the activity of gray of automobiles, cameras, watches, marketers parallels authorized distri- computers, perfumes, wine, chambutors, gray marketers are said to be pagne, glassware, tires and construcengaged in "parallel importation." tion equipment. Gray marketers appeal to their For example, industry sources customers with lower prices. For ex- estimate that about 10% of IBM's ample, if purchased on the gray PC sales and 20% of Sharp Elecmarket, a $54,000 Mercedes 500 tronics' copier sales are accounted SEL, which meets all the US safety for by unauthorized channels. Takand pollution-control requirements, ing again the example of Mercedescan be bought for about 20% Benz, it is estimated that about 22% less than the price charged by the of the automobiles this German car local authorized dealer. Although maker sold in the US in 1984 were gray market goods look similar to supplied by gray marketers. Authotheir domestic counterparts, they may rized dealers accounted for the re75

maining 78%. In 1986, the total value of products distributed in the US through gray market channels was estimated to be $10 billion.

The Coalition to Preserve the Integrity of American Trademarks (COPIAT) has estimated that a typical member company lost more Strained Manufacturer-Dealerthan $4 million in sales to the gray Customer Relations market in 1984. Average sales loss Furthermore, many manufacturers reached $7.4 million per company in rely heavily on the expertise of their the camera industry and $6.5 million dealer network. A strong network in the watch industry. is built on a track record of trusting What has been the response of relationships between top managemultinational corporations to gray ment of the dealerships and the markets? Despite the widespread manufacturer. Such is the case with and persistent nature of the problem, Caterpillar Inc., whose 200-plus companies have been slow to respond dealers constitute one of the strongwith innovative measures. Typical est industrial distribution networks in responses have included lobbying and the world. But even Caterpillar is court battles to seek US Customs' pro- not immune to the gray market. In tection from gray market imports. 1984, an estimated $600 million of As the discussion later in this article gray market construction equipment will illustrate, such efforts have largely flooded US borders. Many coastal failed. dealers were losing sales to gray marketers who were buying EuropeanYet, multinational companies are built Caterpillar equipment at prices not helpless in combatting gray mar- substantially below US list price. ket imports. Indeed, a small number Many became frustrated with this of companies are beginning to for- situation, and some dealers were conmulate and implement creative strate- sidering entering the gray market gies that have proven to be effective. unless some relief was provided. This article explores both reactive and proactive strategies managers can The gray market, therefore, can employ to combat the detrimental strain manufacturer-dealer relations impact of the gray market. The and threaten long-term relationships underlying premise of the article is that support the foundation of a that deliberate and carefully designed strong distribution system. Forturesponses can be more effective than nately, Caterpillar acted quickly to protectionist trade measures. assist its dealers and engaged in some long-term measures to combat gray market activity at its source. W H Y SHOULD

price and exclusive distribution channels (i.e., perfume, cosmetics, watches, etc.). Gray marketers, therefore, are getting a free ride on the brand image created by the manufacturer.

built product is produced for a developing country, it may lack certain safety features required in the United States or Europe. If a fatal accident occurs in the United States, for example, with a piece of equipment that was built for another country, would the manufacturer be liable? Fortunately, such an incident has not yet happened. Disruption of Marketing Strategy and Profits Finally, a company's marketing strategy and overall profit performance can be adversely affected by gray market activities. Forecasting accuracy, pricing strategies, merchandising plans, and other marketing efforts can be disrupted by an unexpected expansion of gray market imports. Therefore, the movement of the gray market should be anticipated when the firm develops its marketing strategy. Indicators such as an increasing price differential between countries, growing inventories, sharp changes in exchange rates and slowing foreign economies are all signals of probable gray market expansion. An important point to recognize is that gray markets can result from a multinational company's deliberate strategy to remain competitive in a particular market. This is often accomplished through aggressive pricing and by trading off market share for short-term profits. In this situation, the manufacturer may tolerate the existence of gray market activity as an outcome of a global marketing strategy.

MANAGERS CARE?

