Parallel Import Channels—Options for Preserving Territorial Integrity IT IS SOMETIMES A Herculean leap from marketing plans to real world operations. Operations can fall short, Consider the following typical parallel import vignettes: © A_ pharmaceutical company shipped some of its American made drugs to its distributor in a Central American coun- try, intending to sell at a substantial discount because the local market could not support American prices. The pharmaceuticals did not_stay in the foreign market. They shipped back to the United States to be sold through drug channels that ‘were not part of the Amer- ican company’s plans. The industry now thinks it can legally stop such unauthorized transactions. © Suzanne Simpson, an English tourist taking holiday in Miami, bought a place setting of bone Chinaware made in Britain. She didn't pay Tobert E, Weigand is Professor of Market. ing et the Unicersty of Illinois at Chicago tehere he teaches international busines. His last “article for the Columbia Journal of World Business was “The Gray Market Comes to Japon," Fall 1989, 18. Spring 1991 Robert E. Weigand Britain's added tax substantial value Further, the dol- it had been just before when the manufacturer hhad set its domestic and for- ign prices. British manu- facturers know these personal imports affect their domestic channels but have not found a way to stop them. Many clever Europeans know that cars are cheaper in Bel- ‘gium than in nearby countries, the difference largely due to substantial tax — differences. European car dealers have been unable to stop the entry of unauthorized imports. that parallel their own authorized transactions, This helps. ex- plain why Belgium is a sub- stantial exporter of automo- biles—more than 25,000 some years—even though it doesn’t produce them. It was once possible 10 buy a new Mercedes Benz in Europe and save money, by- passing the American dealer. The problem is not as great fas it once was because many foreign currencies are more expensive than just a few years ago. But foreign deal- fers-may still sell into the American market cither be- ‘cause their cost of goods is lower or they accept a lower gross margin when selling to a geographically remote cus tomer. American automobile manufacturers and retailers now think they have an im- portant new law on their side. It was meant to stop car thieves, but it may also stop gray market imports. Parallel importation occurs when an authentic branded product comes into the domestic market of a foreign country through marketing channels that rival the product's authorized channel or channels, Parallel impor- tation or parallel marketing channels are often called gray marketing for just this reason, and are closely re~ lated to the practice of reimportation. This matter was addressed in the Columbia Journal of World Business shortly after a_ significant Supreme Court case in 1988 gave a victory 10 unauthorized importers. Since that article was published, trademark own- hhave acquired new tools and strat- -—the focus of this article—to combat the practice of parallel markets, 53Re-imports are first cousins to parallel imports. They occur when branded products are exported but fare returned to the home market, competing with merchandise that moves through the manufacturer's authorized channels. Some reim- ports are commercially motivated, Meaning that astute traders purchase the merchandise overseas because the price is right and it is available, re- turning it to its country of origin, Other re-imports are personal; busi- ness travellers and vacationers by home branded merchandise because it is cheaper in Hong Kong or an airport shop in Amsterdam than in Boston or Indianapolis. More _re- cently, the process is reversed. The cheaper shops are in the United States; the goods are made in Japan, Korea, or Germany; and the buyers are foreigners who. sometimes take the goods back to where they started, Re-imports create many of the very same problems for business strategists as parallel imports. ‘The legal events that Iead to the dilemma, how the problem arises in the intemational arena, and what those who are responsible for global business strategy can and are doing to protect theit channel assets are all worth focusing on especially. ‘THE K MART LEGACY— LIMITING THE OPTIONS ‘The gray market problem reached a high point in May, 1988, when the United States Supreme Court handed parallel importers such as K Mart Corporation, a nearly complete vietory. ‘This landmark case decided that ‘American trademark owners such as Cartier Watches, Duracell Batteries, Seiko Watches, and Fugi Film, gene ally cannot prevent unauthorized im- portation of products bearing their own marks or names. In legal terms, the owners’ rights to control the trademark are exhausted once owner ship changes hands, commonly some- where in Europe,’ Hong Kong, or some other offshore jurisdiction, "The decision was consistent with long standing Customs Bureau practices Unauthorized marketing channels have a long and tortuous history. In 4 Three Routes for Gray Market Goods There is no end to the imaginative ways used to bring parallel