GREY IMPORTS - Parallel lines

For the consumer, grey importing offers low-price products. Vendors may not like it, but it's not illegal. Those that do it say if prices were standardised they would stop. So why do software and hardware companies insist on charging different prices in different countries for the same product?

Last year, a low profile court case between Silhouette, a USVendors may not like it, but it's not illegal. Those that do it say if prices were standardised they would stop. So why do software and hardware companies insist on charging different prices in different countries for the same product? sunglasses manufacturer and an Austrian retailer, set a precedent in European commercial law. The case, seemingly a small matter covering a little-known area of community law brought the issue of grey marketing to the fore in the minds of European traders.

Silhouette took retailer Hartlauer to the European Court of Justice for selling 21,000 pairs of 'out-of-date' sunglasses. The manufacturer sold its goods to the company on the understanding that the goods would be retailed in Bulgaria and the former Soviet Union. In breach of the agreement, the sunglasses were sold back into Austria where they were offered for sale by a discount chain at cutdown prices.

Although this case seems of little significance to the world of IT distribution and sales, the ramifications are, in fact, huge. It raises many questions about the sale of branded products - ranging from computers to peripherals to software - through the grey market.

Grey importing, or parallel importing as it is known in Euro-speak, is a practice whereby goods are resold at a lower list price than that set by the manufacturer back into the market in which they were initially placed. Despite having a sinister name and carrying overtones of counterfeiting and piracy, many people in the business of selling - whether it be cars, cosmetics or computers - argue that restrictions on the practice allow manufacturers an unreasonable grip over their sales channel. Many believe grey importing wouldn't exist at all if manufacturers set level pricing across the world.

Grey importing is not illegal in the UK, although many manufacturers - notably Microsoft - come down hard on the practice, arguing that it is almost impossible to tell counterfeit product from legitimate grey product. Microsoft, backed by the Business Software Alliance (BSA), the Federation Against Software Theft (FAST) and other industry bodies, claim most grey product is counterfeit.

The issue is becoming increasingly controversial. Microsoft recently launched a massive worldwide anti-piracy campaign and, last November, filed lawsuits against six Californian resellers that it alleged were selling counterfeit imported software.

Microsoft's Website tells visitors that software counterfeiting 'is not a victimless crime'. Armed with reams of research data from a little-known research company, also based in Redmond, Washington, the vendor claims that software piracy costs the state of New York $860 million and the loss of more than 7,000 jobs a year, although the exact link between piracy and the loss of jobs is not made explicit.

Many in the industry, such as Steve Bennett, chairman of Software Warehouse, think it's only right that Microsoft should have the final say into exactly how, where, why and in what package its software is sold. He also believes that most grey product is counterfeit and doesn't support, for example, the right of resellers to sell OEM product as retail.

'Manufacturers need to police their sales channels as rigorously as possible to protect not just the consumer but the reseller as well,' Bennett adds.

But others think manufacturers create the situation themselves by setting different prices across territories, with European prices often being higher than US prices. And the issue isn't confined to the IT industry.

Tesco is currently embroiled in a high-profile lawsuit with Levi's in which the supermarket giant is fighting for the right to retail jeans imported from outside the UK. There has also been a number of court cases involving car dealers and manufacturers.

In December 1998, the Parallel Traders' Association - the majority of whose members are in the cosmetics or toiletries industries - told consumer affairs minister Kim Howells that UK consumers could be penalised by manufacturers' policy on grey importing.

UK trade body National Association for Specialist Computer Retailers (NASCR) put its weight behind the drive. Clive Bishop, secretary of NASCR, says European retail markets suffer as a result of the rule. 'The ban means manufacturers, which are largely US companies, can set list prices at will and we in Europe have to accept them. It effectively creates a cartel system, which is not beneficial to the consumer or to the reseller. We would welcome the quashing of restrictions on parallel importing.'

The reason why the law is so nebulous on grey marketing - and the reason the Silhouette versus Hartlauer judgement was so significant - boils down to a part of UK law known as Exhaustion of Rights.

As part of the creation of a European single market, the European Council has made a number of harmonisation directives. These have been adopted by the member states of the European Union as well as Iceland, Liechtenstein and Norway, which together make up the trading bloc, known as the European economic area (EEA).

The objective has been to smooth out differences between the laws of the various member states as a way of reducing, if not eliminating, the barriers to trading across the EEA.