On a similar note, dealer-customer relations become tarnished when the Multinational company executives gray market gets out of control. As HOW GRAY MARKETS have reason to be concerned. Growcustomers become more comfortable DEVELOP ing gray markets complicate at with gray market prices, their percepGray markets, at the international least four aspects of their business tion of authorized dealers may be one level, develop when there are suboperations. of skepticism and distrust. Dealers stantial differences in the prevailing risk losing the respect of loyal cus- prices of the same product between Erosion of Trademark Image tomers and do not gain the needed two national markets. As long as trust to win new ones. the price differential is wide enough Manufacturers whose products are to allow gray market brokers an atsold on the gray market risk a tractive return, they are likely to retarnishing of brand image when cus- Legal Liabilities spond to demand and supply imbaltomers realize that the product is Aside from tarnishing company ances between the two markets. Thus, sold at a lower price through alterimage and relationships, the gray the two fundamental factors motivatnate channels. This is especially true market may cause complications in ing entrepreneurs to engage in parallel of products that have "prestige appeal"established by a premium the legal arena. When a foreign- importation are:
76
COLUMBIA JOURNAL OF WORLD BUSINESS

 substantial price differences between national markets, and the opportunity to offset supply shortages in the importing country at below-market prices. While these factors pave the way for gray market activity, the following conditions also encourage its presence: competitive pricing strategies by a multinational firm leading to differential prices for the same product in different markets (typically between home and host markets); substantial fiuctuations in exchange rates which tend to widen profit margins for gray market brokers; inability of a multinational firm to synchronize demand and supply in various national markets (leading to relative shortages of a product in some markets); unavailability in a market of foreign-made products with desired exclusives (e.g., unavailability of certain Mercedes-Benz and Porsche models in the US); and relative ease with which products can be moved across countries and adapted for local use. (Most consumer products present no special difficulties here, while some industrial equipment may not be sold in certain markets without meeting local requirements.) Typically, a combination of these factors leads to the development of parallel import channels. Managers must monitor these conditions as "telltale" signs of gray market troubles. WHEN TO RESPOND TO GRAY MARKET PROBLEMS But how large can the gray market be allowed to grow before it poses a threat to manufacturer's profitability? Multinationals have a difficult time assessing this point, which we will call the threshold level of gray market activity. It is at this level that an incremental increase in gray market share will substantially reduce the company's overall profits. Intuitively, we know that the threshold level of gray market activity is a function of: (1) gross margin difWlNTER 1988

ferentials between two national markets, and (2) the relative distribution of company sales between the two markets. To illustrate, let's assume that an American multinational corporation realizes far lower profit margins for its product in Europe as a result of an aggressive marketing strategy. However in the US, much higher margins are maintained due to greater demand and competitive considerations. From a strict profitability viewpoint, the multinational can overlook gray market imports of its European product into the US os long as a substantial proportion of its total sales are generated from the more lucrative US market. However, as gray market sales grow in the US, they will "choke off" the higher profit margins achieved from authorized-channel US sales and jeopardize the company's global profits. At this point, the manufacturer wiU be forced to respond to the fundamental factor causing the gray market activity (i.e., substantial price differential between the two markets), or accept lower global profitability for the company.^ Unfortunately, the recognition that the gray market has become a real problem for the company often comes too lateafter it has reached intolerable levels for the company and its dealers. Thus, some managements will only have the opportunity to react to gray markets. Other forwardlooking managers will implement strategies to prevent and minimize the adverse effects of gray market activity. Tables 1 and 2 present reactive and proactive measures, respectively, that companies can employ to cope with gray market imports. As can be seen, many trade-offs exist among the strategies in terms of implementation costs, long-term effectiveness, legal risks and other relevant criteria. In the next two sections, we will elaborate on each strategy. REACTIVE STRATEGIES TO COMBAT GRAY MARKETS Often gray market imports grow unexpectedly to levels that require immediate attention. In this situation.

