Gray Market

About Bob

OPIUM and the Gray Market

First, a definition. Gray market goods, otherwise known as parallel imports, are products legally produced by an authorized manufacturer in another country that are imported into the United States and sold into distribution channels by persons other than the U.S. trademark owner or authorized distributor of the respective brands. They are not counterfeit goods—products manufactured by an unauthorized manufacturer— though the existence of the gray market facilitates the sale of counterfeit products to unknowing consumers.

The gray market flourishes when currency fluctuations create an imbalance in pricing between countries, a practice known as arbitrage, which allows the arbitrageur to profit from the resulting difference in market prices. Here’s a brief example.

In 1976 when Opium perfume was introduced in France and then in 1977 when it was introduced in the United States, the French Franc was worth about 20 U.S. cents. In 1981, the Franc began to weaken and by the end of 1984, it was worth about 10 U.S. cents. While retail prices subsequently changed, in the early years there was parity in the effective price in both countries. Simplistically, this means that about the time of its introduction, the Opium retail price in France was 500 francs, equivalent to $100 U.S., while the retail price in the U.S. was also $100. In the following years, there were price increases in both countries and at a point in time, the price was $125 in the U.S. and 650 francs in France. But because the franc was only worth 10 U.S. cents, the retail French price was equivalent to only $65 U.S., which was less than the U.S. wholesale price.

This created an enormous opportunity for an unauthorized U.S. importer to improperly and, in some cases, illegally obtain the goods in France at or near the even lower French wholesale price, ship them to the United States, sell them into drug and discount stores that ordinarily could not obtain them—since the product was then sold only in department and specialty stores—and make a significant profit along the way. Charles of the Ritz, the legitimate U.S. trademark owner, had a large manufacturing facility in Holmdel, New Jersey where most of the Opium products (other than perfume, such as the greater selling eau de toilettes) were made. Unlike a faucet that can be turned on and off, shutting down much of Holmdel’s production to obtain Opium from our French factory, firing Holmdel’s trained employees and rehiring them years later when the currencies came into balance—as they ultimately did—was not a realistic option, despite its recommendation by a senior official in the U.S. Department of Justice at the time.

This phenomenon was not restricted to perfumes. It affected virtually every consumer product, including, for example, watches, cameras, toothpaste, soda, baby shampoo, cosmetics, batteries, tires and dolls. The related companies were financially wounded by the unauthorized importer who, nevertheless, benefited from the development, marketing and advertising costs paid for by the authorized manufacturer or distributor. This process—selling a product by taking advantage of the consumer demand created by the authorized manufacturer, trademark owner, licensee or agent—is known as free riding, and adds to the potential profit provided by the gray market.

But it was not only the authorized companies that suffered from the gray market. Consumers, too, had their share of problems. Many goods sold in the gray market were not made for sale in the United States and contained ingredients that were different or not approved for use in this country (baby shampoo, soda, cosmetics); contained instructions in a different language (cameras); or proved defective as the gray market importer did not apply certain identification codes required by Customs regulations in laboratory conditions upon import into the United States (watches). Because gray market goods were available in stores that ordinarily did not sell them, it was also much easier for the counterfeiter to sell his counterfeit products there on the pretext that these were gray market goods.

When consumers found their gray market soda tasted different, fragrance was altered and didn’t last as long, or their camera or watch stopped working, they would complain to the store where they bought it, though, inevitably, the complaint went to the authorized manufacturer or distributor. Thus, the conundrum: tell the consumers it’s their problem because they shopped in an unauthorized retailer and bought a gray market or counterfeit version, or deal with the problem by fixing or replacing the defective product. The answer was almost always the same. Try and mollify the consumers who, because of their bad experience, had already formed a negative image of the brand.

The companies impacted by the gray market formed an organization, the Coalition to Preserve the Integrity of American Trademarks (COPIAT) to attack this problem by lobbying U.S. Customs, the Justice Department and members of Congress. The objective was to have the law—the Lanham Act—enforced exactly as it was written. When those efforts failed, COPIAT, through two of its members, Cartier and Charles of the Ritz Group, Ltd., initiated a lawsuit against U.S. Customs to do just that. Eventually, the case found its way to the Supreme Court. Without engaging in much discussion about the law, suffice to say that the Court decided the U.S. Customs’ interpretation was within its authority, thus allowing the gray market to continue as before.

Years later, Givenchy, represented by Washington based Covington and Burling, went back to Court. Rather than trademark law, Givenchy relied on copyright law, which excludes from the United States the unauthorized import of copyrighted goods made for other markets. By copyrighting the design of its boxes, the court ruled that Givenchy had a firm legal basis to exclude gray market goods. But in 2013 the Supreme Court essentially reversed that decision on the basis of the copyright law’s first sale doctrine, which provides that once a product is sold, the purchaser can do with it as he or she pleases. Since the gray market goods were first sold overseas, the gray market importer could legally obtain them from that purchaser and sell them in the United States.

There have been other decisions by lower courts that ruled against the gray market importer based on circumstances specific to those cases such as material differences between the U.S. and gray market products in warranty protection, quality control, service, instructions in a foreign language as well as altered or defaced serial numbers on the product or its package. But the issue is not yet resolved so the court cases will continue until the U.S. Congress deals with it, forthrightly.

Even a cockeyed optimist cannot expect that to happen.