Combating the Gray Market Menace

Transcription

1 Combating the Gray Market Menace When products are sold in the shadows, companies take a hit from lost sales and governments from lost tax revenues. Fighting back begins with rooting out illicit sellers in the supply chain. 1

2 Unauthorized Transactions The gray market is fairly well understood around the globe as many shoppers have either heard of or come across products that they suspect are being sold illicitly. The tell is usually price. A Michael Kors bag or Gucci shoes being sold for a fraction of the retail price is sure to be a gray market product. The gray market is defined as the flow of goods (either genuine or counterfeit) through a distribution channel that is unauthorized, unintended, and unofficial. For consumer product companies, the gray market is largely made up of three product categories: counterfeit, diverted (genuine and usable), and products that are expired, damaged, or returned (see figure 1). In this paper, we provide a brief overview of the gray market and its impact on developing countries, particularly India. Figure 1 Three types of products sold on the gray market Counterfeit products Diverted products (genuine and usable) Expired, damaged, and returned products Unauthorized manufacturing Tampered Expired at trade or distributor Fake product and fake packaging Fake product and genuine packaging Genuine product and fake packaging Genuine product and genuine packaging (unauthorized production) Unauthorized imports of genuine products Channel diversion Damaged across the supply chain Product returns and recalls Trademark infringements Trade diversion Counterfeit imports Area diversion (within India) Source: A.T. Kearney analysis The Gray Menace The gray market is a growing danger for all participants in the consumption ecosystem, including corporations, customers, and governments. For corporations, the danger is in lost sales, brand value, and market share. Many corporations have put in place dedicated brand protection teams to fight back against counterfeiters. For customers, the issue is purchasing gray products and then feeling cheated and distressed by money wasted. In certain cases, such as drug counterfeiting, the gray market can cause significant physical suffering and even death. 1

3 For governments, the struggle is to control the spread of these markets. Not only is gray market commerce a crime, but governments also lose tax revenue when products are purchased in the shadows. In some cases, terrorist activities are funded through profits generated from gray market operations. To assess the gray market menace, industry groups such as the Federation of Indian Chambers of Commerce & Industry have created dedicated task forces, including the Committee Against Smuggling and Counterfeiting Activities Destroying the Economy. India s Gray Market The gray market has witnessed growth of about 15 percent over the past few years and is expected to reach more than $1,500 billion globally. In India, the extent of gray market products range from 2 to 10 percent in consumer product categories to 10 to 20 percent in appliances, accessories, and auto components. Most counterfeit luxury products such as Gucci, Louis Vuitton, and Rolex are sold in street shops in big cities while everyday products such as soap, shampoo, and perfume are often sold to unsuspecting shoppers through regular channels. In other developing countries, such as China, counterfeiting has been a significant issue for multinational corporations. More than 20 percent of personal care products sold in China are fake. P&G estimates a sales loss of 10 percent in China as a result of fake products. Another key implication of counterfeiting is the loss of global revenue. For example, China is the leading country of origin for fake products, accounting for about 80 percent of all fake cosmetic and personal care items seized at the European Union s borders. The gray market has grown about 15 percent over the past few years and is expected to reach more than $1,500 billion globally. Within a sector, the extent of gray market commerce varies by corporation, shadow economics, and the degree to which corporate brand protection controls are enforced. In India, some corporations have been able to keep the proportion of gray market sales of key products in check through periodic market sampling for counterfeits and through enforcement actions such as seizures. From Point A to Points B, C, D, E Gray market participants are entrenched in the supply chain, with products either within a company s regular supply chain or part of an independent supply chain. In a regular supply chain, gray products typically enter wholesale with so-called intermediate suppliers facilitating seamless entry (see figure 2 on page 3). In counterfeit manufacturing, we see both large and small setups. Small gray market manufacturers are focused on pure economics as they produce lookalike products with minimal 2