a company can choose from among seven creative strategies to reduce the adverse impact of gray market activity. These are: strategic confrontation, participation, price cutting, supply interference, promotional bursts, collaboration and acquisition. Strategic Confrontation Strategic confrontation requires the authorized dealer take on the gray market broker head-on. The manufacturer's role with this strategy is one of support. The degree and type of support depend upon the strengths and weaknesses of the victimized dealer. Strategic confrontation can be carried out in the following ways:
Dealer Education

Many weaker, non-aggressive dealers are prime targets for a gray market attack. When under attack, their first reaction may be an outburst of anger toward the manufacturer for allowing the gray market to exist. They may cry out for lower prices and complain that the manufacturer's profit is being made at their expense. Such dealers may benefit from a broad understanding of gray market dynamics, including why it exists, where it exists, and what they can do about it. They also need to understand that the potential for gray market activity has always existed in their territory. Dealers that are more sophisticated may require only training on additional ways to counter expanding gray market activities. More-informed dealers have usually accepted the existence of this threat and focus their energies on keeping the activity down to tolerable levels.
Analysis of Strengths and Weaknesses

Manufacturers can also help dealers identify their strengths and weaknesses. Strategies can be developed that identify what dealer strengths can best be used against the gray market brokers. The analysis includes both the tangible product and the intan77

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gible dealer support-type services. Both must be considered for the analysis to be complete.
Promotion of Dealer Strengths and Competitive Weaknesses

tomers to pick the warranty packages they liked best. By aggressively marketing these programs, many Caterpillar dealers have curtailed the gray market in their territories.

Advertising, direct mail and tele- Participation marketing are effective ways to promote the selected dealer This reactive strategy requires dealstrengths against particular broker ers to purchase machines on the gray weaknesses. Advertising also market. A formal or informal uncan promote dealer strengths derstanding with the manufacturer is whOe, at the same time, build strongly recommended. This strategy doubt in the customers' minds is often used by smaller dealers who about broker warranties and do not have the financial muscle to guarantees. Manufacturers can implement a confrontation strategy. support this effort by sharing in By participating in the gray marthe dealer's expenses. ket, dealers are able to selectively match broker prices and thus prevent Creative Merchandising Plans that provide options to a dilution in their market share. The customers is another way to ac- dealers can maintain their normal cent intangible product differen- transaction price with most customers tiation. Short-term rentals, but have the flexibility to provide leases, special financing (skip or preferential treatment to customers balloon payments), guaranteed who are opinion leaders in their service and maintenance con- community. tracts, guaranteed buy-backs, and Participation requires sound dealerguaranteed availability are only manufacturer communications. The a few of the ways dealers can manufacturer should understand that create a market niche in their this strategy, if used properly, can territory. In addition, manufac- effectively control gray market activturers can participate by provid- ity and lead to higher profit margins. ing either financial assistance or On the other hand, dealers must not free training for dealers who are abuse this privilege by using the gray interested in offering various market as their primary source of merchandising packages. equipment. One possible arrangement would be an informal short-term One East Coast Caterpillar dealer agreement specifying the number of confronted the gray market importers gray market products a dealer would by expanding its short-term rental purchase in a twelve-month period. fleet, keeping a close ear to the mar- This can be seen as a form of the ketplace and by modifying certain one-time price discount. products to differentiate them from their European counterparts. One Participation should only be used example is the modification of a as a short-term strategy to "sting" the D6D Track-Type Tractor with higher gray market brokers until a more horsepower and longer track. The comprehensive strategy can be demodified tractor appealed to a certain veloped. The primary risk in longmarket segment that could not be term participation is that the customer touched by gray market brokers. perceives this as an endorsement of In addition. Caterpillar sponsored the quality and reliability in gray a "PLUS 3" warranty ofler that pro- market products. The dealer then vided customers with a three-year would nullify any effort to create guarantee on the powertrain, 48-hour doubt or uncertainty about the parts availability and 48-hour service broker and his products. turnaround in most countries. Customers could also design their own Aggressive Confrontation: warranty package "cafeteria style" Price Cutting through Caterpillar's Value Assurance Aggressive confrontation is comProgram. This program allowed cus- prised of precise and deliberate
WINTER 1988

