FTC Staff Comment Before the Customs Service Concerning Gray Market Policy Options

, .
Comments of the Bureaus of
Competition, Consumer Protection and Economics
of the Federal Trade Commission·
on
Gray Market Policy Options Facing
The United States Customs Service
October 17, 1986
·i••
/U·,""'--
• 	These comments represent the views of the Bureaus of Competition,
Consumer Protection, and Economics of the Federal Trade Commission and do
not necessarily represent the views of the Commission or of any individual
Commissioner. 	The Commission, however, has authorized the submission of
these comments.

I. 	INTRODUCTION
Under a 	long standing Customs Service 	policy, 	known 	as 	the "related
parties" exception, products bearing genuine trademarks may be imported into
the U.S. without the permission of the U.S. trademark holder, provided that
the U.S. trademark holder is related to the foreign trademark holder. 	Such
imported items are known as gray market imports. 	The Customs Service has
proposed requiring that these imports be labeled as unauthorized imports or
that all trademarks they bear be removed (demarking).
The 	staff 	of 	the 	Federal 	Trade 	Commission 	rFTC" or "Commission")
. strongly 	recommends 	that 	the 	proposal 	be 	rejected. 	E... en 	if 	it 	were
established that gray market imports could cause some sort of damage in the
market place, the Customs Service proposals are not the appropriate method
of solving the problem. 	If the problem is considered to be ·free riding" by
unauthorized 	importers 	on 	the 	promotional 	efforts 	of 	authorized 	U.S.
distributors. 	the 	dispute 	is 	about 	contractual 	obligations 	of 	the 	foreign
manufacturers and should be resolved privately between the firms involved.
If. 	for 	example, 	the 	problem 	is 	that 	consumers 	are 	deceived 	about 	the
services associated 	with gray market 	goods, the FTC itself has jurisdiction
to act under Section 5 of the FTC Act.
II. 	SUMMAR Y OF THE FTC STAFF'S COMMENTS
According to the Customs Service request for comments. 1 proponents of
changing the current policy contend that these new trade restrictions would
increase consumer 	welfare because 	the 	related 	party exception ·discourages
U.s. 	trademark 	owners 	from 	investing 	in 	marketing 	or 	servicing 	of
1 	Federal Register, Vol. 51, No. 116, June 17, 1986.

trademarked 	products 	by 	permitting 	others 	to 	'free 	ride' 	on 	these
investments." 	Proponents 	of 	the 	proposed 	regulations 	also ·argue 	that 	the
influx 	of 	gray 	market 	goods may 	deceive or 	confuse 	consumers about 	the
source 	of 	the 	trademarked 	products 	and 	therefore 	about 	the 	quality 	or
availability of warranties on those products."
The 	FTC 	staff 	recommends 	against 	adopting 	either 	of 	the 	proposed
restrictions for two reasons.
First, 	there 	are 	alternative 	private 	and 	public 	remedies 	for 	potential
free rider or deception problems, if they exist. 	Even if international free
rider problems do exist, firms can deal with them privately, just as they do
domestically, 	where 	the 	government 	does 	not 	intervene 	to stop 	free 	rider
problems 	of 	this 	sort. 	If 	gray 	market 	imports 	pose 	consumer 	deception
problems, 	these 	problems 	already 	fall 	within 	the 	jurisdiction 	of 	the
Commission 	under 	Section 	5 	of 	the 	FTC 	Act.2 	The 	Customs 	Service
proposals are a far more intrusive solution than are more carefully targeted
remedies aimed at particular consumer deception problems.
Second, 	there 	are 	several 	equally 	plausible 	theories 	for 	gray 	market
imports. 	In 	addition 	to 	the 	free 	rider 	and 	consumer 	deception 	theories,
there 	are 	other 	theories 	that 	imply 	that 	gray 	market 	imports 	involve
significant consumer benefits. 	The available data on gray market imports are
much 	too 	sketchy 	and 	anecdotal 	to 	determine 	reliably 	",.. bich 	theory 	or
theories are valid. 	Without such information, there is insufficient reason to
2 	The 	FTC 	also 	has 	regulations 	requITIng 	that 	retailers 	make 	any
warranty 	available 	for consumer 	inspection 	before 	purchase. 	(See 	16 CFR
702.) 	If 	no 	warranty 	is 	applicable 	on 	a 	gray 	market 	purchase, 	the 	FTC
regulations could 	help prevent deception concerning warranty coverage. 	It
should 	also 	be 	noted 	that 	the 	large 	price 	differences 	themselves 	might 	be
expected 	to 	alert 	consumers 	to 	potential 	differences 	betv.. een 	authorized
imports and gray market imports.
2

..
consider 	adopting 	govern men t 	trade 	restrictions 	on 	gray 	market 	goods.
Blanket 	government 	restrictions 	on 	gray 	market 	imports, 	such 	as 	those
proposed 	by 	the Customs Service, are inappropriate where so many 	private
remedies are 	available, where conflicting explanatory 	theories 	abound, and
where 	there 	are 	such 	great 	uncertainties 	about 	the 	reliability 	of 	the
empirical evidence about potential costs and benefits to consumers.
These conclusions are discussed 	below. 	The 	free 	rider and 	consumer
deception hypotheses are treated in Section III, parts A and B. 	Alternative
explanations 	are 	discussed 	in 	Section 	IV. 	Available 	empirical 	data 	are
analyzed 	in 	Section 	V. 	A 	summary 	of 	our 	conclusions 	is 	presented 	in
Section VI.
III. 	THE FREE RIDER AND CONSUMER DECEPTION EXPLANATIONS
A. 	Free Rider
While there are potential free rider problems at both the domestic and
international 	levels 	in 	product 	distribution, 	they 	can 	best 	be 	addressed
through 	private 	contractual 	agreements 	between 	manufacturers 	and
distributors. 	Because 	distributors 	benefit 	from 	promotional 	activities 	and
services 	provided 	by 	other 	distributors 	even 	if 	they 	do 	not 	contribute 	to
them, manufacturers often seek to develop vertical restraints on distributors,
including exclusive territories. 	Without such restraints. distributors may lack
sufficient 	incentives 	to 	provide 	high-Quality 	services 	and 	promotional
programs and to build a brand's reputation. 	Because a brand's reputation is
an important aid 	to consumer choice, inadequate 	investment in 	reputations
will injure consumers. 	In 	addition, 	inability to establish a reputation 	may
undermine 	incentives 	to 	produce 	high 	Quality 	goods. 	Free rider 	problems
3

