Coping with Gray Markets: The Impact of Market Conditions and Product Characteristics

Abstract

Gray markets, also known as parallel imports, have created fierce competition for manufacturers in many industries. We analyze the impact of parallel importation on a price‐setting manufacturer that serves two markets with uncertain demand, and characterize her policy against parallel importation. We show that ignoring demand uncertainty can take a significant toll on the manufacturer's profit, highlighting the value of making price and quantity decisions jointly. We find that adjusting prices is more effective in controlling gray market activity than reducing product availability, and that parallel importation forces the manufacturer to reduce her price gap while demand uncertainty forces her to lower prices. Furthermore, we explore the impact of market conditions (such as market base, price sensitivity, and demand uncertainty) and product characteristics (“fashion” vs. “commodity”) on the manufacturer's policy towards parallel importation. We also provide managerial insights about the value of strategic decision‐making by comparing the optimal policy to the uniform pricing policy that has been adopted by some companies to eliminate gray markets entirely. The comparison indicates that the value of making price and quantity decisions strategically is highest for moderately different market conditions and non‐commodity products.

Keywords

gray markets parallel importation parallel markets strategic pricing demand uncertainty uniform pricing

Get full access to this article

View all access options for this article.

References

2020health . 2011. Parallel importing and exporting of pharmaceuticals severely limits the options in designing an effective UK drug pricing scheme. Available at http://2020health.wordpress.com (accessed date January 14, 2015).

Ahmadi

Yang

B. R.

. 2000. Parallel imports: Challenges from unauthorized distribution channels. Market. Sci. 19(3): 279–294.

Altug

van Ryzin

. 2013. Supply chain efficiency and contracting in the presence of gray market. Working paper.

Antia

K. D.

Dutta

Bergen

. 2004. Competing with gray markets. Sloan Manage. Rev. 46(1): 63–69.

Autrey

R. L.

Bova

Soberman

. 2013. Organizational structure and gray markets. Working paper.

Bucklin

L. P.

1993. Modeling the international gray market for public policy decisions. Int. J. Res. Market. 10: 387–405.

Cachon

G. P.

Lariviere

M. A.

. 1999a. Capacity choice and allocation: Strategic behavior and supply chain performance. Manage. Sci. 45(8): 1091–1108.

Cachon

G. P.

Lariviere

M. A.

. 1999b. An equilibrium analysis of linear, proportional and uniform allocation of scarce capacity. IIE Trans. 31: 835–849.

Chan

L. M. A.

Shen

Z. J. M.

Simchi‐Levi

Swann

. 2004. Coordination of pricing and inventory decisions: A survey and classification. Simchi‐Levi

S. D.

Shen

Z. J. M.

, eds. Handbook of Quantitative Supply Chain Analysis: Modeling in the E‐Business Era. Kluwer Academic Publishers, Boston, MA, 335–392.

10.

Chen

2009. Gray marketing: Does it hurt the manufacturers? Atl. Econ. J. 37(1): 23–35.

11.

Dasu

Ahmadi

Carr

. 2012. Gray markets: A product of demand uncertainty and excess inventory. Prod. Oper. Manag. 21(6): 1102–1113.

12.

Dutta

Bergen

John

. 1994. The governance of exclusive territories when dealers can bootleg. Market. Sci. 13(1): 83–99.

13.

Dutta

Heide

J. B.

Bergen

. 1999. Vertical territorial restrictions and public policy: Theories and industry evidence. J. Market. 63: 121–134.

14.

Ganslandt

Maskus

K. E.

. 2004. Parallel imports and the pricing of pharmaceutical products: Evidence from the European Union. J. Health Econ. 23(5): 1035–1057.

15.

Hines

W. W.

Montgomery

D. C.

1990. Probability and Statistics in Engineering and Management Science. J. Wiley, New York.

16.

Pavlin

Shi

. 2013. When gray markets have silver linings: All‐unit discounts, gray markets and channel management. Manuf. Serv. Oper. Manag. 15(2): 250–262.

17.

Huang

Lee

B. C. Y.

S. H.

. 2004. Consumer attitude toward gray market goods. Int. Market. Rev. 21(6): 598–614.

18.

Kanavos

Holmes

. 2005. Pharmaceutical Parallel Trade in the U.K. The Institute for the Study of Civil Society, London, U.K.

19.

KPMG . 2008. Effective channel management is critical in combating the gray‐market and increasing technology companies bottom line. Available at http://www.agmaglobal.org (accessed date January 14, 2015).

20.

Krishnan

Shao

McCormick

. 2013. Impact of gray markets on a decentralized supply chain. Working paper.

21.

Lariviere

M. A.

Porteus

E. L.

. 2001. Selling to a newsvendor: An analysis of price‐only contracts. Manuf. Serv. Oper. Manag. 3(4): 293–305.

22.

Maskus

K. E.

. 2006. The impact of parallel imports on investments in cost‐reducing research and development. J. Int. Econ. 68: 443–455.

23.

Maskus

K. E.

2000. Parallel imports. World Econ. 23(9): 1269–1284.

24.

Matsushima

Matsumura

. 2010. Profit‐enhancing parallel imports. Open Econ. Rev. 21(3): 433–447.

25.

New York Times . 2008. After China ships out iPhones, smugglers make it a return trip. Available at http://www.nytimes.com/2008/02/18/business/worldbusiness/18iphone.html (accessed date January 14, 2015).

26.

Petruzzi

N. C.

Dada

. 1999. Pricing and the newsvendor problem: A review with extensions. Oper. Res. 47(2): 183–194.

27.

Schonfeld

2010. Fighting grey goods with trademark law. Managing Intellectual Property. Available at http://www.pancommunications.com/_docs/burnslevinson20100601.pdf (accessed date February 10, 2013).

28.

Schweitzer

M. E.

Cachon

G. P.

. 2000. Decision bias in the newsvendor problem with a known demand distribution: Experimental evidence. Manage. Sci. 46(3): 404–420.

29.

Shulman

J. D.

2013. Product diversion to a direct competitor. Working paper.

30.

Mukhopadhyay

S. K.

. 2012. Controlling power retailer's gray activities through contract design. Prod. Oper. Manag. 21(1): 145–160.

31.

Thompson

2009. Gray power: An empirical investigation of the impact of parallel imports on market prices. J. Ind. Compet. Trade 9(3): 219–232.

32.

Xiao

Palekar

Liu

. 2011. Shades of gray – The impact of gray markets on authorzied distribution channels. Quant. Mark. Econ. 9: 155–178.

33.

Chen

. 2010. The effect of demand uncertainty in a price‐setting newsvendor model. Eur. J. Oper. Res. 207(2): 946–957.

34.

Yao

Chen

Yan

. 2006. The newsvendor problem with pricing: Extensions. Int. J. Manage. Sci. Eng. Manag. 1(1): 3–16.