A little grey sells

The grey market isn't just about product piracy - it can even help vendors if they let it, writes Marc Ambasna-Jones.

In February a report by consultancy KPMG on grey-market trading confirmed what many have believed for some time: that the grey import market remains a massive thorn in the side of hardware and software vendors.

Despite well-publicised attempts to curb the grey trade, vendors worldwide are still suffering to the tune of £3.1bn in a market that is valued by KPMG at about £25bn.

But this is not the whole story. The grey market is a broad term for the unauthorised channelling of products, a subversive supply chain whose image is one of dodgy traders, counterfeiting and organised crime.

Yes, there is counterfeiting and yes, many imports are not meant for the UK market and risk invalidating support. But for one industry player, this has turned into an above-board £50m business.

"I struggle with the definition of the grey market," explained Martin Smith, managing director of distributor Gamma Global.

And so he should, because Gamma operates in the grey market but denies claims that 'grey' is all about counterfeit and obsolete products.

According to Smith, Gamma has brought a level of respectability to the grey brokers, achieved through an ISO9001 validation process.

The distributor buys its products - usually end-of-line or excess stock - from authorised channels, both distributors and resellers.

All products go through the validation process to ensure that they are not counterfeit and that they are legitimate for their intended market. This can throw up some unusual results.

"There is a percentage of product we buy from authorised distributors that has to go back because it fails our validation process," said Smith.

Although he would not elaborate on this claim, and refused to name names, it is a chilling reminder that even authorised channels are susceptible to what Smith calls the "slush" of dodgy products around the globe.

He finds it surprising that many authorised distributors are not as well geared as Gamma to identifying illegal products.

Money in the bank
Or maybe they are, which is why they are willing to sell them to unauthorised outlets. It's money in the coffers, isn't it?

The KPMG study, which considered 43 authorised distributors and resellers, including 15 European outlets, revealed an interesting paradox.

"Distributors see few benefits to the grey market," the study claimed. "More than three-quarters of the distributors surveyed were concerned about poor quality and support, and 92 per cent cited purchasing counterfeit products as a significant risk.

"However, distributors and brokers are attracted to the grey market's price advantages and convenience.

"Of the distributors surveyed, 71 per cent claimed it was necessary to purchase grey-market items to be competitive on pricing and fulfilment, yet 81 per cent of distributors said their competitive position would improve if grey-market activity was eliminated."

It's a case of 'If you can't beat them, join them,' at least while it lasts, and this market is not going to go away. But VARs knowingly buying products from grey marketers are taking a risk. While the pricing is very attractive, it can open a can of worms.

Julia Philpott, Microsoft's tireless campaigner against piracy and counterfeit products, still regards the grey market as "a bit of a grey area".

She sees a lot of counterfeit product sold as grey product and has been instrumental in educating distributors and resellers about the risks, while also rapping a few on the knuckles when they are caught red-handed.

Berkshire-based software distributor Blue Solutions was the latest subject of legal action by Microsoft. It settled out of court.

It was claimed that Blue Solutions "inadvertently purchased and sold counterfeit or incorrectly licensed Microsoft products" to its 7,000-strong reseller network.

Last November, a case involving Greengage Computer Products ended in a similar result. The company paid Microsoft an undisclosed sum in compensation after it "unwittingly purchased and sold on counterfeit copies of Microsoft software, including Microsoft Office 97 and Microsoft Office 2000 software licences".

Both companies were buying through the grey market. Smith claims that this kind of activity destroys the reputation of his business. Grey is still a dirty word.

Much of the problem comes from outside the European Economic Area (EEA). Peter Blampied, operations director for EMEA at US Robotics, claims that from his perspective the KPMG figures are about right.

"It's a massive market, and from an IT point of view it seems that the core of it is in the traditional trading zones in the Middle East or eastern Europe," he said.

"These regions have lower labour costs and can therefore make a profit on items that in this country would offer little to no margin."

Fuelling demand
There is a market for grey products. Lower-income and less-educated buyers that want to get on the internet, for example, fuel the demand for grey imports.

Philpott supports Blampied's claim that the problem originates mainly outside the European Union (EU), especially where there are pricing differentials in areas such as the Middle East and Africa.

The legality of importing goods from outside the EU without the authorisation of the brand owner was tested last year with the drawn-out Tesco vs Levi Strauss case, which the clothing manufacturer won. Tesco had imported jeans from a US supplier and therefore bypassed the manufacturer's authorised channel.

Because it dealt directly with a US supplier it managed to keep costs low and sold the jeans at reduced prices, much to the pleasure of Tesco's customers.

But this was an infringement of trademark law, not copyright law. As it stands now, if a company can prove that a product is genuine and gets permission from the brand owner, it is free to import.

Rules for within the EEA are a little different. The Tesco precedent applied to transatlantic trade, where products in the US are not marketed within the EEA.

If a distributor or reseller in the EEA gets its hands on non-counterfeit products from within that area then it is free to sell them at whatever price it chooses.

This, according to Smith, is where Gamma Global sits. It has a supplier database of about 600 names worldwide and each is an authorised outlet, Smith points out. It has a 600-plus dealer base that spans 35 countries, and Smith is adamant that his business is growing.

While Gamma's 'Buy, hold, sell' business accounts for 70 per cent of turnover, it is the 'Sell, source, deliver' part that is actually growing.

