The Hidden Costs of the Gray Market

Peter Hlavnicka, treasurer for the Alliance for Gray Market and Counterfeit Abatement (AGMA) warns that the gray market in IT products continues to thrive to the detriment of authorized channel partners and vendors. The lower price tag of such goods can often hide poor quality and a lack of service.

The term "gray market" is widely misunderstood and highly debatable. It is commonly used to describe the unauthorized brokering of branded goods, which have been diverted from authorized distributors into the hands of unauthorized dealers, brokers and the like. The gray market generally promotes new, genuine, branded goods (diverted from authorized channels), but a buyer can actually receive used or remarketed, counterfeit, or mislabeled goods as these items also flow through the gray market channel and are often purposely misrepresented as new, genuine goods.

Unauthorized dealers trade goods acquired from various sources, usually at discounted prices due to price arbitrage, service or incentives fraud, theft, or simply because the products are not what they appear to be. Buyers can never be certain of the authenticity and condition of products purchased from the gray market and are often misled to believe the goods are identical in every way (including warranty, service, quality etc.) and they may appear to be the same as those sold by authorized distributors, just with a lower price tag.

What end-users do not see are the hidden high costs of lower quality service and support, loss of OEM warranty, potential legal exposure due to use of unauthorized or pirated software and invalid software licenses, lack or absence of post-sales service,  especially from online brokers, and potential business interruptions and loss of vital business and personal data. Since unauthorized dealers do not have contractual obligations or costs associated with preserving OEM brand reputation, quality standards, and customer support, they can afford additional discounting.

OEMs sell only through authorized distributors (and directly only to select customers) to balance their cost of distribution, brand protection and product integrity. OEMs expect authorized channels to make an investment in marketing, supporting and servicing their products, and offer incentive programs, geographic territories and price protection in exchange. Unfortunately, some authorized distributors are attracted to the gray market due to larger discounts and advertised product availability and shorter lead-times as most unauthorized dealers “guarantee” much faster delivery than offered by authorized distributors or OEMs. By networking with each other, unauthorized dealers can acquire a bulk of goods that are immediately available. To meet the tight deadlines, the goods often ship to customers from different places “as they lay.”

Many unauthorized dealers also offer warranties that exceed the OEM’s warranty (mostly a sales pitch without any intent or ability to honor it); hence some end-users take the chance for bargain-basement prices. They often end up calling the OEM when something goes wrong.  Most OEMs will lecture them about buying outside of authorized distributors but in the end they may choose to provide some support to avoid brand-reputation loss. This “practice” is good for end-users but it also leaves gray market goods in the buyer “comfort” zone as the buyer knows that the OEM will help. This exacerbates the issue for OEMs.

Ironically, some authorized distributors that sell to or buy from the gray market do so because they feel competitively threatened by the gray market. Herein lies the “gray market conundrum.” Where OEMs may not have adequate contractual provisions for their authorized channels, may not adequately monitor for compliance and may not enforce contracts consistently, OEMs also perpetuate the gray market problem.

Some distributors may find the opportunity to make a quick sale, or obtain products sooner and at a lower cost, which is not outweighed by contractual or implied limitations and are too irresistible. The key to changing distributors’ behavior is exacting consequences for those who participate in the gray market. 

The annual IT sales in 2007 almost doubled from 2002, and with the growth in counterfeiting and gray-market fraud (service fraud, product misrepresentation, etc.) it is logical to assume some gray market growth. Most OEMs that have active brand protection programs experienced a modest decline in gray market activity especially from diversion of new, genuine products from authorized channels. AGMA estimates that the gray market grew slower than the IT industry.

A joint gray market study by KPMG and AGMA estimated that in 2002 as much as US$40B in IT sales passes through the gray market on an annual basis.  In the same year, IT sales were estimated at US$402B, therefore placing the gray market between 5% and 10% of total IT sales. KPMG and AGMA are expected to release a 2008 gray market study by mid-year.

More information is available at the AGMA website:

(Peter Hlavnicka is treasurer of the Alliance for Gray Market and Counterfeit Abatement (AGMA)

TAGS: IT,marketing,gray market

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