Living Economics

Gray Market
Gray markets appear when cheaper goods in one market are diverted to compete with more expensive but similar goods in another market.

A gray market of cigarettes is growing rapidly in the U.S. as a result of 50% increase in domestic cigarette prices over the recent two years. The made-for-export cigarettes have managed their way through a complex and often shadowy distribution network and landed on shelves in U.S. stores. These cigarette packages look different from the ones made for U.S. sale, and the formulations may be different. Despite the differences, smokers are happy to snap up the bargains and enjoying these diverted products, thus leaving authorized cigarette distributors of multibillion-dollar brands in desperation (Wall Street Journal, 1/28/1999).

In the gray market, diverters buy the products from the low-end market and re-import them back to the high-end market. With foreign products, such diversion results in cheaper unauthorized imports from the low-end market competing with more expensive authorized imports in the high-end market. Thus, gray market goods are also known as parallel imports. The big price difference between the two markets enables the diverters to sell the product at a price that is lower than the market price in the high-end market and still make a big profit. Consumers are happy to see the low prices and tend to overlook the insignificant differences, such as different packaging.

Gray markets reduce the profitability of price discrimination by leveling price difference in different market segments. Manufacturers and authorized distributors have repeatedly fought to ban gray market goods. Because gray market goods are not counterfeits, the U.S. customs has not banned them until the 1993 Lever Brothers Co. vs. United States court ruling (Journal of Commerce, 4/26/99). Only physically and materially different parallel imports are banned. But when there is a big profit to be made, gray market will flourish regardless its legal status.

References:
  • Hwang, S. "As Cigarette Prices Soar, a Gray Market Booms," Wall Street Journal. 1/28/1999.
  • Weiser, S. & Kaplan, A. "A Primer for Customs' New Regulations on gray market imports," Journal of Commerce. 4/26/1999.
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