4 Figure 2 Gray products often enter markets via intermediate suppliers Legal product flow Counterfeit flow Counterfeit manufacturers Diverted flow ~25% ~60% ~10% ~5% Supplier Supplier Depot Distributor Wholesaler General trade grocer Cosmetics and pharmacy Products diverted from other states, CSD, and illegal imports Modern trade Sources: interviews with distributors, wholesalers, and retailers; A.T. Kearney analysis consideration for quality, efficiency, or safety. Large-scale counterfeit manufacturers often operate in two ways: they produce naked products (without lookalike logos) for local brands and have undercover operations to manufacture counterfeit brand products. In select cases, a supply chain for diverted and expired or damaged products branches out from the regular product flow. Recent examples in India include Apple s iphone 7 and 7 Plus. The phones are imported from other countries and sold in gray market hubs such as Mumbai s Heera Panna, New Delhi s Gaffar Market, Kolkata s Fancy Market, and even on ebay, purchased through unauthorized channels to evade duties and taxes. Identifying counterfeit products diverted from the discounted CSD channel presents a whole new challenge1. A prime example is liquor, which can traverse multiple layers before being sold as individual bottles. The introduction of smart cards to manage rationing has reduced the incidences of diversion, but additional measures are needed to fully curb the practice. 1 CSD, short for Canteen Stores Department, refers to India s government-owned stores that sell goods to military personnel at a discount. 3

5 How to Combat the Menace A corporation s first step in combating the menace of gray market products begins with assessing the impact on key product categories identifying both internal and external sources fueling the market and the extent of the damage (see figure 3). Figure 3 Prevention of gray market production begins with damage assessment Internal assessment Size of the prize Market and field investigation External assessment Source: A.T. Kearney analysis Leaks in the internal supply chain are usually the biggest culprits, requiring a rebalancing of all materials at each stage of the supply chain. At the manufacturing stage, in-depth variance analysis within a company s own plants as well as contract manufacturers plants will go a long way to identify waste, spillage, yield norms, and data variations. In addition, process audits can identify where the destruction of finished products and printed packaging materials most likely occurs. For instance, a global consumer products company put a system in place to analyze inventory at each stage of the supply chain with a dedicated analytics team to ensure process adherence and to check for leakage. At the procurement stage, it is important to thoroughly assess all contracts and even perform surprise audits with raw material and packaging material suppliers, such as undertaking a thorough examination of theft incident records and insurance claims for in-transit raw materials and packaging materials. To ensure there is no leakage in procurement, you ll want to reconcile manufactured quantities (allowing for relevant tolerances) with the receipt of materials, either at the company site or at the contract manufacturer s site. At the manufacturing stage, it is important to analyze consumption and material balancing across all manufacturing locations. Consumption analysis addresses the question of yield and giveaways being within the norms for crucial raw materials and packaging materials. These 4

6 variances need to be measured for a period of time (daily, weekly, or monthly) according to the bill of material specifications for the manufacturing process, and the norm should be challenged if the tolerance band is larger than the tolerance band provided by the equipment manufacturer. Conversely, material balancing analysis reconciles the flow of critical raw materials and packaging materials on the premises including warehouse to plant and within the plant until production of final goods. A higher than usual wastage during the manufacturing process could be a channel of leakage to the gray market. In distribution and logistics, a thorough review can point to sudden inventory variations (surplus or deficit) at distributors or leakage (theft) during transit. Here, a material balancing analysis of distributor inventory over a longer time period quarterly, semi-annually, or annually can indicate two potential gray market sources: an inventory deficit could indicate diversion of stock, and an inventory surplus could indicate counterfeit selling and merit identifying a new source of extra stock. In geographies such as Africa, where distribution structures are not well established, unauthorized imports can reach as high as 5 percent. For an external audit, we recommend a statistical approach identifying a relevant sample across SKUs, outlets, channels, and geographies followed by a field sample analysis with a thorough physical and chemical examination to establish patterns and signatures for counterfeiting. In addition to statistical sampling, the idea is to visit counterfeit and imported product hotspots and markets, wholesalers, and distributors and interview sector experts, trade staff, and sales people to better understand the gray market ecosystem. These visits can be supported by data on import shipments, latent demand of product, and market share of established players and private labels to gauge the overall market situation. Analysis of customs data for a consumer products manufacturer revealed that unauthorized imports had crossed 0.5 percent of annual sales. In geographies such as Africa, where distribution structures are not well established, unauthorized imports can reach as high as 5 percent. Out from the Shadows Most large corporations have dedicated in-house teams in place for periodic enforcement and seizure actions based on information provided by on-the-ground investigators. Hewlett Packard, for example, conducted raids in Bangalore, Delhi, and Gujarat and seized more than 12,000 counterfeit products, including ink and toner packages. In another instance, Hindustan Unilever Limited conducted more than 140 raids on retailers and wholesalers to recover products worth $100,000. Stronger internal controls are also useful in deterring pilfering, especially technology-based solutions both overt technologies such as holograms, barcodes, and color shifting ink and covert technologies such as hidden images and machine-readable taggants. 5