Here Gamma helps resellers by sourcing products on their behalf. "Resellers get frustrated when they can't get a product they need urgently for their customer even through authorised distribution," explained Smith.

Gamma will take on this burden and will sometimes go out on a limb and promise a rapid delivery, all on dealer credit as well.

Smith recognises that giving dealer credit alone is a risky business but he sees it as an essential part of the overall service, especially as the dealer channel is "significantly under-capitalised".

Speed king
The quick-delivery issue is in direct response to the expectations that the channel has over service-level agreements, according to Smith.

He cites the example of one reseller who called at 4.40 on a Friday afternoon desperately needing a Sun product. Gamma sourced the item from the US (it was an EEA-marketed product), validated it and delivered it by Tuesday morning.

So why would dealers look outside the authorised distribution channel? The bottom line is price. Smith insisted that pressure on resellers in terms of eroding margins, stretched credit limits and longer sales cycles have given rise to what he terms "the independent distribution channel". Resellers, when they realise that it is legitimate, welcome the choice.

But while price is a defining factor in the buying process, speed is also important. The authorised distribution channel cannot always deliver.

"There is some incremental business here for the vendors," explained Smith. "We can pinpoint opportunities around the world and capitalise on them quickly.

"We can move a manufacturer's products around the world quicker than its own channel; most vendors are now about just-in-time manufacture and build-to-order, and try to keep inventory out of the channel. We equalise the problems of famine and feast in the supply chains."

Smith is well aware of the demand for the products and services he offers; the company's turnover speaks for itself.

He likens the role Gamma plays to "a trouble shooter for the channel", and believes that vendors need to recognise the legitimacy of the role independent distributors such as Gamma play in the industry.

"It's time to begin a dialogue with the vendors, because we could not exist if there wasn't a real demand for our services," he said.

However, it seems unlikely that this will ultimately lead to recognition and authorisation because, while on the one hand Gamma helps, in the eyes of vendors it also complicates the channel.

"I'm not ultimately sure what the vendors really think of people like us," said Smith.

He privately believes that vendors are unofficially happy with the role played by distributors in the Gamma mould, because they help move slow stock.

The company works mainly with Hewlett-Packard (HP), IBM, 3Com, Cisco and Sun products, and Smith believes that Gamma has helped significantly in reinforcing the brands, without hurting them as a stereotypical grey-market operator might.

The problem for resellers is identifying where the real brands are being sold. "If it seems too good to be true, then it probably is," warned Philpott. And that's a sound rule to follow.

Ultimately resellers have to decide for themselves, but vendors can do their bit by cutting down on the illegal stuff from their end. Localised packaging, smaller pricing differentials and better inventory management will all help.

"Vendors should put end-of-life products through authorised channels and not through brokers," suggested Blampied, although it is often the authorised distributors that are selling on this problem.

Dick Vincent, head of the European electronics practice at KPMG LLP, the US arm of the consultancy, said: "The grey market is clearly thriving. Manufacturers need to understand its impact on their profits and brand integrity and scrutinise their internal and external controls.

"If they want to gain control over grey-market activities and improve profits, they need to improve relationships at all levels of the distribution channel. Those that do stand to gain significantly."

Big investment
It all sounds simple but, as Microsoft has seen, it takes considerable investment and resources.

When grey-market products become a major competitor to your authorised channel then something has to be done, and it is no coincidence that, since Microsoft revealed a few years ago that piracy was its biggest rival, it has been pumping money into authorisation codes and special packaging for its software.

Vendors argue that grey-market figures would be much higher if it wasn't for the industry trying to police the grey trade.

Bodies such as the Anti-Gray Market Alliance (AGMA), which last year added 3Com, Cisco, HP, Nortel and Xerox to its ranks, are trying to cut down the trade through restrictive distribution.

But the grey market is not about just counterfeit products, and the AGMA knows it. Brokers and independent distributors often play a vital role in moving slow stock out of the authorised channel and finding a home for it.

Take that away and suddenly authorised distributors and resellers will be faced with inventory problems. This will ultimately rebound on the vendors.

Manufacturers need to define the grey market more appropriately. Calling it criminal doesn't help anyone, and the sooner vendors openly recognise there is legitimacy in the grey channel, the better.

This year we will see another test case for grey importing, when the British Phonographic Institute takes CD and DVD online retailer Music Trading Online (HK) - the company behind CD-Wow.com - to court over what it alleges is a breach of UK copyright law.

It could be a new chapter and precedent for grey importing, because this concerns copyright, not trademark law.

The company was not importing illegal products. The CDs and DVDs were genuine, but were imported without the permission of the copyright holder.

As far as the Copyright, Designs and Patents Act of 1988 is concerned, Music Trading Online could be in trouble. Independent grey-market distributors will be watching with interest.

Independents' day
Independent distributors offer European resellers six key services, according to Martin Smith, managing director of Gamma Global:

• Access to tier-one-vendor products that may be constrained via traditional distribution sources.
• The guarantee of OEM domestic warranty cover in the end-user country for all hardware supplied.
• Opportunity to return better margins from hardware sales.
• Provision of incremental credit lines to the reseller channel over and above authorised distribution channels.
• Customer service levels. The independents have not been given the right to supply by vendors; they have to earn the right to supply resellers.
• Resellers are able to provide tier-one hardware solutions that compete on price with lower-ranking brands, thus adding market share into sectors of the SME communities that are difficult to penetrate under normal resale conditions.