One of the directives, which was made in 1988, concerns trademarks and its provisions deal with the exhaustion of rights. This is a legal principle which sets out that the owner of a trademark loses the right to control what happens to its goods when the products bearing the trademark are placed on the market within the European Union by the owner or with its consent.

In the Silhouette case, the issue before the European Court was whether the principle of exhaustion of rights applied to products which had been put on to the market by the brand owner outside the EEA and subsequently imported back into the EEA without the brand owner's consent.

The court found in favour of Silhouette. It ruled that exhaustion of rights occurs when the product has been placed on the market in the EEA by the brand owner or with its consent.

Because brand owners invest so much of their resources into creating a brand, they are naturally sensitive about how that brand is maintained in the sales channel. European law backs the wishes of most manufacturers to control the type of outlets through which their products are sold.

It is usual for a brand owner to be concerned as to the location of the outlet, the ambience within it, the position in which its products are displayed and the range of stock held by the retailer or reseller.

In the case of sales channels for hi-tech industries, such as cars and computers, the stakes are higher. Every IT vendor of significant size will have an accreditation process, whereby in addition to the concerns listed above, the technical knowledge and support skills of staff are paramount in deciding whether a retailer or reseller should be allowed to sell the products.

This factor adds weight to the argument that brand owners should be allowed to set list prices. If so-called aspirational products are available at non-aspirational prices and in retail environments that do not enhance their image, the aspirational quality of such products begins to evaporate.

Brand erosion is a fashionable area of law and the case between Tesco and Levi's will ultimately rest on whether the latter can convince the court that its products being sold at discount prices in a supermarket has eroded its brand. This is why vendors argue that the grey marketeer is effectively a parasite - it feeds off a recognised brand, but fails to put in the R&D and market growth investment, the mantra being 'pile it high, sell it cheap'.

Cases such as Silhouette and the ongoing lawsuit between Tesco and Levi's has brought the grey marketing issue into the public forum. Last December, Martin O'Neill MP, chairman of the UK Trade and Industry select committee, promised an investigation into parallel pricing in European countries.

Within the past few weeks, research has begun into the issue of grey marketing and related issues.

The investigation is still at the consultation stage and O'Neill is unable to discuss any of the findings. But he says research will be done across a number of key industries - including IT - as to whether current rules on grey importing are benefiting all parties.

'It has been suggested that some brand owners in certain industries are being a bit punitive. We find it hard to understand, for example, why Levi's can complain on the one hand that its clothes are being sold cheaper in supermarkets, if it is selling these clothes cheaper at factory outlets,' O'Neill adds.

But Microsoft and other IT vendors argue the dispute between Tesco and Levi's is totally irrelevant to its anti-piracy drive. Microsoft claims it needs to impose strict controls on its products in the distribution channel to prevent piracy. But some resellers and retailers believe the piracy issue is a convenient way of distracting attention from the fact that vendors are artificially keeping prices higher in certain territories.

Will Copeland, managing director of Norwich retailer One Step Beyond, has a typical ambivalence towards the piracy campaign. 'I abhor the idea of counterfeiting, and I fully respect Microsoft's drive to draw attention to the problem. But I do think it and other vendors use the piracy issue as a stick to beat dealers with. For example, if you buy Microsoft OEM product from the US for legitimate OEM retail in this country, it classifies it as piracy. Surely we should have the right to source our products wherever they are cheapest - as long as they are legitimate?'

Copeland believes this is particularly relevant for smaller dealerships.

'The main USP of being an independent, as opposed to a chain, is freedom to be able to get the best deals. These restrictions keep prices high. It could only be to the benefit of the consumer to end restrictions on importing and the only possible reason for (vendors) must be to keep their prices artificially high.' He adds there are easy methods of policing piracy open to big vendors.

For example, CDs in the games industry are always coloured black, which indicates their legitimacy. But Copeland argues that it will take more than a government select committee investigation to break the pricing stranglehold.

'Most independent resellers and retailers privately resent the fact that pricing is largely higher in the UK than in the US, but there are few companies big or brave enough to take it in a court case. There hasn't been a test case since Silhouette, because no one wants to take on Microsoft in court.'

But Robin Bloor, managing director of Bloor Research, believes the growth of internet software distribution will ultimately iron out different price structures in different territories.

