Peggy E. Chaudhry, PhD
Villanova School of Business, Villanova, University

A gray market involves the distribution of legitimate product through a channel that is unauthorized by a brand. Though not counterfeit, gray market, “parallel,” or “diverted” goods can still damage a brand.  A brand can use reactive strategies to extinguish a gray market that currently exists or proactive strategies to avert a gray market from arising in the first place (Chaudhry 2014).  This article summarizes anti-gray market schemes for brand protection professionals.

Reactive: Strategic Confrontation

Most high-technology brands use “stacked incentives” on sales of their products. In the Deloitte report, the analysts recount that the majority of the respondents in the high-technology sector use greater than 5,000 channel members to distribute their products and at least 50% of their sales use some type of incentive scheme. These were as high as 55% off the list price: 25% contractual discount; 12% channel partner accreditation; 8% programmatic; and 10% end user (Deloitte 2011).

Stacked incentives, however, create an opportunity for gray marketers to purchase at a reduced price and re-sell the product in another market closer to the list price. The brand needs to re-evaluate this negative outcome of stacked incentives and establish contractual agreements that will legally limit the ability to re-sell its products. This creates the necessity for sales teams to effectively work with the company’s legal counsel to resolve this gray market issue.  My research with legal expert Robert Bird on gray markets in the pharmaceutical sector of the European Union found a quagmire of legal challenges presented before the European Court of Justice—and the need for synergy between marketers and legal professionals (Bird and Chaudhry 2011).

Reactive: Supply Interference

A brand’s adeptness at legally restricting access to its products by controlling the volume of goods available or establishing random wholesale or retail delivery dates can deter gray marketers. This tactic does present a conflict with the sales team for the brand: disrupting the supply chain to diffuse a gray market may not be worth the possible alienation to the brand’s legitimate customers. Nevertheless, some brands have taken extreme measures here, such as when Apple temporarily closed its retail stories in Beijing and created an online booking system that allowed only one purchase per phone per day. This may not work in other industries, but is an example of tactics used to control a gray market.

Reactive: Promotional Bursts

Warning consumers about gray market products may require brands to make a decision about honoring warranties. Nikon, the Japanese camera manufacturer, used its “Peace of Mind” campaign to stress the value of buying through a legitimate supply chain and reward consumers with an extended warranty for such purchases.  Because gray marketers rarely want to be identified, brands may use ‘track-and-trace’ technology to identify gray market distribution (Transportgistics 2016).  At the point of purchase, however, gray marketers can circumvent such tracking by removing the manufacturer’s warranty card, the authorized dealer stamp, or the product serial number. 

Proactive: Product Differentiation

A homogeneous product presentation allows a gray marketer to re-sell from one market to the next without the buyer questioning the authenticity of the product. If the brand sells its product designed for a higher-priced domestic market ‘as is’ to a lower-priced market, than the brand should be prepared to observe its product diverted back to the original marketplace. The main drawback of creating a non-homogeneous product presentation is the cost and practicality. The brand must question whether producing distinct products for differing domestic markets to deter a gray market outweighs the economies of scale associated with a standardized product presentation.

Proactive: Strategic Pricing

The volatility in currency movement between the U.S. dollar and U.K. pound is testimony to how rapid a political situation like “Brexit” can change prices and create a gray market.  About one year ago, (October 2015), the spot pound was trading at $1.51685/£—today it closed at $1.27861/£ (October 5, 2016). The difficult enigma for the brand is to manage its price, such as establishing price bands with an upper and lower limit, in order to set maximum and minimum price thresholds.  Some do so through programs such as MAP (manufacturer’s advertised price) but this may also “encourage” diversion with the need to get rid of slow selling products that are part of these programs.  However, a gray market can still occur with a minimal price differential between markets if a large quantity of goods can be sold. 

Proactive: Dealer Development

The brand must enhance its relationship with its sales function to affect its authorized channel members to impede a gray market. But, as alluded to legitimate channel members can also be the gray marketers—they do not have to be separate entities. Feasible options are to: 1) develop better metrics of the brand’s stacked offerings of incentives and assign functional teams to oversee these offerings; 2) create a uniform policy that governs incentives offered throughout the life-cycle of the product and to provide consistent communication to channel members about policy direction and compliance as well as measures for non-compliance; 3) foster a culture of compliance and respect for distribution plans; 4) educate stakeholders, such as sales teams, and solicit input from channel members about improving the incentive structure for long-term health of the brand and not just short-term profit;  and 5) establish ‘touch points’ to screen the channel partners, such as arranging a self-assessment of their activity, scrutinizing their selling behavior online, and performing on-site inspections and internal audits (Deloitte 2011).

Proactive: Marketing Information System

The implementation of a marketing information system should monitor these red flags: 1) pricing that is too low; 2) unreasonable spikes in orders; 3) unusual orders such as size runs and certain styles; 4) special discount requests; 5) warranty exchange requests; and 6) unusual delivery requests. (Sugden 2009) suggests key methods of detection may include:

  • Audits—the brand holder’s contracts with its distributors and re-sellers should include language on the right to conduct audits, such as random spot checks, to use point-of-sale reports to gauge illogical sales activity.
  • Internet monitoring—to monitor the abundance of information, including that on auction sites and selling platforms, that must be scrutinized on the internet, a brand may retain an outside service, although this will obviously require budget and some measure of oversight.
  • Trap Purchases—the brand may hire mystery shoppers or investigators to covertly assess the gray market behavior of the authorized channel members.
  • Informants—a gray marketer can work with an elusive identity, but the operation can be uncovered by informants. Paul Mitchell, a manufacturer of salon products, allows all levels of informants to report diverted products to its company website and a toll-free hotline.

Proactive: Long-term Image Reinforcement

This maneuver targets consumers through advertisement that reinforces the brand’s image and thus cultivates a buyer’s desire to obtain goods from authorized channel members. This is an interesting tactic since the gray market product is genuine, so a brand must leverage intangibles, such as customer-loyalty programs, to make the lower-priced gray market alternatives unattractive for consumers.

Proactive: Strategic Alliances

Associations such as the Alliance for Gray Market and Counterfeit Abatement (AGMA) for the high-tech industry, whose members include Cisco, HP, and Microsoft, are an invaluable resource for brands seeking advice and accessing relevant research on the issue. They also help educate government stakeholders and thereby shape public policies regarding gray markets.

Gray Markets Expected to Persist

The continued growth of global business, reduction of barriers to trade through free-trade agreements, and increased volatility in exchange rates are just a few trends that will continue to foster gray markets.  However, employing some of the above stratagems will help brands effectively respond to this trade diversion—especially by reinforcing the strength of authorized channels and implementing information systems to monitor the extent of the problem.