7 As companies counter the gray market menace and reclaim their rightful share, it is imperative to look for solutions in current areas of influence while also working with others in the industry to shape the external environment. In particular, action is needed across three fronts: 1. Strengthen existing processes Companies with stronger, tighter controls will be in a better position to curb the emergence of gray market products. The focus, first and foremost, must be on enforcement of laws already on the books to quell gray market counterfeiting. Enforcement tends to vary by location so consistency in enforcement would go a long way to solving the problem. Also in the mix is limiting the number of expired and tampered products that remain in the market long after their sell by dates. Identifying and tracking expiring products requires better control of supply chains and packaging, and curbing the number of unauthorized imports that manage to sneak past customs is best handled by developing stronger relationships with customs. This last point is contingent on India overcoming some serious challenges in customs, including bureaucratic inefficiencies and budget issues that affect their ability to conduct raids. Curbing unauthorized imports is best handled by developing stronger relationships with customs. 2. Change current ways of working Eliminate the need and rationale for gray products, and enable effortless identification of fake products. It is never easy to change how people and departments work but the odds get better if the right controls are in place. For example, stronger controls on intellectual property and materials critical to the production process will help keep new ideas and materials off the gray market. And increasing the number of authentication features on key products the more features the more likely counterfeiters will be tripped up will help customers spot the counterfeits. 3. Shape the external environment Ridding the world of gray market products requires working collaboratively with others. The adage that two minds are better than one certainly applies when discussing ways to reshape an environment in which counterfeiting has become the norm. For corporations, one solution is to formulate a strong advocacy policy against the gray market menace. Defining this approach requires identifying the priority issues, determining the stakeholders and authorities who can address the issues, and ascertaining the platforms and forums for advocacy. For example, if unauthorized imports is the priority issue then addressing it requires liaising with customs (stakeholders and authorities) to monitor imports and restrict unauthorized products. Corporations can then leverage different platforms such as media, or shipping and transport associations to create a joint force that supports customs in curbing such imports. The corporation will want to assess the issues to determine which require a policy advocacy intervention and which do not. For example, the company might see a business rationale in legally importing products that are in high demand, which could, of course, end unauthorized imports altogether. 6

8 Time to Fight Back The gray market threat is growing at an alarming pace, inflicting economic losses on corporations and doing physical harm to consumers. Because leaks often spring from the internal supply chain, preventing gray market sales will require finding solutions in existing processes and ways of working while also collaborating with other industry stakeholders to shape the external environment. It s time to fight back, to root out illicit sellers that are damaging India and its citizens. Authors Neelesh Hundekari, partner, Mumbai neelesh.hundekari@atkearney.com Subhendu Roy, principal, Gurgaon subhendu.roy@atkearney.com Rajat Tuli, consultant, Gurgaon rajat.tuli@atkearney.com 7

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