Are You Going Gray?

CEOs have tremendous power to control the gray market-piracy that robs firms of profits, brand integrity, channel viability and customer satisfaction. Yet few companies aggressively attack "gray market" piracy. This type of piracy is defined as real product leaked inappropriately into a market so that the manufacturer is not paid per the terms of the established value chain partner agreement. No product is immune to it.

At its core, gray market leakage results from a lack of discipline over the manufacturer's end-to-end value chain. Three major causes drive gray market leakage: poor or unstable financial health of network partners; manufacturer operating practices, such as the level of price protection, stock balancing and other allowances; and the business model, including the number of tiers in the value chain, cross border coverage and partner hand-offs needed.

The Alliance for Gray Market and Counterfeit Abatement, an initiative composed of technology companies, reports that "over $40 billion in legitimate IT products move through the gray market channel each year, resulting in $5 billion in lost profits annually to IT manufacturers."

Software pirates operating in China were recently arrested and charged with manufacturing $500 million worth of counterfeit Microsoft and Symantec software. In 2006, Motorola handsets sold to an Australian Telco at a steep discount for a promotion were acquired by a gray market operator, who sold them in Asia.

Tightening supply/value chain controls is the key to recapturing lost revenue. Experts agree that cracking down on product diverters is a better bet than relying on copyright and trade mark infringement litigation.

A case in point is Quality King Distributors Inc. v. L'anza Research International Inc., a Copyright Act case settled in 1998 by the Supreme Court, which ruled that the first sale doctrine is applicable to imports. This ruling made clear that "once the copyright owner places a copyrighted item in the stream of commerce by selling it, he has exhausted his exclusive statutory right to control its distribution."

Part of the reason gray market piracy exists is the complexity of the operating environment. Global supply chains often have complex pricing, distribution, control and cross functional coordination challenges. If not managed well, these open the door to a number of opportunities that pirates can leverage. Poor network management allows members in an extended partner network to circumvent policy and pricing guidelines.

A key requirement for mitigating gray market leakage is understanding how your supply chain partners work and what market conditions they face, particularly those operating in countries with unstable economies and fluctuating exchange rates. For instance, how do your stocking programs en courage distributors to manage end-of-life cycle products in a way that is financially favorable to them and therefore discourages leaking products or selling across other borders for price arbitrage advantages?

To stop gray market leaks, manufacturers can implement and police company- initiated measures to tighten up supply chain leaks through improved process controls; self-fund and enforce investigative measures of the supply chain to identify and stop leaks; and pursue remedies through the courts.

The first option should be the front-line offense to control gray market losses. It encompasses building and renewing a defensive global plan that operationally hedges the currency, distribution and logistics risks associated with gray markets. The second, the business solution, is far better economically than a legal solution for thwarting this shady secondary distribution system. Whatever approach you favor, CEOs have the control to determine the outcome.