imports to ‘market. Yet, three methods represent the bulk of the gray market imports and are the focus of much of the legal attention. Case First, end most common, are thase products made overseas by American firms. The foreign units may be subsidiaries, joint ventures, or some other entity where there is 2 ‘commonality of interests withthe American comaary. The foreign affiliate ofthe U.S. firm ‘may sel to nearby authorized distributors, whether in France, Germany, Italy, and $0 on, ‘Somewhere in the authorized channel, marketing contro is lest the product gets into the Unauthorized channel and some of it is exported to the United States where it competes with similar domestically produced products. ‘The KMart vs. Carter case made it clear thatthe controversial Section 526 of the Tarif ‘Act of 1930 does not protect the Amorican firm in such situations. The American frm, though i isthe authorized trademark owner, cannot cite the Act to stop unauthorized imports of their watches because the two entities are independent of each other. Largely for {his reason, paralie! importers are delighted withthe Supreme court's decision, Manufacturer | “Manufacturer (sa) trance) - - fathrzea Wnouthoreod | [auttoraed |, | Unnutoriea tmddomen "mzaamon Middleman ‘daemon aSogaue pce suanaa customers tee Case 2: ‘Second, a foreign manufacturer may license an American company to be the exclusive Importer ofa product bearing a foreign name or trademark. The American company registers the foreigner’s name, becoming the logal trademark owner in the United States, and agrees to pay royalties. Believing it wil be the sole beneficiary of its commercial effors, the ‘American company develops the market forthe product. Now, suppose that a third party trader purchases an allotment of the product, which was Intended for the Spanish market, in Amsterdam. The third party trader then ships the Product to Philadelphia to clear customs and to make a profit. However, since 1930, the U.S. Bureau of Customs has interpreted the 1930 Tariff Act so as to prevent goods brought into the U.S. by an outside trader. ‘The Bureau of Customs now prevents these goods from clearing customs unless the ‘American licensee or trademark owner agrees to thei importation in writing. This agreement wil of course not be glen, and thus the importation is stopped. The efforts to create a parallel gray market channel resembling Case 2 have been effectively thwarted. This is good news for American licensees, ‘Manufacturer = =, Ss a pen st) | ee) | vo a 2 ‘Customers COLUMBIA JOURNAL OF WORLD BUSINESSCase 3: ‘third possibilty fora gray market arises when a manufacturer exports from its producing base, only later to have the exports dverted back tothe home market. These “reimports” aren't true parallel imports because there are not authorized imports with which they compete. However they are first cousins to parallel imports because they generate the same sort of concem among the company's authorized middleman, Remports may never ass through any foreign marketing channels, ay never even clear customs, They simply sit at an air or sea pot for few days before being loaded onto a return carrie. This approach is particulary attractive (1) when the manufacturers strategy isto sel into the foreign market ata sutstantially lower price than in the home market, due either to the ‘market being poorer or dramatic exchange rate changes, and (2) when the foreign market Is geographically close to the home market, thus minimi2ig the return transport costs. A current example is occurring in Japan where products are marketed through the county's growing number of discount houses; many ofthe products are labelled ‘Made in Jaan," but instructions are in Chinese or Korean, suggesting that they were meant for Taiwan, Hong Kong, or Korea ‘Manutacturer (us rs) Distributor ‘Unauthorized Retailer customer ‘Key for Cases 4, 2, nd 3 ‘@ case now 105 years old, a US District Court largely washed its hands of the parallel importation problem—at least for the time being ‘A European company granted Ap- polinaris the exclusive right to import Hunyadi Janos spring water from Hungary. But a clever importer named Scherer learned the water could be bought in Germany, and transported to America; therefore, he could underscl! the authorized Hunyadi Janos. Ap inaris sued for protection, arguing that the marketing channels were not the ones intended by either the Hun- garian bottler or the American licensee. The New York District Court agreed that Scherer’s parallel channel disrupted some well meant plans. But the goods were genuine and thus could not be legally stopped." Spinc 1991 In a later case that went to the Supreme Court, an American cos- metics licensee of a French firm was unable to prevent the unauthorized importation of certain cosmetics, even though it believed it was the exclusive imporeer. In response to these two cases, par- ticularly the latter, Congress included ‘4 paragraph in the Tariff Act of 1922 declaring that imports bearing trade- marks owned and registered by a United States citizen, corporation or association cannot be imported un- less, “written consent