may also occur if the identity of the distributor acts as a signal of product
quality when consumers cannot readily ascertain quality in ot~er ways.s
Because manufacturers can be expected to recognize potential free rider
problems and 	because they are free 	to contract with distri:utors, most free
rider 	problems 	could 	be 	addressed 	by 	the 	manufacturel'"S' 	own 	private
initiatives.· 	This 	applies 	to 	gray 	market 	imports 	as 	well 	as 	to 	domestic
transshipments. s 	Consequently 	there 	is 	reason 	to 	doubt 	thlt 	gray 	market
:5 	T. R. Overstreet, Jr., Resale Price Maintenance: E:?nornic Theories
and 	Empirical 	Evidence, Washington, D.C.: The Federal Traje 	Commission,
1983, page 60.
• 	Of 	course, 	manufacturers' 	vertical 	restraint3 	have 	to 	be
consistent with U.S. antitrust laws before they can be implemented.
Even 	if 	vertical 	restraints eliminate all 	intrabrand 	free 	riding, 	there
may still be interbrand spillover effects from one brand's promotional efforts
to other 	brand's promotional efforts. 	Thus, the problem oi free 	riding 	in
intrabrand competition is not unique.
Even 	if 	aoo 	private 	remedies 	were 	ineffective, 	the 	benefits 	of 	the
Customs Service proposals would still have to be traded off against potential
market 	power 	or 	other 	costs 	to 	consumers 	of 	government 	restrictions 	on
gray market imports.
The manufacturer may also have alternative public remedies available.
Recent 	legal 	research 	(B. Coggio, J. Gordon, and 	L. Corum, "The 	History
and 	Present 	Status 	of 	Gray 	Goods," 	The 	Trademark 	Re:orter, 	Vol. 	75,
September /October 	1985, 	pages 	433-496.) 	suggests 	that 	free 	rider 	issues 	in
gray markets could be pursued in U.S. courts under legal theories of unjust
enrichment, 	third-party 	beneficiary, 	and/or 	interference 	v.ith 	contractual
relations. 	The Court of International Trade could also be a~proached on a
usurpation or infringement theory.
5 	In an international context, some private remedies tr.ay be available
that are not available in domestic markets. 	For example, the manufacturer
might 	be 	able 	to 	alter 	its 	trademark, 	labeling, 	product 	specifications,
promotions, pricing, or distribution contracts in different countries to reduce
or eliminate free riding. 	The manufacturer could use a different trademark
in each country to discourage gray market trade. 	The manufacturer could
also 	discourage 	gray 	marketing 	by 	producing 	goods 	with 	distinguishing
features for different countries.
Some 	additional 	remedies 	may 	be 	more effective 	in 	the 	international
context, although they are available domestically as well. 	For example, the
manufacturer could promote the effectiveness of its authorized distribution
system 	in 	maintaining 	quality 	over 	long 	shipping 	distances. 	The
manufacturer could find that its efforts to identify the distributors that sell
to 	gray 	market 	importers 	and 	to 	terminate 	these 	distritutors 	or 	limit
4

imports stem largely from 	free 	rider problems. 	Of cours:. there might 	be
unexpected 	circumstances 	that 	result 	in 	loopholes 	in 	pri..-ate 	enforcement
efforts, 	but 	these 	should 	disappear 	as 	new 	private 	metb~s of 	addressing
these loopholes arc developed.
Even if free riding might persist despite private enfor:ement efforts, it
does 	not 	automatically 	follow 	that 	government 	should 	stc; 	in 	and 	enforce
these 	private 	conu;.acts 	as 	the 	Customs 	Service 	proposals 	would 	do. 	In
general, private contractual relationships that benefit the contractual parties
should 	be 	enforced 	through 	private 	efforts. 	In 	addition. 	the 	benefits of
solving any residual free rider problems through governme::t action have to
be weighed against the costs of the government intervention.
B. Consumer Deception
If authorized 	imports 	and 	gray 	market 	goods 	werc 	identical, 	then 	it
seems unlikely that any risk of consumer deception would exist. 	Similarly, if
differences 	between gray market 	and authorized 	imports ue 	obvious, 	well
known, 	or 	easily 	discoverable, 	little 	risk 	of 	deception 	exists. 	A 	risk 	of
consumer 	deception 	may 	arise, 	however, 	if 	consumers 	a:e 	not 	aware 	of
material 	differences 	between 	gray 	market 	goods 	and 	au~~orized imports.
Such 	differences 	could 	conceivably 	arise 	from 	differe~ces in 	services
provided with the product, other products included in the transaction, or the
principal product itself. 6 	However, the FTC already has authority to deal
shipments to tbem are more effective when the goods have to cross national
boundaries.
6 	One potential problem with gray market goods is in:ompatibility for
use 	in 	the 	U.S. 	In 	some 	cases, 	such 	as 	automobiles, 	th~e problems 	are
addressed by changing the product once it has arrived in t~e U.s. 	In other
cases, 	where 	the 	value of 	the 	product is not 	high enough 	to warrant such
5

with 	consumer deception 	problems, 	including deception 	problems 	involving
gray market imports, and to date has not determined that there is any need
to take action in this area.
Consumer 	confusion 	about 	the 	actual 	characteristics 	of 	gray 	market
goods 	could 	potentially 	cause 	both 	immediate 	and 	longer 	term 	injury 	to
consumers. 	Immediate 	injury 	would 	result 	if 	consumers 	pay 	for 	a
characteristic 	that 	is 	not 	actually 	included 	in 	the 	product. 	Longer 	term
injury 	would occur if consumers dissatisfied with gray market goods could
not differentiate higher Quality authorized imports. 	In such circumstances,
consumers eventually might be unwilling to pay a price premium sufficient to
cover incremental costs associated with producing or distributing the higher
Quality authorized 	import, and 	the 	higher 	Quality product 	might disappear
from the market.?
As noted in the appendix, Commission staff investigations of consumer
deception in connection with gray market goods have not produced evidence
of substantial systematic deception to date.
C. Relabeling and Demarking Remedies
Neither 	the 	relabeling 	proposal 	nor 	the 	demarking 	proposal 	is
consistent with both the free rider and consumer deception theories for gra y
modifications, 	gray 	markets 	have 	not 	generally 	emerged. 	An 	example 	is
cellular phones where 	frequency 	differences have discouraged 	gray market
imports 	despite 	reportedly 	attractive 	price 	differences 	between 	countries.
"Conversation 	with 	a 	Gray 	Marketeer," 	Consumer 	Electronics, 	July 	1985,
pages 49-50.
7 	See G. Akerlof, "The Market for 'Lemons': Quality Uncertainty and
the Market Mechanism," Quarterly Journal of Economics, August 1970, pages
488-500.
6

'.
market 	imports. 	Relabeling 	is 	more 	relevant 	to consumer deception 	while
demarking is more relevant to free riding.
If 	authorized 	imports 	and 	gray 	market 	goods 	have 	different
characteristics, 	including 	services 	and 	warranties, 	that 	are 	the 	source 	of
consumer 	confusion, 	a 	label 	that 	specifies 	the 	distribution 	channel 	would
directly 	reduce 	this 	problem. 	Demarking 	would 	also 	accomplish 	this 	by
alerting consumers to 	the likelihood 	of differences, but this solution could
remove too much information. 	Trademarks serve an important function 	in
identifying superior quality 	manufacturers even 	if they are also identified
with particular distribution channels. 	Demarking would eliminate consumers'
ability to identify superior manufacturer quality and could cause consumers
to undervalue the demarked 	product. 8 	Moreover, if deception of the type
allegedly 	posed 	by 	gray 	markets 	is 	a 	problem, 	the 	generally 	preferred
solution 	is 	to 	make 	sure 	that 	consumers 	have 	access 	to 	information about
material 	differences. 	This 	is 	a 	less 	intrusive 	remedy 	that 	addresses 	the
problem 	directly 	and 	does 	not 	destroy 	potentially 	valuable 	consumer
information in the process, as disparaging relabeling or demarking might.
There 	are 	private 	remedies available 	if there are 	consumer deception
problems. 	Any measure that enables consumers to distinguish between gray
market and authorized imports would effectively eliminate whatever consumer
deception 	problems 	might 	exist. 	Authorized 	distributors 	could 	affix
additional 	trademarks 	indicating 	that 	their 	items 	are 	authorized 	for 	U.S.
distribution and have been distributed in the authorized manner. 	Similarly,
8 	Similarly, 	relabeling 	might 	cause 	consumers 	to 	perceive. greater
quality risk than in fact exists and to undervalue the gray market product.
This 	might 	occur, for 	example, if 	the 	label 	disparaged 	the 	quality 	of 	the
gray market product.
7

