A fascinating story in the Wall Street Journal about Mexican Coca-Cola in the US convinced me to write this week about one of the most perplexing topics in business ethics: The gray market.
"Black market" refers to trade which is prohibited by law. This includes goods that are counterfeit (i.e., says Nike but it isn't); contraband (Nike is illegal in this country) or underground (real, legal Nikes bootlegged to avoid taxes). Business ethics types tend to agree that this trade is unethical, unless the law itself violates moral standards. (example: The law forbids import of a vital product.)
"Gray market" refers to trade which is outside a manufacturer's approved supply chain. In most places it's not prohibited by law, though typically it is limited by contract. Companies with valuable brand names typically present vastly different price and product mixes in different countries in order to maximize the value of their brand. Israel, for instance, often gets products which are already discontinued in Europe or the US (though this happens less than it used to). In general, less developed markets may pay less money for brand names or have access to older, discontinued lines, but sometimes they may also have to pay more for less since there is less competition.
The gray market is a kind of arbitrage whereby private distributors buy a brand name product in a country where it is inexpensive and resell it in a place where the official distributors get a high price. It is not unusual for the retail price of gray-market goods to be less than the wholesale price of the authorized distributor. Customs officials generally can't stop these imports, because there is nothing illegal about buying sunglasses (a common gray market item) in Latin America and then bringing them to the US.
Manufacturers don't have a lot of options to fight this monster, which is, after all, a creature of their own discriminatory market policies. The WSJ article writes that Coca Cola "condemns" the gray market sales, that it is "galling" to them, that it is an "irritation," but the reporter did not find a single concrete example of effective legal action against them.
What are the ethical issues? The clearest victims are the authorized distributors, who are incensed by the unfair competition of the gray marketers. But it's hard to see exactly what the resellers are doing wrong - they don't have any contract with the company that restricts their purchase or sale of the products, and they seem to be engaging in a perfectly legitimate sort of arbitrage.
One possible problem is that the third-country wholesalers are generally forbidden to sell to gray marketers, and so the gray market sellers are in effect inducing a breach of contract. But the wholesalers claim that they can't possibly police every customer to see if there is actually a little drug store in a distant village or if the order actually comes from a gray market reseller.
Manufacturers usually claim to be enraged at the resellers' success in undermining their marketing plans. Sometimes, this frustration is no doubt genuine. Sometimes, it is feigned to assuage the sorrow of distributors, since the manufacturer often doesn't really care where the sales are generated. Sometimes, the manufacturer's sorrow is pure crocodile tears, as in many cases they have been suspected of dabbling in the gray market themselves.
By contrast, some view the resellers as heroes - guerrilla fighters in the war against monopoly power. The Institute for Global Ethics Web site reports that the European Court of Justice "ruled that trademark owners...can prevent their goods from being brought into the European Union countries without their approval," but also reports that the decision "raised howls of protest from supermarket chains and consumer groups."
I personally don't believe that the government should intervene in this trade. I can't identify any overriding public interest in preventing people from importing and selling genuine brand-name items just because the manufacturer would prefer that they refrain. Existing laws, including contract law applying with distributors and sellers as well as copyright and trademark statutes, provide adequate latitude for manufacturers to control their distribution channels, while existing gray market reselling provides an adequate check on excessive market power.
There is a need for some transparency, however. In most cases the manufacturer doesn't warrantee gray market items and, of course, the customer should be informed of this on electronics and similar items where the manufacturer's warrantee is of significant value. (But sometimes resellers provide their own private warrantees which are indistinguishable to the buyer, and for some items, like clothes, warrantees are more or less irrelevant.)
The gray market in Mexican Coke has an unusual twist: The Mexican Coke is actually different than the American version, and a lot of people like it better. Instead of thriving by selling at a discount, stores in the US sell it for more than regular Coke. The happy ending is that Coca Cola is planning to allow more distributors to sell the south-of-the-border version, expanding the white market for this venerable brown potion.
The writer is research director at the Business Ethics Center of Jerusalem (www.besr.org), an independent institute in The Jerusalem College of Technology. He is also a rabbi.