of the owner of such trademark is produced at the time of making entry.” The words seem clear enough. Territorialists, led by the Coalition to Preserve the Integrity of American Trademarks, placed much of their faith in this bastardized reconstruction of original Congressional intent. Later, the ‘Supreme Court construed this Section 526 narrowly, deciding that Congress did not mean what it seemed to say. intent was solely to protect American licensees that were marketing prod- ucts whose trademarks were owned by European and other foreign com- panies, American licensees have the same rights today. Thus, an Amer ican lens manufacturer who has been licensed by, say, Kim's Optics to use the Korean company’s intellectual Property such as patents or tradc~ marks can prevent Kim's products made in Seoul (or elsewhere) from passing through customs in San Francisco, citing Section 526, However, parallel importers such as K Mart claim a nearly complete a small portion of their _merchandise falls into. the foreign licensor-American licensee category just described. Two cate- gories of gray marketed products are beyond the narrow protection pro- vided by the Court's interpretation of the legislation Fint, the bulk of gray market im- ports consist of products made by foreign subsidiaries, joint ventures or otherwise controlled foreign units of American companies or by forei companies who have no licensee in the United States. Second, foreign licensees of Amer jean companics may produce goods that enter into unauthorized channels, ultimately making their way to the United States. The Court ruled that imports produced by these two classes of units cannot be stopped by the 1922 law, FIRST CAUSES ‘Three factors, sometimes working alone but often in consort, virtually assure that parallel marketing chan- nels will arise unless they can be stopped by trademark owners who seek to protect their authorized chan- el_members. They are (1) ex- change rate differences, (2) the power of the discriminating monopo- list, and (3) opportunistic behavior by members of administered market- ing channels 35‘Table 1 suggests the ways the three forces just described are different. If the topographic cause is fluctuating exchange rates, then goods moving into gray market channels can only flow from the low valued currency country to the high valued currency ‘country, the proximate cause is ex- ternal to the firm, the opportunit will only last until underlying condi tions such as the exchange rate or fan artificially low purchase price are corrected, and can only occur inter- nationally. ‘The discriminating monopolist must tace the possibility of parallel im- ports moving from the low priced to the high priced country because of price policies instituted by the manu- facturer; the importation will last as long as the policy continues and will take place internationally. (We must ignore here the possibility that the manufacturer may also attempt to price discriminate domestically, as ‘many do.) ‘And finally, parallel imports that derive from opportunistic channel be- havior can occur randomly because distributor opportunism has no par- ticular time limit and can occur either internationally or domestically. Exchange Rate Differences Like many currencies, the dollar is more or less allowed to find its ‘own value relative to other currencies. ‘The dollar has cheapened relative to the currencies of some of America’s most important trading rivals. The global marketer knows that the dollar's deterioration has temporarily lessened the gray market issue in the United States, meaning only that the problem has’ broken out in other parts of the world. (See CJWB, Fall 1989, pp. 18-24.) Exchange rate fluctuations are more likely to explain gray market transactions if the rate change is swift. If a rate change is protracted it allows the manufacturer to. make price adjustments that negate a mid~ dleman's potential windfall profits" Exchange rates can be used to ex- jin long term domestic market Share won by foreign firms, largely 56 Table 1 ‘Topographic Causes and Consequences ‘Topographic Causes Flow Direction Casual Origin Time Span Nexus 1. Fluctuating Low valued External Indeterminate international ‘exchange rates currency country to high valued 2, Discriminating Low priced Manufacturer Unlimited International monopolist ‘country to price policy high priced country 3. Opportunistic Random Distributor Unlimited International behavior perfidy or domestic because the cost of acquiring such shares may be purchased when a domestic currency is undervalued. If the domestic currency’s value rises, the foreign firm's market share will erode only slowly if at all because the cost of maintaining market share is vastly less than the cost of first earning it.’ Further, exchange rate changes are not necessarily passed through to middlemen or end users. ‘As domestic currencies gain ot lose value vis-a-vis foreign currencies, foreign sellers may elect to reduce or raise price, thus neutralizing the volume effect’ of currency fluctua tions.