maneuvers to quickly reduce local gray market activities through price adjustments. This approach is riskier than strategic confrontation, and specific actions should be carefully assessed to identify if they fall within the company's range of comfortable business practice. A common mode of aggressive confrontation is selective temporary price cutting. A financially strong authorized dealer can identify those "bread-and-butter" models of the gray market broker and either match or beat the gray market price. The manufacturer may even participate by offering the dealer a one-time price discount on selected models. The key to a successful price-cutting strategy lies in the dealer's ability to sustain the low price long enough to effectively reduce gray market activity. This strategy may carry two primary dangers: Irreversible profit loss may result if the broker survives the attack or the attack lasts so long that customers begin to perceive the low price as normal. Legal action may be taken by the broker if he can prove that the price cuts were designed and implemented for the sole purpose of eliminating competition. Multinationals with foreign manufacturing facilities are in a better position to assist their distributors with temporary price cutting. These manufacturers can simply step up production of their lower-cost foreign plants to create a finite, one-time pool of equipment that could be allocated to dealers on a "need" basis. Each distributor could then selectively price its product at or below that of the gray market broker. If a machine would be sold at a normal price, the distributors could place the excess profit in a pool to provide additional discounts later. This strategy was used successfully by some US equipment manufacturers in early 1985, and in less than twelve months the first gray market brokers started trading foreign-manufactured equipment with higher price differentials. Other brokers shifted their
79

trading focus to less competitive industries. As one distributor's sales manager said, "When we were certain that we would lose the deal, we would pull out a new, fully warranted "pool" machine priced 5% under the broker's price and pull the rug right out from underneath his feet." Such a strategy refiects the careful assessment of the manufacturer's strengths and weaknesses. In this case, a global manufacturing network provided a definite advantage.

watches have remained scarce among the discount storespossibly influencing consumers' choice of stores for purchasing the produet. Although this strategy may be effective in targeted areas in the short term, the inability to attack the source of the gray market imports may not justify its high cost.

ers have negotiated with their local gray market broker. Agreements usually require the dealer to purchase a fixed amount of gray market goods in exehange for the exclusive right to sell that particular brand in designated territories. In one industry, a dealer initiated this strategy by default. In 1982 the manufacturer's produet was in short supply. This was also a peak year for gray market activity, and the dealer risked losing his loyal customers to local brokers. To continue selling the manufacturer's brand, the dealer agreed to buy this brand from local gray market brokers in exehange for the exclusive right to sell it in his territory. As a result, the dealer kept his current customers, added some new business, and made a healthy profit off the low-cost foreign product. Collaboration usually is used when the dealer believes the gray market activity is a short-term problem that will disappear, perhaps with changes in the exchange rate. Collaboration allows the dealer to temporarily maintain his clientele without going to war with his loeal gray market broker. Collaboration, although efEeetive, does carry some legal risk. The primary coneern is restraint of trade or collusion. In the above example, the dealer could not get the product through the manufaeturer so it was doubtful that trade was restrained. On the other hand, when two retailers agree to sell only to designated customers, they effectively agree not to compete, which may violate antitrust laws.

Aggressive Confrontation: Promotion of Gray Market Product Limitations

A third example of aggressive confrontation, promotional bursts, have been a popular gray market strategy among manufacturers and authorized dealers. These bursts flood the media with messages that identify product differences and tactfully build doubt about gray market goods. Although such efforts do not curtail gray market activity at its source, they may reduce the amount of gray market imports in targeted areas. For example, some Komatsu dealers in US coastal territories advertised that they may not be able to supply parts for gray market construction equipment. Mercedes-Benz of North America mailed hundreds of letters to insurance companies, banks, and leasing eompanies warning them of the dangers and inereased risks associated with gray market automobiles. Seiko and Rolxe used radio and newspaper ads, respectively, to warn consumers that the manufacturer's warranty may not apply to produets purchased through unauthorized channels. Most reeently, IBM has chosen to deter gray market activity by warning end-users it would not accept warranty claims for its PCs purehased from unauthorized dealers. In addition to newspaper advertisements apprising customers of the warranty policies, IBM now places such notices on PC shipping cartons " . . . to help ensure end-users' satisfaction and to protect IBM's channels of distribution."

