While it’s not the black market, the gray market can cause high-tech manufacturers even greater harm overall, once you count up loss of reputation, lost revenues to eroded margins, and the costs of covering the warranties and returns of illicitly acquired products.
For tech companies, the term “gray market” refers to transactions involving a product that take place through distribution channels that are unofficial, unauthorized, or unintended.
These gray markets tend to emerge under particular market conditions. For example, when there is a glut of product in the market, or when there is a significant price disparity for a product between different countries or regions, gray markets tend to thrive.
For manufacturers, these markets can impact pricing power, disrupt distribution strategy execution across your channel network, and dilute brand value through potential harm to the company’s reputation if the products sold through these channels are of lower quality or are not serviced properly.
How bad is it? A worsening problem, experts say
It’s difficult to precisely quantify the size of the high-tech manufacturing gray market for several reasons:
- Lack of transparency: The gray market operates outside of official authorized distribution channels. Transactions occur under the radar and aren’t recorded or reported.
- Dynamic and fluid nature: The gray market is highly volatile and can fluctuate rapidly in response to factors such as changes in exchange rates, regulatory environments, and manufacturers’ pricing strategies.
- Diverse range of products and channels: The gray market encompasses a wide variety of products and distribution channels. It spans everything from overstock reselling and regional arbitrage, to online marketplaces and second-hand sales.
- Intermingling with legal markets: Gray market products often end up being sold alongside legitimate products, especially in online marketplaces. This blurs the line between the gray market and the official market.
Some industry analysts have tried to quantify some gray market activity. For example, Oliver Wyman estimates that revenues flowing through the gray market for B2C products has grown more than 60% over the past six years. This would mean that approximately 13% of global consumer sales came from products sold in markets other than those chosen by the manufacturer, usually at prices 20% to 30% below the retail price, the firm said. For B2B sales, the AGMA (Alliance for Gray Market and Counterfeit Abatement), a non-profit organization focused on IP protection for the high-tech industry, estimates that “billions” of dollars of revenues go through gray channels every year.
Be aware of the many different kinds of gray markets
Another reason it is difficult to get a handle on the gray market is that there are numerous different forms of them in the high-tech manufacturing sector alone. Here are just some of them:
- Overstock reselling: This occurs when an authorized distributor or a large customer buys more of a product than they can sell or use, typically to take advantage of volume discounts. They then sell surplus stock through unofficial channels, usually at prices lower than the market rate.
- Regional arbitrage: This is the case when unauthorized distributors or brokers take advantage of regional price differences. They buy products in a region where prices are low (due to exchange rate differences, lower taxes, or aggressive pricing strategies by the manufacturer, or other reasons) and then resell them in regions where they can get a higher price.
- Unapproved online marketplaces: These are internet-based platforms that facilitate the selling of products by various sellers, including unauthorized ones. Due to the wide reach of these platforms, they can effectively bypass the manufacturer’s official distribution network.
- Counterfeit products: Although not a gray market in the strictest sense, counterfeit goods often find their way into the market through the same unofficial channels used by gray market operators. These are unauthorized replicas of the original product and are typically of inferior quality.
- Parallel importation: This is when a product is imported into a country without the consent of the manufacturer. This differs from regional arbitrage because the product is imported by a third party rather than an unauthorized distributor.
- B2B or B2C exchanges: These are platforms where businesses or consumers can exchange products without the authorization of the original manufacturer. For example, a business may have surplus stock that they wish to offload or a consumer may wish to resell a product they no longer need.
- Refurbished and second-hand sales: Sometimes, third-party vendors or even customers sell used or refurbished products without the manufacturer’s authorization. These products are often sold at much lower prices than new products, which can undercut the manufacturer’s sales of their latest offering.
- End-of-life products: Products that a manufacturer has discontinued can sometimes reappear on the gray market. Because the manufacturer no longer supports these products, customers can turn to gray market vendors who still have stock.
- Promotional items: Occasionally, products that were intended to be given away as promotional goods end up being sold on the gray market. This might happen when customers or event attendees decide to sell the promotional items they received, or when a large quantity of promotional items are left over and end up being sold off by the event organizer or promotional company.
- Unauthorized bundling: In some cases, unauthorized sellers might bundle the manufacturer’s products with other goods or services to create a package deal that isn’t offered through official channels. This can create a unique value proposition that draws customers away from the authorized vendors.
Avoid selling to the forbidden “Entity List”
While not a gray market itself, it is so important it belongs in a category of its own. Product transfers to persons or entities on this list can occur through the gray market and this is illegal.
“The Entity List” is a tool used by the U.S. Department of Commerce’s Bureau of Industry and Security (BIS) to restrict the export, re-export, or in-country transfer of items subject to the Export Administration Regulations (EAR) to persons (individuals, organizations, companies) who are believed to be involved, or pose a significant risk of becoming involved, in activities contrary to the national security or foreign policy interests of the United States.
Entities on this list are subject to licensing requirements and policies that are more restrictive than those that apply to the country in which they are located.
The Entity List can play a significant role in gray market activities. High-tech manufacturers are required to adhere to all export control regulations, including ensuring that they are not inadvertently selling to entities on this list.
An important note: If a manufacturer’s products end up on the gray market, there is a higher risk that they could be purchased by an entity on the list, which could lead to legal and reputational damage for you.
In essence, because the gray market for high-tech goods increases the difficulty for you to control where your products ultimately end up, this puts you at risk of violating export controls. This can result in steep fines, among other negative consequences.
Why you should care
The gray market can wreak havoc for high-tech manufacturers. Here are some of the reasons why:
- Price erosion and lost sales: Gray market goods are typically sold at lower prices than goods sold through official channels. This can lead to price erosion and lost sales for the manufacturer and its authorized dealers, who can struggle to compete with the lower prices.
- Brand reputation: When gray market goods are of lesser quality (for instance, used or refurbished items, or even counterfeit goods), this can harm the brand’s reputation. Customers may not understand the difference between gray market goods and those bought from an authorized dealer and may associate any negative experiences with your brand itself.
- Warranty and service costs: Gray market goods often lack the manufacturer’s warranty. However, some customers might still seek repair or replacement under warranty, and it can be difficult for the manufacturer to verify the source of these goods. This can result in increased costs for you as you service or replace the products.
- Channel conflicts: The gray market can also create conflicts between the manufacturer and its authorized distribution network. Authorized distributors who abide by the manufacturer’s pricing and service guidelines can be undermined by gray market sellers who don’t follow these rules. This can lead to strained relationships. Manufacturers who don’t keep the gray market in check can – and have – lost valuable distributor partners.
- Regulatory risks: As mentioned earlier, there are also potential regulatory risks, such as inadvertently violating the Entity List export controls.
- Market intelligence distortion: Gray market sales are not typically reported back to you, making it difficult to accurately forecast demand, plan for production, or develop future-facing market strategies.
- End customer risks: Finally, customers who buy from the gray market may not receive proper instructions, warnings, or service, which can not only hurt the brand’s reputation but also pose potential safety risks.
What high-tech manufacturers should do
Today’s multi-tier distribution models are complex and are growing even more so, especially as opportunities in emerging markets grow. But most manufacturers have no visibility into these vast distribution networks. Manufacturers, distributors, and resellers rarely share information with each other. As a result, your business has little control over the burgeoning gray market activities around the globe.
Stay tuned for Part II of this series, were we’ll look at the ways that you can gain transparency into your sales and channels, and better control certain gray market challenges.
For more information on how you can better track channel data to connect and drive channel revenue, check out this report.