authorized 	distributors could 	inform 	customers 	of 	the 	advantages 	of 	their
products, e.g., warranty terms. Q
Although 	either 	relabeling 	or 	demarking 	would 	have 	the 	effect 	of
slowing 	or 	disrupting 	imports 	of 	gray 	market 	goods 	and 	v.ould 	therefore
serve 	to 	shelter 	the 	U.S. 	trademark 	holder's 	investments 	in 	promotion 	or
services, 	only 	demarking 	directly 	addresses 	possible 	free 	rider 	problems.
Free riding on promotion requires that consumers perceive the gray market
imports to be the same as the authorized goods. 	This perception would be
eliminated by demarking if demarking really disguised the brand. 	Relabeling
would not remove free riding on promotions conducted by manufacturers or
authorized 	distributors 	because 	the 	advertised 	trademark 	would 	still 	be
apparent.
IV. 	ALTERNATIVE EXPLANATIONS
A 	number 	of 	alternative 	explanations 	for 	gray 	market 	imports 	apart
from 	free 	rider or consumer deception 	have been developed in conjunction
with 	the 	debate over 	retail 	price 	maintenance. 	The 	recent 	Federal Trade
Commission 	staff 	report, 	cited 	earlier,10 	reviewed 	several 	of 	these 	in
addition to variations of the free rider hypothesis. 	Although the theoretical
foundations and empirical support for these alternative explanations for gray
market 	imports 	arc 	often 	as 	extensive 	as 	those 	of 	the 	free 	rider 	and
consumer deception explanations, the Customs Service proposals mention only
Sl 	Since authorized dealers will reap the benefits, there is some logic
in having them bear the burden of distinguishing their product. 	In contrast,
the Customs Service proposals put the burden on gray market suppliers and
on the tax payers. 	An alternative arrangement would be to have authorized
importers reimburse the Customs Service.
10 	T. R. Overstreet, Jr., cited at footnote 3.
8

the 	price 	discrimination 	explanation. 	The 	explanation 	based 	on 	lags 	in
adjusting 	to 	exchange 	rate 	changes, 	in 	particular, 	has 	not 	received 	any
attention.
A. 	Exchange Rate Adjustment Lags
Manufacturers' 	output 	constraints,l1 	strategic 	output 	and 	pricing
considera tions, 12 	barriers 	to 	entry,13 	and 	long-run 	marketing
11 	If a foreign producer faces contractual (or political) obligations in
its home market with respect to price or price and quantity, is producing at
o capacity, and faces a lag in adding new capacity, it may be forced to price
discriminate against U.S. consumers. 	These are the conditions necessary to
preclude 	diversion 	of 	the 	type 	envisioned 	by 	R. 	Landes 	and 	R. 	Posner,
WMarket 	Power 	in 	Antitrust 	Cases," 	Harvard 	Law 	Review. 	Vol. 	94, 	March
198J. pages 937-996.
12 	A 	foreign 	supplier 	cooperating 	in 	a 	cartel 	witt. 	U.S. 	producers
might 	price 	discriminate 	against 	U.S. 	consumers 	to 	avoid 	disrupting 	the
cartel. 	The same could be true for a territorial division of markets between
foreign 	producers and 	U.S. firms. 	Foreign producers migh: similarly price
discriminate 	against 	U.S. 	consumers 	to 	avoid 	political 	action 	by 	U.S.
producers 	directed 	at 	increasing 	tariffs 	or 	other 	trade 	res:rictions. 	(The
fact that trade restraints can be imposed on a country-by-co;lntry basis may
remove 	much 	of 	the 	free 	rider 	problem 	in 	organizing 	voluntary 	export
restraints of this type.)
Other strategic considerations 	might also 	be 	important. 	For example,
efforts to establish 	first 	mover 	advantages in 	a 	particular geographic area
may encourage geographic price discrimination. 	For an example of such first
mover 	advantages, 	see 	M 	T. 	Flaherty, 	WMarket 	Share 	Determination 	in
International 	Semiconductor 	Markets," 	Cambridge, 	Mass.: 	Harvard 	Business
School Working Paper J-782-04, April 1984.
13 	Barriers to entry or exit may give importing firms an incentive to
dampen exchange rate changes in their pricing. 	When the importing county's
currency 	is 	appreciating, 	such 	barriers 	may 	make 	importers 	reluctant 	to
expand 	their distribution networks or to 	build 	additional capacity to meet
increases in demand that °may be temporary, especially when these expansion
efforts 	involve 	sunk 	costs. 	When 	the 	importing 	countD"s 	currency 	is
depreciating, barriers to entry or exit may make the importers reluctant to
effectively 	abandon 	their 	home 	market 	by 	allowing 	their 	prices 	to 	fully
reflect the exchange rate changes. 	The reason is tha t they realize that the
decline 	in 	demand 	may be temporary and 	that 	the firm's expected present
value may be higher by staying in the market during the lov.. demand period
because 	it 	allows 	them 	to 	avoid 	exit 	costs 	or 	later 	reentry 	costs. 	For 	a
discussion 	of 	the 	role 	of 	sunk 	costs 	in 	determining 	responses 	to 	demand
9

considerations1• 	may 	make 	foreign 	suppliers 	reluctant 	to change 	their 	U.S.
prices 	in 	lock 	step 	with 	changes 	in 	exchange 	rates. 	To 	the 	extent 	that
foreign 	suppliers 	base 	their 	decisions 	on 	these 	longer 	run 	considerations,
their 	pricing 	decisions 	may 	differ 	from 	those 	of 	independent 	middlemen.
The 	available 	evidence 	on 	trade 	reactions 	to 	changes 	in 	exchange 	rates
suggests 	that 	lags 	are 	extremely 	common. 16 	Some degree 	of 	lag 	may 	also
arise 	from 	differences in 	the 	inventory 	positions of 	potential arbitragers 16
changes, see, for example, W. Baumol, "Contestable Markets: An Uprising in
the Theory of Industry Structures," American Economic Review, Vol. 72, May
1982, pages 1-15.
14 	Some retailers of imports may be risk averse with respect to price
variations. 	A seller facing such customers may find 	it attractive to offer
long 	term 	supply 	contracts 	in 	which 	the 	seller 	insures 	the 	buyer 	against
changes in exchange rates. 	The premium on this type of contract takes the
form of higher than short run competitive prices when the buyer's currency
is appreciating and lower than competitive prices when the buyer's currency
is depreciating. 	Alternatively, there may be substantial costs associated with
frequently changing prices. 	For instance, if retailers have printed catalogues
or 	have 	customers, 	such 	as 	the 	U.S. 	government, 	that 	demand 	long 	term
supply 	contracts, 	frequent 	price 	changes 	may 	be 	quite 	costly. 	Consistent
with 	this 	hypothesis, 	D. 	Carlton 	reports 	that 	price 	stability 	is 	positively
related to the length of association between buyers and sellers in his article
"The 	Rigidity 	of 	Prices," 	American 	EconQmic 	Review, 	Vol. 	26, 	NQ. 	2,
September 1986, pages 637-658.
Two 	respondents 	to 	the 	Commerce 	Department 	survey 	indicated 	that
dampening 	exchange 	rate 	fluctuations 	was 	necessary 	tQ 	stabilize 	their
distribution 	system. 	See question 	A.6.e. 	Gray 	market 	impQrters apparently
cannot 	offer 	this 	type 	of 	price 	stability. 	Gray 	market 	importers 	do 	not
participate in bids to supply GSA for this reason, for example.
16 	See, for example, R. Dornbusch, "Exchange Rate Dynamics," Journa I
of 	Political 	Economy, 	Vol 	84, 	1976, 	pages 	1161-1176; 	F. 	Giavazzi 	and 	C.
Wyplosz, "The Real Exchange Rate, The Current Account and the Speed of
Adjustment," 	Essex 	Economics 	Paper 	.194, 	1984; 	C. 	Wilson, 	"Anticipated
Shocks and Exchange Rate Dynamics," Journal of Political Economy, Vol. 87,
1979, pages 639-647.
16 	Because of transactions costs associated with switching accounting
systems (or assQciated with operating a second accounting system with more
economically 	meaningful 	figures) 	or 	because 	of legal 	constraints, different
suppliers may be operating with different inventory systems or with similar
systems but with different inventory levels. 	These differences in accounting
systems may cause different suppliers to adjust to changes in exchange rates
10