Aggressive Confrontation: Supply Interference

A second aggressive confrontation technique is supply interference. If a financially strong dealer can identify the source of gray market importation, he may be able to bid up the price of these goods to a level where the gray market broker cannot sustain a profit. Manufacturers also can participate in supply interference. Channels of supply can be interrupted at the wholesale or retail level with varying degrees of effectiveness. IBM used interference at the wholesale level in 1984 when it canceled several dozen of its 2,200 microcomputer dealers for participating in gray market activities. Sometimes the mere threat of cancellation is enough to limit gray market activity. Hewlett-Packard, NEC Electronics, Leitz Inc., and Charles of the Ritz Group are among the companies that used announcements to discourage sales to unauthorized channels. On the domestic scene, Lotus Development Corporation stated that it intends to terminate anyone in its distribution network who was supplying its products to unauthorized dealers. TTie strategy was used to stop dealers from ordering large quantities of software at volume discounts and then selling the excess on the gray market. Swatch Watch USA used retail interference when it purchased 70,000 watches from brokers selling on the retail market. The retailers included mass merchandisers such as K-Mart, deep discount brokers sueh as 47th Street Photo and numerous catalog showrooms. As a result, Swatch 80

Acquisition
A final reactive strategy against a threatening gray market importer is acquisition. Such a strategy can be seriously considered when the broker operations are located in a highopportunity area where the authorized dealer has limited operations. Before deciding on acquisition, several faetors should be considered: the finaneial ability and potential likelihood of the broker to reopen under a different name after the aequisition is completed;

Collahoration
This strategy ean be summarized with "if you can't beat them, join them." Only a few authorized deal-

COLUMBIA JOURNAL OF WORLD BUSINESS

 effect of the acquisition on the operate in extremely cold weather dealer's image; and (functional feature). cost of the aequisition versus the Ford and General Motors, on the cost of other alternatives. other hand, by simply discontinuing Acquisition is probably the most the placement of EPA certification expensive strategy and is seldom used. stickers on their Canadian-built cars, Its large initial cost must be weighed made it more diffieult to import gray carefully against long-run benefits. market autos through US Customs From a legal standpoint, acquisitions (labeling feature). are safe as long as they are not assoServiee differentiation can be just ciated with attempts to monopolize. as efiective. Through extended warNevertheless, the finaneial demands ranties or improved parts and serviee often make other strategies more at- availability, a manufacturer can make tractive. its produet more appealing than the gray market counterpart. Implementation of such strategies may warrant PROACTIVE STRATEGIES TO long-term deeisions on product quality PREVENT GRAY MARKETS and parts and service requirements. While reactive responses may proProduct differentiation efforts can vide relief from parallel imports, none be enhanced by ensuring the availare designed to address the fundaability of popular models. Because mental causes of gray markets. Therefore, multinational companies must some automobile models are not sold develop and implement proactive in the US, a certain prestige appeal strategies to protect themselves and may be built around these models. their authorized dealers from the When gray market sales reached harmful effects of gray market activity critical levels, Porsche responded by must be included in developing stra- making all of its models available in the US. tegie marketing plans. Proactive strategies to prevent gray market imports include product/ service differentiation and availability, strategic prieing, dealer development, marketing information systems, longterm image reinforcement, establishing of legal precedence, and lobbying. Table 2 provides additional comments about each proactive strategy. Product/Service and Availability Differentiation

Porsche has apparently accommodated for the gray market in its US pricing strategy. By "holding the line" on US prices, Porsche hopes that consumers will prefer to go through authorized channels rather than risk the uncertainty of purchasing on the gray market. Dealer Development If manufacturers expect to enjoy high profitability through differential pricing, they can reduce resulting gray market complications by paying attention to their dealers' long-term development needs. Strong dealers who aggressively and creatively market their goods have a much higher probability of warding off a gray market attack in their territory.