* Although these observations affect international transactions, they do not obviate the need for attention to the issue of parallel imports. The Discriminating Monopolist Parallel importation can also occur when the strategist tries to price dis- criminate. among markets, charging a lower price in those markets less able to pay and more in high income markets, The concept of price dis- crimination is nearly faultless, if price strategists can find a way to prevent low priced goods destined for a low income market (or, more accurately, a market composed of buyers who are less willing to pay a higher price) from seeping into the high priced market? Opportunistic Middlemen Even in the authorized channels where the strategists have carefully selected their distributors, deceitful behavior occurs. An enormous amount of literature suggests disagreement ‘about the nature and use of private property and how opportunism may pay handsomely." Readers must look hard to find scholars who argue that preserving channel integrity is re- warding.” ‘Table 2 lays out the calculations an authorized and rational distributor should make in deciding whether to ‘engage in perfidious behavior, mean- ing making an unauthorized ‘sale to a gray market participant. Such opportunistic behavior is, likely to happen when the middle- man’s gross margin is disproportion- ately large relative to the marketing task performed. Further, it is par- ticularly attractive if the transaction ‘occurs outside the distributor's as- signed territory. If the sale is geo graphically remote, the opportunistic distributor may assume that the sale is not made at the expense of the distributor's own full markup sales. Or at least that is the distributor's, reasoning until other distributors be- gin to behave similarly HOW INTELLECTUAL PROPERTY OWNERS CAN AND DO RESPOND ‘The K Mart decision was unques- tionably a disappointment for those ‘American firms that control their COLUMBIA JOURNAL OF WoRLD Bustvessforeign supplier. Even so, there are other options available to those with the stamina and funds to continue the fight. Based on the literature, interviews, and correspondence, the following six methods are commonly used by those who want to protect their intellectual property rights: Frequent Price Changes Reducing the price differential be~ tween the authorized and gray market product is a powerful tool for redue- ing the attractiveness of the parallel import. The issue quickly becomes a standard exercise in pricing—deter- mining whether the manufacturer takes the brunt of the price reduction or if it is shared with authorized middlemen. Gray marketers point out—often correcily—that they give the customer just as much as the authorized chan- nel gives. They say that their outlets are clean and convenient, they sell on credit, refund money if not satis- fied, provide a store warranty that as good as the manufacturer's, never sell stale or damaged merchandise, service the product after the sale, and have sales people who know just as much about the product as those in the authorized channel. Most im- portant of all, they do all of the above while undercutting the authorized retailers’ price. If the customer per- ceives these arguments to be true, parallel importers are indeed tough Reducing retail prices is unpopular among retailers, even though the manufacturer or distributor may also have incurred reduced gross margins. Retailers may understand the gray market issue very well, but believe that something other than reducing their prices should be done. Even so, it happens. For example, Concord watch dealers were author- ized to offer rebates as large as $1,000 to combat unauthorized sales. Advertisements promoting the offer appeared in the country's major newspapers, admitting that exchange rate differences were creating major price differences between America and much of the rest of the world And in Japan, BMW-Japan reduced its Yen prices so as to discourage SpRING 1991 customers from making a short to a nearby country to purchase an identical car at substantial savings."® currency which they believe is more able rather than their home coun- y's money. Thus sales contracts may be made in the dollar or Swiss franc, even though the partics are neither American nor Swiss. And global companies do not quote a price to a foreign customer in a declining currency unless the forecasted rate of deterioration is built into the contract. Dollar Price in Foreign Markets Second (or third country) curreney price quotes are well known to read- ers of this journal. The most com- mon reason for the practice is to hedge against a currency’s deteriora- tion. Global companies sometimes price their merchandise in a foreign A second and much tess familiar reason for second (or third country) Table 2 Modelling the Rational Authorized Distributor's Decision ‘The Problem: The authorized Importer in Country X must calculate whether to make a ‘onetime sale of 25,000 units to an unauthorized Customer in Country ¥. The Assumptions: Manufacturer is a discriminating monopalist in Country A who charges Authorized Importers in Countries X and ¥ 1.0 QUs (currency units) and 4.2 (CUs respectively. Authorized Importers traditionally have taken @ 40% mark-up on