or from differences in the speed with which firms recognize demand and cost
shifts. IT
Where 	suppliers 	either 	individually 	or 	collectively 	do 	not 	respond 	to
exchange 	rate 	changes 	with 	prompt 	price 	adjustments, 	sufficient 	price
differences 	may 	emerge 	to 	encourage 	gray 	market 	good~" 	Whether 	the
emergence of a gray 	market is good, 	bad, or 	indifferent for consumers in
these situations depends on 	the 	cause 	of 	the 	lag 	in 	the supplier's response
to exchange 	rate 	changes. 	In 	many cases, 	however, 	gray markets 	improve
consumer welfare by internationalizing markets. 18
at different speeds. 	For example, if the authorized distributor in the U.S. is
operating under a LIFO inventory system, while gray marKet importers are
buying 	from 	foreign 	dealers 	with 	FIFO 	inventory 	systems, 	the 	U.S.
authorized 	distributor 	would 	perceive 	higher 	marginal 	costs 	than 	the 	gra y
market 	importers, even 	though 	their 	economic 	opportunity costs 	might 	be
identical, as long as the U.S. currency was appreciating. 	S~ J. Hilke, Firm
Size and Regulatory Compliance Costs; The Case of LIFO Regulations, FTC
Staff 	Report, 	1984, 	for 	a 	discussion 	of 	the 	costs 	of 	switching 	accounting
systems and of the cash flow implications of different accounting systems.
IT 	Some gray market suppliers arc professional arbitragers who focus
their 	entire 	attention 	on 	responding 	quickly 	to 	exchange 	rate 	adjustment
imperfections. 	Firms that are concerned with manufacturing and distribution
arrangements 	might 	not 	be 	as 	proficient 	in 	detecting 	and 	responding 	to
exchange rate adjustment situations. 	Arbitragers generally perform the role
of identifying adjustment problems by exe"cuting trades that take advantage
of the 	problem. 	In accord with 	this explanation, many gray market goods
reportedly 	are 	bought 	and 	sold 	in 	several 	currencies 	before 	reaching 	the
U.S. 	See "Camera 	Prices in 	a Shambles," 	New 	York 	Times, 	December 	11,
J982, pages 41, 43. 	Lags in adjusting to exchange rate changes apparently
occur 	with 	airline 	tickets, 	where 	failure 	of 	the 	airlines 	to 	adjust 	ticket
prices 	to 	reflect 	exchange 	rate 	changes 	prompts 	the 	emergence 	of 	travel
agencies 	that 	specialize 	in 	arbitraging 	these 	differences. 	("Travel 	Agents
Woo Clients by Offering Rebates and Other Money-Saving Deals; Wall Street
Journal, September 3, 1986, page 29.)
18 	In 	a 	macroeconomic 	context, 	gray 	markets 	increase 	the 	rate 	of
response 	to exchange 	rate changes. 	To the extent that such 	trade changes
are necessary to balance financial flows, rapid trade changes help to dampen
exchange ra te f1 uctua tions.
I I

B. 	DistrjbutQr CQllusiQn
ImpQsitiQn 	of 	geographic 	restrictiQns 	by 	manufacturers 	might
cQnceivably 	stem 	frQm 	the 	insistence 	Qf 	cQlluding 	retailers 	or 	wholesalers
whQ are seeking tQ raise their margins. 19 	By limiting intra brand competitiQn
from 	gray market goods, across-the-board 	restrictions on gray 	market gQQds
might therefore allQw retailers or whQlesalers tQ raise their margins fQr all
brands 	in 	an 	industry. 	Since excessive 	retail 	Qr 	whQlesale 	margins 	WQuid
reduce 	the demand 	experienced 	by 	manufacturers, manufacturers 	might 	be
expected tQ resist 	retailer Qr wholesaler cQllusiQn. 	Facilitating gray market
impQrts might be a way in which manufacturers resist distributQr cQllusiQn Qf
this 	type. 	If 	SQ, 	gray 	market 	imports 	benefit 	consumers 	by 	helping
manufacturers tQ limit distributQrs' markups. 	Use Qf the CustQms Service tQ
pQlice 	collusive agreements 	impQsed 	by distributQrs WQuid 	harm CQnsumers
and nQt be an apprQpriate use Qf gQvernment funds.
C. 	Disciolining Exclusive Djstribu!Qrs2o
A 	PQtential 	source 	of 	cQnflict 	between 	manufacturers 	(or 	their
vertically 	integrated 	wholesalers) 	and 	distributors 	is 	the 	size 	of 	the
distributor 	margin. 	A 	distributor 	with 	exclusive 	distribution 	rights 	fQr 	a
brand 	may 	seek 	to 	widen 	its 	margin, e.g. 	in 	response 	to an 	unanticipated
increase 	in 	market 	pQwer 	when 	the 	dQllar 	is 	appreciating. 	In 	this 	case,
HI 	To dQ this, distributQrs must be able tQ threaten the manufacturer
intQ 	adQpting 	pQlicies 	that 	would 	be 	against 	its 	best 	interests 	absent 	the
threat. 	See Overstreet, Qp. cit.
20 	For discussiQns Qf this argument, see Overstreet, Qp. cit., pages 25·
32, 	and 	R. 	Steiner, 	-Basic 	Relationships 	in 	CQnsumer 	Goods 	IDdustries.~
Research in Marketjng. VQI. 7, 1984, pages 165-208.
12

manufacturers may have incentives to discipline their distributors. 21 	In some
cases, manufacturing firms may find that gray markets are an efficient way
to discipline their retailers.
Since 	the 	purpose of 	gray 	market 	imports 	in 	this context 	may 	be 	to
reduce 	market 	power, Customs Service 	restrictions on 	gray 	market 	imports
could 	harm 	consumers 	by 	disrupting 	manufacturers' 	efforts 	to 	discipline
retailers.
D. 	Price Discrimination
Another 	potential 	explanation 	for 	gray 	market 	goods 	is 	price
discrimination 	against 	American 	consumers 	practiced 	by 	foreign
manufacturers. 	In 	considering 	the 	price 	discrimination 	explanation, 	it 	is
important 	to 	note 	that 	price 	discrimination 	can 	produce 	greater 	harm 	to
consumers in the international context than in the domestic context. 	When
price discrimination takes place domestically, the profits remain in the U.S.
In contrast, when the price discriminating firm is foreign, the profits from
the price discrimination are transferred out of the U.S. economy entirely.
21 	Some evidence consistent with this argument has been reported in
camera sales. 	Hasselblad camera company decided to meet gray marketing in
the 	U.S. 	by 	offering 	direct 	consumer 	rebates 	for 	authorized 	imported
cameras. 	See "'Gray Market' Hits Camera, Watch Sales," Advertising Age,
pages 	3 	and 	62. 	The 	use 	of 	direct 	rebates 	to 	consumers 	rather 	than
wholesale discounts may indicate uncertainty that wholesale discounts would
be fully passed along to consumers.
Porsche, 	another 	company 	with 	significant 	gray 	market 	imports,
announced plans to abolish its traditional franchise system, although it later
reconsidered 	its 	plans 	after 	being 	sued 	by 	the 	Porsche 	dealer 	association.
See "Lower Price Porsche Due for U.S. in 	1986," Automotive News. May 20,
)985, pages 1 and 62.
Several respondents to the Commerce Department survey noted strained
relationships with retailers as a result of gray market imports. 	See question
B.S.
13