Product/service differentiation can be a very efiective method of stifiing the gray market. By designing products with exclusive features that have strong appeal to a certedn market, manufacturers can reduce gray market activity. Product differentiation may include safety, luxury, and functional features. These exclusive features can then be used to create brand preference over gray market imports. For example, a Canadian contractor might be reluctant to purchase gray market tractors from South America because they may not have been designed to
WINTER 1988

Therefore, it pays for manufacturers to invest time with their dealers to develop a strong distribution network. Caterpillar Inc. has extensive dealer development programs to improve dealer skills and expertise in marketing, finanee, service, parts, data processing and other areas. Human resource development consultants of the company provide specialStrategic Pricing ized training on effective management As a multinational marketer de- techniques, situational leadership and velops competitive prieing strategies organizational development. Furtherin various national markets, large more, a team of experienced Caterpriee differentials should be expected pillar representatives and managers to trigger the gray market. Manage- are available through decentralized ment may move away from uniform district offices around the woTld. prieing in global markets for a num- These district teams provide continber of reasons: to penetrate a foreign uous support and guidance to the market with high sales potentials, to dealer and valuable marketing inforward off a competitive attack on a mation to the manufacturer. particular market, or to lower inManufacturers with less extensive ventory levels of its foreign-manufacresources may want to consider hosttured products. Whatever the case ing gray market informational semmay be, the larger the price differeninars for their dealers. Such a tial, the higher will be the probability program was implemented by Canon of gray market expansion. USA's Copier Division. The educaFirms, therefore, should carefully tion program informed authorized eonsider the gray market implications dealers about the long-term hazards of their pricing strategies. Although of participating in the gray market. differential pricing may improve profitability, increased gray market activity "chokes off" some of this Marketing Information Systems additional profit. Beyond the threshMarketing information systems are old level of gray market activity, any a "must" in tracking gray market additional price differential will only movements in the global arena. The result in decreased global profits for most common method of tracking the company. gray market goods is with warranty
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registration cards that are secretly coded to identify the original dealers who purchased the product. With this information, companies can identify where distribution system leakages are occurring and take the necessary corrective action. Caterpillar's Service InformationManagement System (SIMS) provides its dealers with worldwide access to warranty and service infonnation on a particular machine through the machine's serial number. With a little ingenuity, Cat dealers can find out if their local brokers are selling used machines as new ones or painting a rosy picture about the machine's service history. Furthermore, Caterpillar can use this information to identify those dealers who are sourcing the gray market products to brokers. Similar information systems have been implemented by Lotus Development Corporation and Yamaha to identify the source of leakage from their distribution channels. Information can be gathered in other ways. In Japan, both Komatsu and Hitachi used insf>ectors to develop black lists of gray marketers by monitoring shipyard activities. Similar lists not only identify the brokers, but also indicate the volume and type of equipment being imported. Such information is critical to determine the type of strategy a manufacturer should use in response to movements in the gray market. Manufacturers can gather a significant amount of information through their distribution networks. Many dealers have extensive information systems on their territory activity and their customers. In addition, a large amount of information is passed by word of mouth. Manufacturers should not overlook this source. An information system should be designed to monitor the following critical factors: price differentials between authorized distributor and gray market channels; threatening levels of gray market activity in sales territories; sources of leakages in distribution system;
WlNTER 1988