'Once software downloading starts to take off, it will be very hard for manufacturers to justify different prices for each territory,' he says.

'There are almost no distribution costs associated with it, and, frankly, it just looks naff to say: "You're British, so we're going to tax you more".'

Bloor adds that the ruling ultimately has more significance for the hardware industry. 'Europe has always suffered on the hardware front. In the days of the minicomputer, it was always pound to dollar - ie #100 to $100 - and this has set a precedent. To some extent this has remained the same today and I think manufacturers leverage this just to make profit.'

He believes that the higher prices of computer hardware, networking and peripherals equipment has a significant negative effect on the economies of European companies. 'So much of what makes one business more or less competitive than another boils down to its computer infrastructure. If European firms are constantly spending a percentage more on their IT systems than US ones, then there's an obvious difference in their competitiveness. If your business is computers, you have a massive disability purely by virtue of being in a different territory.'

James Wickes, chairman of Ideal Hardware, agrees that grey marketing is almost entirely a product of differential pricing from territory to territory. 'The greatest irony of this situation is that the Americans are the first people to go on about free trade, but when it comes down to it, there's one rule for US customers and another for the rest of the world. Manufacturers will swear blind that pricing is the same from one territory to the next, but its not.'

He is ultimately quite pessimistic about the capability of the EC to effect change. 'At the end of the day, the union can do what it likes, but the only way to make a difference is for sales channels in different territories to apply constant but gentle pressure. Even then the effect is negligible.'

But others in the industry are more optimistic about the effect of a European single currency for consumers, retailers and resellers. Some manufacturers are beginning to co-ordinate their worldwide marketing and sales accordingly. Fujitsu recently produced a white paper on the euro and its impact on worldwide computer sales. The report states: 'The long-term effect of the euro is that we will have to review our marketing activity to cope with price transparency across the Eurozone.'

Fujitsu recognises that as marketing campaigns come to be co-ordinated on a global scale, it's no longer acceptable to apply different prices to different territories. The paper concludes: 'Manufacturers will not find it as easy to exploit price differences in PC products that exist between European countries, as there is more than likely to be some levelling of prices throughout the Eurozone. PC suppliers, which currently operate in a strongly price driven market, will have to find smarter ways of adding value to their products and differentiating them because of this price transparency.'

A representative of Fujitsu says the manufacturer fully supports anything which would create a level purchasing field. Competition from non-US manufacturers is increasing and is likely, over time, to force some sort of price levelling across different territories.

Legal observers also believe that the entry of supermarkets and other retail chains into the IT market could provide the muscle needed to take on the IT giants. Stephen Sidkin, commercial law partner at City company Fox Williams, believes that retailers and resellers are becoming more canny about pricing and less willing to simply accept the prices thrown at them by manufacturers.

Sidkin claims it is only a matter of time before a significant action will set a legal precedent. 'In the past six months, we've seen a leading supermarket start to trade in PCs and we've seen that same company issue proceedings against a brand owner for wrongful threat of trademark infringement. Whether it's computers, sunglasses, jeans or herbal medicines is immaterial. It only takes one action and I think that action will not be far off.'

He adds there are legitimate options for retailers or resellers to challenge the strong arm of manufacturers. For example, the refusal of a brand owner to admit a retailer or reseller into its distribution network constitutes a breach of an EC trade directive. UK law also provides its own recourses - the 1980 Competition Act allows the Office of Fair Trading (OFT) to investigate companies if it is believed that they are unduly harsh in their unwillingness to supply distributors. But the OFT can only investigate companies with a turnover of more than #10 million per annum and at least 25 per cent market share.

There are two courses of action for outlets that deal in grey market goods. The first is to act in the way Hartlauer did and source trademarked goods from outside the EEA for sale within the EEA, in the hope that trademark owners won't see their threats through. But this is 'crude brinkmanship', says Sidkin, and although many manufacturers won't carry out their threats, few companies will be disposed to take on a multinational IT vendor. The second is to seek to argue that the manufacturer has imposed unacceptable and artificial restraints on the reseller or retailer by preventing grey marketing.

Industry observers are confident that developments such as the legal challenges, e-commerce and electronic software distribution, will eventually mean that manufacturers can't get away with having one pricing scheme for the US and another for the rest of the world.

In the mean time, retailers, distributors and resellers will always want to get the best deals for their products. Customers, of course, will continue to seek out the best bargains.