Rather 	than 	charging 	the 	same 	prices 	relative 	to 	costs 	in 	all
locations,22 some firms might find it feasible to charge higher prices to U.S.
consumers. 	For 	an 	individual 	firm 	to 	practice 	geographic 	price
discrimination of 	this sort, it 	must 	be able 	to exercise some market power
with 	its 	particular 	brand(s).2! 	To 	exercise 	such 	market 	power, 	the 	seller
would 	have 	to 	differentiate 	its 	brand 	from 	other 	brands 	and 	restrict
arbitrage. including gray market imports. 	Even then market power would be
short lived 	unless barriers to entry were high 	or entry lags were long due
either 	to 	inherent 	industry 	characteristics 	or 	to 	government 	intervention
.(such as patents).
Geographic price discrimination also might originate through collusion
among 	manufacturers. 	Collusion 	would 	limit 	the 	threat 	of 	interbrand
competition 	to geographic price discrimination. 	Success would still depend,
however, 	on 	entry 	barriers 	and 	on 	limiting 	arbitrage 	from 	gray 	market
imports.
Another potential source of price discrimination that might give rise to
gray market goods is cartelization imposed by foreign governments. 	Foreign
governments 	may 	assist 	cartelization 	simply 	to 	transfer 	wealth 	from 	the
importing 	nation 	to 	the 	exporting 	na tion. 	Political 	pressure 	on 	the
exporting nation 	to limit 	the volume of exports 	may also lC3d 	the foreign
22 	See W. Landes and R. Posner, "Market Power in Antitrust Cases,R
Harvard Law Review. Vol 94, March J981, pages 937-996. 	For a critique, see
R. Schmalensee, "Another 	Look 	at Market 	Power 	in 	Antitrust: Cambridge,
Mass.: MlT Sloan School Working Paper J238-8l, July 1981.
23 	Evidence 	of 	price 	discrimination 	in 	the 	sale 	of 	premium priced
automobiles 	within 	Europe 	is 	presented 	in 	Y. 	Martens 	and 	V. 	Ginsburgh,
"Product 	Differentiation 	and 	Price 	Discrimination 	in 	the 	European
Community: The Case of Automobiles,R Journal of Industrial Economics. Vol.
34, No.2, December 1985, pages J51-J66.
14

government 	to limit exports to the 	U.S. 	Ironically, the discrimination and
emergence of the gra y market in this case would stem from U.S. pressure to
limit imports.'·
Whatever the source of the price discrimination, gray markets develop
as 	independent 	importing 	firms, 	retailers, 	or even 	individuals 	purchase 	at
lower 	prices 	abroad 	and 	sell 	at 	higher 	prices 	in 	the 	t:.S. 	Since 	price
discrimination may harm U.S. consumers and impose efficiency losses on the
U.S. economy,2S 	gray markets benefit consumers under this explanation.
Perhaps 	more 	important 	than 	the 	actual 	competition 	effects 	of 	gra y
.market goods are the potential competition effects. 	Manufacturers 	are not
likely 	to 	even 	attempt 	to 	price 	discriminate 	or 	collude 	against 	U.S.
consumers 	if 	gray 	markets 	can 	rapidly 	undercut 	the 	discrimination 	or
collusion. 	Any effort by the Customs Service to make gray marketing more
difficult in the future might therefore harm consumers of goods whose prices
are now constrained by the threat of gray market imports.
2. 	Japanese 	construction 	equipment 	manufacturers 	were 	reportedly
reluctant 	to 	lower 	their 	U.S. 	prices 	for 	this 	reason 	while 	the 	dollar 	was
fmng. 	"Gray Market: 	Boon 	or 	Bane 	for 	Equipment 	Users'?" 	Construction
Equipment. September 15. 1985, pages 55-60, especially page 58.
2S 	Price discrimination has a variety of potential welfare effects. 	The
maximum loss of efficiency would occur if price discrimination is perfect,
but 	all 	of 	the 	transfer 	to 	producers 	is 	consumed 	in 	enforcing 	the
discrimination. 	No efficiency loss would occur if price discrimination were
perfect and no resources were consumed in enforcing the discrimination. 	If
these 	resources 	were 	transferred 	out 	of 	the 	country, 	however, 	U.S.
consumers 	would 	be 	harmed 	without 	any 	compensating 	gain 	by 	U.S.
producers. 	In 	this case, although 	there would 	be no efficiency loss, there
would be a loss in U.S. welfare. 	Other varieties of price discrimination and
other 	levels 	of 	enforcement 	costs or 	international 	transfers 	would 	produce
intermediate levels of social loss or inefficiency in the U.S.
15

E. 	Inefficiencies Induced by Regulation
Some retailers might be more efficient in carrying out some distribution
functions 	that 	are 	usually 	provided 	by 	the 	manufacturers. 	If 	this 	is 	the
case, distribution costs could be reduced if manufacturers \lo'ere able to offer
their 	products 	at 	a 	lower 	price 	to 	retailers 	who 	would 	undertake 	such
distribution 	functions. 	Such 	cost-related 	discounts, 	however, 	may 	be
discouraged by perceptions of U.S. pricing regulations,26 which may make the
process 	of 	justifying 	a 	price 	difference 	of 	this 	type 	both 	costly 	and
problematical.
The gray market might provide an avenue through which manufacturers
with foreign operations can offer lower prices to retailers who assume more
of 	the 	distribution 	costS. 27 	If 	so, 	retailers 	taking 	advantage 	of 	gray
market opportunities would 	be substituting some of their own services 	for
the 	manufacturers' services 	that 	are 	not 	provided 	for 	gray 	market 	goods.
This 	arrangement 	would 	not 	be 	economically 	attractive 	to 	gray 	market
importers unless they could 	provide these services at a lower cost than the
authorized distributor.28
26 	The 	Robinson-Patman 	Act 	bars 	price 	discrimination 	between
retailers 	that 	is 	not 	cost-justified. 	Several 	commentators 	have 	suggested
that the burden of proving that price differences are cost-justified has been
quite 	onerous. 	See, 	for 	example, 	R. 	Posner, 	The 	Robinson-Patman 	Act:
Federal 	Regulation 	of 	Price 	Differences, 	Washington, 	D.C.: 	American
Enterprise 	Institute, 	1970; 	U.S. 	Department 	of 	Justice, 	Reoort 	on 	the
Robinson-Patman 	Act, 1977; and F. Scherer, Industrial Market Structure and
Economic Performance. 2nd cd., Chicago: Rand McNally. 1980. page 578.
27 	To the extent this scenario is true, one would 	Dot expect foreign
manufacturers to be enthusiastic about Customs Service restrictions on gray
markets.
28 	It 	is 	possible 	that 	a 	whole 	class 	of 	retailers 	will 	fit 	into 	this
category and that this class of retailers will be in competition with another
class 	of 	retailers 	that 	require 	the 	higher 	cost 	services 	provided 	by 	the
manufacturer. 	During the evolution of retailing from one type of retailer to
16