specific product models that be- cases, importers have agreed to pay come the target of gray market some of their profits, to re-export importers; and goods, to sell them to the trademark owners or to label them as gray profile of gray market customers. niarket goods. Building a reliable information system may take time, planning and coordi- Lobbying nation. However, the pay-off lies in knowing when to react, where to react Lobbying can be thought of as a and how to react to the gray mar- type of political advertising that proketers before they cause irreversible motes company's viewpoints and imdamage to company profits. proves the chances that favorable legislation will be passed. With regard to gray market imports, lobbyLong-Term Image Reinforcement ists can work on three fronts: inLong-term image building may be fluencing exchange rate policy; seekthe most overlooked proactive strategy. ing protectionism against parallel imRepetitive messages that promote the ports; and increasing non-tariff bardealer's image and intangible services riers through regulatory agencies. may discourage would-be gray marAmerican multinationals have reket buyers. Promotion also can be used to reassure current customers sorted to all of these actions with that they made the right choice by relatively little success. While most buying from a particular distributor. efforts focused on exchange-rate A targeted direct mail program to stabilization during the first half of existing customers is one way a dealer the 1980s, recent attempts have been can reinforce customer loyalty. After in favor of protectionist legislation a dealer has established a strong and non-tariff barriers. Recently, for image, promotion can be used to cre- example, a proposal has been made ate anxiety about doing business with for mandatory theft-marking of luxury gray market autos. other dealers or brokers. Much of the lobbying effort against Image building can also revolve the unauthorized importers by US around symbolic intangibles that ap- trademark owners has been assumed peal to the customer's need for pres- by the Coalition to Preserve the Intige and/or power. A manufacturer tegrity of American Trademarks or a dealer with a strong image may (COPIAT). Formed in 1983, appeal to customers who have a need COPIAT is now made up of more to affiliate with that image. These than 40 companies that suffered the customers usually build a strong erosion of product image and marloyalty to a particular distributor or keting investment. manufacturer. This loyalty may go undisturbed by low gray market prices. A long-awaited Supreme Court rulTherefore, it makes sense for manu- ing on the legality of gray market facturers and dealers to invest in imports, released on May 31, 1988, image building. came as a major disappointment to COPIAT members and other manufacturers of trademark goods. Establishing Legal Precedence COPIAT had sued to obtain an order The legality of parallel imports has directing the Customs Service to exnot been clear.^ As a result, some clude the importation of gray market manufacturers have attempted to goods. COPIAT contended that the establish legal precedence by filing regulations (19 CFR 133.21 (c) multiple suits against small brokers (l)-(3)) that permit entry of such who cannot afford a costly defense. goods if the US and foreign tradeSuch action was taken by Coleco In- marks are owned by the same or dustries Inc. in an action to stop the affiliated entities or if the American parallel importation of Cabbage trademark owner has authorized the Patch Kids. Other companies have foreign entity to use the mark are filed suits against gray market im- inconsistent with 19 USC 526. Alporters of such goods as toothbrushes, though the District Court ruled against pain killers and apparel. In settling COPIAT, the D.C. Circuit Court re83

versed the ruling on May 6, 1986, claiming that the exclusions were unreasonable and therefore invalid because they conflict with the statute. When the COPIAT case reached the US Supreme Court's consideration early in 1988, a five-justice majority ruled that subsections (1) and (2) of the regulation are consistent with the statute. That is, when there is common ownership or control of the trademark in issue (which represents the greatest portion of gray market imports), the US Customs Service will continue to allow importation of gray market goods. The Court ruled, however, that allowing imports under the "authorized use" exception (subsection 3) was inconsistent with the law. CONCLUSION: MANAGEMENT ACTION IS NEEDED

are better off implementing their own measures, which should prove more promising. Managers should examine each of the proposed strategies carefully for potential implementation. The measures offered differ in terms of cost and difficulty of implementation, relief provided to authorized channel members, long-term effectiveness and legal implications. Some require close participation of dealers for successful implementation. Consequently, the most appropriate strategy response will vary. It is also important to note the complementary nature of the proposed strategies; simultaneous implementation of several strategies is often needed. Efforts in the area of dealer development or marketing information systems, for example, will prove effective when used in conjunction with other strategies.

pect any sweeping publicly initiated resolutions to the gray market problem in the near future. Both the Congress and the Treasury Department have been slow to resolve the issue. The Treasury is considering altematives, including mandatory labeling and mandatory removal of the trademark. Mandatory labeling is designed to ensure that customers are aware of risk-price trade-offs when purchasing gray market products. In addition, misrepresentation of essential product characteristics, such as limited warranty, potential parts incompatibility and limited service can be minimized. In conclusion, multinational manufacturers and their authorized dealers have good reasons to be concemed about the gray market. Failure to respond with creative company strategies to expanding parallel imports can result in a tarnished trademark image, injured relations with dealers and customers, increased legal problems and impaired implementation of marketing strategies. The best solution is prevention, a strong proactive strategy. If, however, gray market activity approaches critical levels, there will be no choice but to react quickly. Afterward, when the gray market falls back to tolerable levels, manufacturers and dealers should continue to monitor this activity and acknowledge its existence in their long-term strategies.