Where 	gray 	markets 	facilitate 	efficient 	wholesale 	pricing, 	Customs
Service 	efforts 	to 	restrict 	gray 	market 	imports 	would 	impose 	efficiency
losses on the U.S. economy and higher prices on U.S. consumers.
V. 	EMPIRICAL EV ALUA TlON OF ALTERNATIVE EXPLA~ATIONS
In the previous sections, several alternative theoretical explanations for
gray 	market 	imports 	were 	identified. 	Apart 	from 	the 	free 	rider 	and
consumer deception theories, these theories generally suggest that consumers
are likely to benefit from gray market imports. 	In this section, we examine
the 	empirical 	support 	for 	the 	various 	theories. 	We 	find 	that 	there 	is
insufficient 	basis to conclude 	that gray market 	imports are caused by free
rider or consumer deception problems.
We focus on four charaacteristics of gray market import that shed some
light 	on 	the 	alternative 	explanations:29 	gray 	market 	imports 	were 	not
observed in most industries before 1981; manufacturers' wholesale prices and
profits often have differed across countries when gray market imports have
been prominent; manufacturers' efforts to curtail gray market imports have
sometimes been contradictory or less complete than one might expect if free
riding 	were 	the 	main 	cause 	of 	gray 	market 	imports; 	and 	systematic 	and
another, 	manufacturers 	might 	be 	under 	pressure 	from 	the 	older 	form 	of
retailer 	not 	to 	offer 	the 	cost-justified 	discount 	to 	the 	newer 	form 	of
retailer. 	(This 	sort 	of 	conflict 	over 	retail 	innovations 	in 	the 	grocery
business 	contributed 	significantly 	to 	passage 	of 	the 	Robinson-Patman 	Act.
See M 	Adelman's well known analysis, A&P; A Study in Price-CQst Behavior
and 	Public PQlicy, Cambridge, Mass.: Harvard University Press, 	1959.) 	See
alsQ Overstreet, Qp. cit. and 	pages 25-32 	and the 	case studies described Qn
pages 	106- J 60. 	CQnsistent 	with 	this 	interpretation, many 	retailers Qf gra y
market gQods are discount Qr mail order firms including large retail chains
that 	prQvide 	their 	Qwn 	warranties and 	other services. 	See 	the 	CQmmerce
Department survey results, page 6.
See the appendix for details.
17

material 	consumer 	deception 	has 	not 	been 	found 	in 	the 	Commission's
investigations of gray markets. 	These characteristics are discussed below.
A. 	Lack of Gray Markets before 1981
If gray market goods were largely a free rider or consumer deception
phenomenon, appreciable levels of gray market imports would probably have
been observed for many years, in particular before the rapid appreciation of
the dollar that began in 1980.s0 	For example, at the purely domestic level,
secret 	sales 	by 	authorized 	dealers 	to 	unauthorized 	dealers 	in 	other
geographic 	areas 	have 	been 	repeatedly 	reported 	within 	the 	U.S. 	where 	no
exchange rate issues exist. sl 	In addition, gray market flows not only to but
from the U.S. most likely would have occurred regularly, since manufacturers
and 	distributors 	would 	find 	it 	profitable 	to 	free 	ride 	on 	promotion 	and
services offered 	by 	distributors 	abroad 	or 	to deceive 	consumers 	abroad 	as
well as in 	the 	U.S. 	Instead, 	in several 	industries, we find 	no mention 	of
gray market 	imports prior to 	1980-81, and only 	limited amounts of reverse
gray market flows have been observed, and these have occurred only when
the dollar has declined in value.52
30 	What 	is 	not 	expected 	is 	the 	virtual 	absence 	of 	reports 	of 	gray
market activity 	before 	1980. 	For free riding to be the dominant cause of
gray market imports, but for gray marketing to be dormant until J981, all of
the 	gray 	market 	industries 	must 	have 	had 	free 	rider 	incentives 	that 	were
just 	shy 	of 	the 	shipping 	and 	related 	transaction 	costs 	of 	establishing
channels of gray market distribution.
31 	See 	Overstreet, 	op. 	cit., 	for 	discussion 	of 	cases. 	Also 	see, 	D.
Coursey, "Compaq's Canion: Micro Gray Mart 	Is 	IBM's 	Fault," Management
Information Systems Week. April 7, 1986, pages 21, 46.
52 	A small volume of reverse gray market trade has been reported to
the FTC staff by camera distributors, but it has occurred only over the last
few months as the dollar has declined.
18

The 	reported 	lack 	of 	gray 	market 	imports 	before 	the 	1980s suggests
that free riding or consumer deception are unlikely to be the sole incentives
underlying gray 	market imports in the 	1980s. 	However, there could 	be an
interaction 	between 	free 	rider 	incentives 	and 	lags 	in 	exchange 	rate
adjustments. 	For example, a product sold in both Europe and the U.S. might
be promoted with extensive national advertising only in the U.S. with costs
per unit 	of 20 cents. 	If transactions costs were 25 cents per unit through
gray market channels, no gray market activity would be observed. 	However,
if a currency revaluation 	took place and 	prices in 	the 	U.S. were ten cents
higher 	as 	a 	result, 	extensive 	gray 	market 	imports 	might 	occur. 	While 	it
would be true 	that the revaluation triggered the gray market imports, most
of the reason would be incentives to free ride. 	There is insufficient data to
evaluate this possibility empirically.
B. 	Wholesale Price Differences
Wholesale price differences between countries (even after adjusting for
cost differences including transportation) were apparently common in several
industries when the dollar was rising. 	In the Commerce Department survey,
several respondents acknowledged this. 	This may be due to adjustment lags.
Neither 	the 	free 	rider 	nor 	the 	consumer 	deception 	theories 	predict 	these
wholesale price and profit differences.
C. 	Modest Manufacturer Efforts to Curtail Gray Markets
Although some foreign manufacturers whose products are gray marketed
have 	evidenced 	substantial 	interest 	in 	curtailing 	gray 	markets, 	many
manufacturers have 	failed 	to 	take seemingly low-cost actions (for example,
19

labeling products distributed 	through authorized channels) that 	might solve
their 	problem. 33 	Other 	manufacturers 	have 	taken 	actions 	that 	seem
inconsistent with full opposition to gray market imports. 	Cnder a free rider
hypothesis, manufacturers should oppose gray market imports, and ambiguous
manufacturer 	behavior 	toward 	gray 	market 	imports 	should 	be 	rare. 	This
observed 	ambiguous 	behavior 	is 	consistent 	with 	the 	retail 	discipline 	and
distributor collusion hypotheses.
D. 	Lack of Substantia! Systematic Consumer Deception
In the Commission staff's investigations of complaints about deception
from 	gray 	market 	imports, 	insufficient 	evidence 	has 	been 	found 	to
recommend Commission intervention under Section 5 of the F.T.C. Act. 	We
conclude 	that 	consumer 	deception 	is 	not 	widespread 	enough 	to 	justify
government intervention of the type contemplated by the Customs Service.
VI. 	SUMMARY
The Customs Service proposal to relabel or demark gray market goods
is 	based on 	two conclusions: (I) government 	restrictions are appropriate 	if
sellers 	are 	free 	riding 	or 	deceiving 	consumers 	and 	(2) 	free 	riding 	and/or
deception are the reasons for gray market imports. 	Our analysis leads us to
reject both of these conclusions. 	First, there are less intrusive remedies to
free 	riding 	and 	consumer 	deception 	are 	available. 	Second, 	the 	empirical
evidence is insufficient to conclude that gray market imports are caused by
free riding or consumer deception.
33 	Failure 	to 	take 	more costly actions does not 	necessarily imply a
lack 	of 	interest 	in 	stopping 	gray 	market 	imports, 	just 	a 	recognition 	that
such efforts are too costly relative to the expected benefits.
20