To date, most multinationals have The Supreme Court decision sends simply ignored or resorted to reactive a clear message to trademark owners rather than proactive strategies to that they cannot rely on existing cope with gray market imports. This legislation to prevent parallel impor- results from their failure to consider tation. A better strategy is to pursue the impact of the gray market in efforts to combat gray market activity developing marketing strategies. Howat its source. As the discussion in ever, with effective information systhis article clearly demonstrates, man- tems and other proactive measures, agers have a variety of strategy gray market movements can be options to effectively deal with gray prevented or at least detected before market imports. Rather than brush- they reach critical levels. ing aside the problem as a temporary Outside of individual company phenomenon or hoping for governmental help, multinational companies actions, it would be unrealistic to exNOTES 1. Gray market activity is not encountered in the international context alone. Conflicts have developed in domestic marketing between traditional and newer channel members when the latter made the same goods available to customers at lower prices. The continuing struggle between full-price department stores and off-price retailers, such as Marshalls, T.J. Maxx and Plums, is a contemporary example. The off-price retailers have taken sales away from department stores by launching designer apparel at substantially lower prices. An interesting twist to parallel distribution problem was encountered by Lotus Development Corp., which found that its authorized dealers were taking advantage of volume discounts and selling the surplus to discount houses. Despite the legal battles, manufacturers have not been able to restrict prices that discounters can charge or to limit their access to the merchandise. 2. In practice, two problems are encountered with this analysis. First, the volume of gray market imports is very difficult to assess since most manufacturers have inadequate information on gray markets. Therefore, the question of when to act is never clear. Second, apart

from the opportunity costs to the manufacturer, there are some non-monetary harmful effects of gray market activity (e.g., impaired relations with authorized channel members) 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 Importation," Journal of Marketing, Vol. 52, No. 3, July 1988, 75-83. Legislative history on gray market importation dates back to a landmark 1923 Supreme Court ruling, A. Bourjois & Co. v. Katzel. The French manufacturer and trademark owner sold its US business, goodwill and trademark rights to the American plaintiff, Bourjois. The defendant, Katzel, a foreign importer, lawfully purchased a large quantity of the trademarked facial powder in France and sold it in the US under the same marks. Justice Holmes found that the genuineness of goods did not automatically entitle any seller to market them under a trademark belonging to another. The Court noted that Bourjois had purchased and reregistered the mark and had expended considerable sums on the trademark's development. Thus, it would be "most unfair" COLUMBIA JOURNAL OF WORLD BUSINESS

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to permit Katzel to sell facial powder in the US without the consent of the trademark owner. The Supreme Court ruling was later formalized in legislation by Section 526 of the Tariff Act of 1930. Section 526 of the Act makes it "unlawful to import into the United States any merchandise of foreign manufacure if such merchandise . . . bears a trademark owned by a citizen of, or by a corporation or association created or organized within the United States," when the trademark is registered with the Patent and Trademark Office and the Customs Service, unless consent of the trademark owner is obtained. Although the legislation appeared to be absolute, the Customs Service identified four exceptions. The restrictions do not apply to parallel imports when:

(1) both the foreign and the US trademark or tradename are owned by the same person or business entity; or (2) the foreign and domestic trademark or tradenanie owners are parent and subsidiary companies or are otherwise subject to common ownership or control; or (3) the articles of foreign manufacture bear a recorded trademark or tradename applied under authorization of the US owner; or (4) the objectionable trademark is removed or obliterated prior to importation. Because of the Section 526 exclusions, most multinational companies have not been able to take advantage of the Customs Service protection against unauthorized imports.

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