Alternative Remedies: 	Even if free riding or consumer deception were
found, several factors argue against the type of governmental restrictions on
international 	trade 	the 	Customs 	Service 	has 	proposed. 	Most 	importantly,
private 	remedies 	such 	as 	additional 	labeling 	efforts 	by 	manufacturers,
changes in promotional strategies, additional private enforcement of vertical
contractual 	agreements, 	or 	new 	forms 	of 	product 	differentiation 	might 	be
expected 	to 	develop 	to 	alleviate 	any 	substantial 	remaining 	consumer
confusion and 	free 	riding. 	This is the approach that has been 	taken with
domestic free riding problems. 	In addition, alternative publi: remedies are
. also available. 	In particular, Section 5 of the F.T.C. Act alre:ldy invests the
Commission with authority to intervene where gray market imports deceive
consumers.
Inconclusive 	Empirical 	Evidence: 	The 	analysis 	in 	this 	commen t
identifies a 	number of alternative reasons why gray market imports might
occur. 	Some 	of 	these 	theories 	suggest 	that 	gray 	market 	goods 	benefit
consumers. 	The available empirical evidence is not systematic or complete
enough to enable us to accept or reject any of the theories for gray market
imports. 	The 	possibility 	that 	gray 	markets 	arise 	because 	of 	lags 	in
manufacturers' 	adjustments 	to 	exchange 	rate 	changes 	appears 	to 	be
consistent with many of the reported characteristics of gray market imports,
but 	some 	of 	the 	evidence 	is 	inconsistent 	even 	with 	this 	explanation.
Therefore, although fuller empirical information might conceinbly allow the
Customs Service to conclude that free riding or consumer deception underlie
some 	gray 	market 	imports, 	the 	current 	information 	is 	inadequate to 	reach
such a conclusion. 	Given the extensive array of private remedies available,
21

it is also questionable whether residual free rider problems could account for
a substantial level of gray market activity.
In 	addition 	to 	these 	two 	principal 	reasons 	for 	rejecting 	the 	Customs
Service 	proposals, 	there 	may 	be 	two 	additional 	potential 	costs 	of 	the
Customs 	Service 	proposal 	which 	require 	consideration 	and 	which 	weigh
against 	the 	proposa Is. 	First, if 	the 	Customs Service 	were 	to 	restrict 	gra y
market 	goods, 	it 	could 	result 	in 	higher 	cost 	for 	consumers 	who 	would
increasingly import gray market goods directly under Section 1526(d) of the
Tariff Act of 1930. 	This section explicitly allows importation of gray market
goods 	for 	personal 	use.s• 	Forcing consumers 	to 	do 	the 	importing 	directly
themselves 	rather 	than 	allowing 	a 	firm 	to 	act 	as 	their 	agent 	is 	likely 	to
raise consumers' costs if there are economies of scale in searching for gray
market 	goods and 	importing 	them.ss 	Second, U.S. 	trade 	relationships with
other countries are not necessarily robust and rational, especially in the area
of 	import 	restrictions. 	U.S. 	consumers, 	as 	well 	as 	consumers 	around 	the
world, have a great deal to lose from disruption of free trade relationships.
For 	this 	reason, 	government-imposed 	blanket 	trade 	restrictions 	that 	may
invite 	retaliatory 	trade 	restrictions 	in 	other 	countries 	pose 	a 	risk 	of
substantially harming consumers generally.
,. 	For a discussion, see A. Parten, ·Olympus Corp. v. United 	States:
A Study 	in 	Imperfect 	Parallels," 	unpublished, 	University 	of 	Virginia 	Law
School, J 986.
35 	See, for 	example, "Auto 'Gray Market' Takes Ofr: L. A. Times,
December 30, 1984, Section V, pages 2-3.
The existence of the personal exemption from gray market restrictions
also 	raises 	the 	possibility 	that 	restrictions 	on 	gray 	market 	imports 	could
result 	in 	efforts 	to 	circumvent 	the 	restrictions 	through 	cooperative buying
arrangements. 	This 	could 	make 	the 	new 	restriction 	difficult 	to 	enforce
without violating the intent of the personal exemption section of the
statute.
22

· .
Given 	the contrasting implications of the alternath'e explanations for
gray market goods, the inconclusive empirical information, and the additional
potential costs of the Customs Service proposals noted above, 	the FTC staff
concludes 	that 	the 	proposals 	could 	pose 	a 	significant 	risk 	of 	harming
consumers rather than helping them in both the short run and the long run.
The FTC staff therefore advises against changing the Customs Service gray
market rules.
23

APPENDIX A. THE NATURE AND EXTENT OF THE GRA Y MARKET
Empirical information on the nature and extent of the gray market is
quite limited. 	The most widely cited source of data on gra)" markets is the
Department of Commerce survey of 1984. 1 	Scattered news reports and public
releases 	by 	firms 	involved 	in 	importing gray market 	goods or 	in 	opposing
gray market imports make up the rest of the publicly available information.
On 	the 	basis of 	these 	largely 	anecdotal sources and 	the Commission's own
investigations of alleged consumer deception in gray markets. the 	following
are characteristics reported about gray market imports:
1. 	The 	volume 	of 	gray 	market 	imports 	into 	the 	Cnited 	States 	has
increased 	and 	decreased 	with 	the relative value of the 	dollar'. 	Few 	gray
market goods were imported into the United States prior to 1981, except for
photographic equipment which appeared in substantial quantities beginning in
1 	"Economic Effects of Parallel Imports: A Preliminary Analysis," U.S.
Department of Commerce, Patent and Trademark Office, 1985.
2 	The Commerce Department survey, op. cit., asked for the time path
of 	gray 	market 	imports. 	Respondents 	indicated 	that 	gray 	market 	goods
increased 	after 	1981 	while 	the 	value 	of 	the 	dollar 	was 	in.:reasing. 	This
pattern has also been noted in numerous press accounts. 	For example, "The
$7 	Billion 	Gray 	Market: 	Where 	It 	Stops, 	Nobody 	Knows," 	Business 	Week,
April 15, 1985, pages 86-87; "'Gray Market' Fight Isn't Black and White," The
National 	Law 	Journal, 	October 	28, 	1985, 	pages 	1,22-23; "Gray 	Market' 	in
Camera 	Imports 	Starts 	to 	Undercut 	Official 	Dealers," 	Wall 	Street 	Journal,
April 	I, 	1982, page 29; "Importers See Red Over Gray Market," Advertising
Af&, July 21, 1980, page 57; and "Gray Market: Boon or Bane for Equipment
Users?" 	Construction 	Equipment, September 	IS, 	1985, 	pages 	55-60. 	Active
gray markets for construction and other industrial equipment did not appear
until fairly 	late in 	the rise of the dollar in 	the 	1980s. 	See "Gray Market
Expands to Industrial Goods," ~ July 1985, page 22.
Some firms involved in gray market imports of construction equipment
into the U.S. were active in 	1970s in gray market exports from the U.S. to
Japan. 	See "Gray Market: Boon or Bane for Equipment Users'?" Construction
Equipment, September IS, 1985, pages 55-60.

the 	mid 	1970s. 3 	Since the 	value of the dollar 	began 	falling against 	other
major currencies in 1985, gray market imports have declined significantly.·
2. The brands involved in gray markets are usually premium brands that
are 	among 	the 	most 	highly 	differentiated 	in 	their 	category 	in 	the 	United
States 5. 	Part 	of this differentiation 	has 	been accomplishe-: 	through 	media
3 	Several 	respondents to the 	Commerce Department survey indicated
that no gray market activity was know to them prior to the increase in the
value of the dollar in the 1980s. 	For cameras, Pentax and Hasselblad found
no 	gray 	market activity until 	after 	1980. 	Nikon 	experienced 	gray 	market
activity earlier. 	The earlier advent of gray markets in cameras may have
stemmed 	from 	a 	tactical 	shift 	in 	the 	distribution 	policies 	of 	Canon, 	a
Japanese manufacturer. 	In the mid-1970s, Canon discontinued using Bell and
.Howell 	as 	its 	U.S. 	distributor 	and 	simultaneously 	undertook 	a 	major
expansion of output in Japan. 	This apparently resulted in expanded output
by 	several 	Japanese 	manufacturers 	(because 	of 	their 	concern 	about
maintaining 	their 	market 	shares) 	and 	substantial 	pressure 	on 	Japanese
distributors 	to 	increase 	Japanese 	sales. 	This 	may 	have 	reduced 	prices 	in
Japan 	generally 	and 	led 	to 	gray 	market 	exports 	before 	the 	currency
revaluations of the 	1980s. 	See "'Gray Market' in Camera Imports Starts to
Undercut Official Dealers," New York Times, December 11, 1982, pages L41
and L43.
4 	See, 	for 	example, 	"Dollar's 	Drop 	Drubs 	Gray 	Marketeers,"
Washington 	Post. May 4, 	1986, page 	F3, and "Is the Gray Market Dead 	or
Alive?," 	Modern 	Tire 	Dealer, 	July 	1985, 	pages 	17-18. 	In 	fact, 	many 	gray
market automobile importers have reportedly exited. 	See "Dollar Dulls Auto
Gray Market," Journal of Commerce and Commercial. March 4,1986, page lA(2).
5 	That is, the 	brands have no very close substitutes. 	For a recent
discussion, see R. Caves and P. Williamson, "What Is Product Differentiation,
Really?," Journal 	of Industrial 	Economics, 24:2, December, 1985, pages 	113-
132. 	Reported gray market activity has been particularly intense in brands
that 	have 	the 	highest 	prices. 	See 	generally, 	"A 	Cheaper 	Way 	to 	Get 	the
Goods," 	Insight, 	October 	21, 	1985, 	pages 	56-58. 	The 	respondents 	to 	the
Commerce Department survey emphasized 	these products too. 	See question
A.I. for a listing.
Although 	gray 	market 	goods 	have 	predominantly 	been 	highly
differentiated 	premium 	products, 	gray 	markets 	have 	also 	arisen 	in 	some
industrial products where an unexpected supply situation in one country has
developed. 	This 	reportedly 	occurred 	for 	computer chips and 	construction
equipment in 	1985. 	In both cases, unanticipated declines in world demand
were followed 	by growth in U.S. demand 	relative to foreign demand. 	See
"The $7 Billion Gray Market: Where It Stops, Nobody Knows," Business Week,
April 	15, 1985, pages 86-87, and "Gray Market: Boon or Bane for Equipment
Users?" Construct jon Equipment, September 15, 1985, pages 55-60.
2

advertising by the 	manufacturers. 6 	The 	value 	of gray 	market imports has
apparently 	been 	greatest 	in 	the 	premium-priced 	automobile, 	watch, 	and
camera 	equipment 	businesses. 	Gray 	market 	imports 	are 	also 	commonly
reported 	in 	premium 	tires, 	perfumes, 	ski 	equipment, 	wine$, 	and 	consumer
electronics.
3. 	U.S. 	wholesale 	prices 	for 	products 	with 	significant 	gray 	market
activity 	were 	commonly 	substantially 	higher 	than 	comparable 	foreign
wholesale prices when the dollar was appreciating 7. 	Cost differences do not
appear sufficient to explain all these wholesale price differences. 8 	However,
6 	See 	the 	Commerce 	Department 	survey 	results, 	question 	B.3.
Camera, 	perfume, 	and 	ski 	boot 	respondents 	reported 	advertising 	and
promotion 	costs as 	15% to 30% of sales. 	Consumer 	electronics respondents
reported advertising costs of 5% of sales.
7 	Several firms replying to the Commerce Department survey confirmed
charging 	different 	prices in 	different countries. 	None 	of the 	respondents
denied 	fOllowing 	this 	practice. 	See 	question 	6.d. 	for 	these 	responses.
Nikon, Nordica, Minolta, and Evinrude. each 	noted 	wide differences in 	the
prices 	that 	they 	charge 	at 	the 	wholesale 	level 	at 	least 	partly 	based 	on
demand 	differences. 	K-Mart 	responded 	that 	price 	differences 	were 	the
primary incentive for its gray market imports.
At the request of F.T.C. staff, buyers for the U.S. Army and Air Force
Exchange Service reported data on the wholesale prices paid by their buyers
in different countries for products that have been subject to gray marketing.
Although 	the 	number 	of 	observations 	is 	limited, 	the 	data 	confirm 	that
wholesale prices did differ across countries in several instances. 	The data
are listed in Appendix A.
Numerous press accounts note large wholesale 	price differences across
national 	boundaries. 	See, 	for 	example, 	"The 	Gray 	Market: 	Where 	a 	$200
Watch Can Be Bought for $140," Washington PQst. December 16, 1985, pages
L]-L2; 	"The 	$7 	BilliQn 	Gray 	Market: 	Where 	It 	StQPS, 	l'Qbody 	KnQws,"
Business Week. April 	] 5, 	1986, pages 86-87; "What Price Mercedes?" Forbes,
August 27, 1984, pages 134, 136, 139.
When 	some 	fQreign 	manufacturers 	have 	equalized 	prices across 	areas,
gray 	markets have largely disappeared. 	For example, Michelin 	tires were
gray 	marketed 	until 	it 	recently 	equalized 	prices 	acrQSS 	areas. 	Since 	this
pricing actiQn, gray markets have been nearly eliminated. 	See "Is the Gray
Market Alive Qr Dead?" Modern Tire Dealer. July 1986, pages 17-]8.
8 	CQnsistent 	with 	this 	interpretatiQn, 	fQreign 	manufacturers 	were
repQrted 	to 	have 	earned 	unusually 	high 	profits 	by 	not 	lowering their U.S.
wholesale 	prices as 	the 	dollar 	rose 	in 	value. 	See "Watching 	From Abroad
with Mixed Emotions," Fortune. August 	19, ] 985, page 32. 	WhQlesale prices
have 	also 	reportedly 	differed 	by enough 	to 	make 	it 	prQfitable 	to 	buy 	at
retail 	in Europe for 	export 	to the U.S. 	See "The $7 	Billion Gray Market:
Where It Stops, Nobody KnQws," Business Week. April IS, 1986, pages 86-87.
With 	the 	recent 	drop 	in 	the 	value 	Qf 	the 	dollar, 	Japanese 	firms, 	in
particular, 	are 	reportedly 	taking 	much 	lower 	profit 	margins, 	transferring
productiQn 	to other countries, or making extra cost cutting efforts in order
3

sometimes 	wholesale 	prices 	were 	similar. 	but 	U.S. 	ret3il 	margins 	were
bigher.~
4. Manufacturers have engaged in varying degrees of private efforts to
curtail 	gray 	market 	imports lO 	under 	the 	current 	Customs 	Service 	policy.
While 	some 	manufacturers 	have 	made 	efforts 	to 	discourage 	gray 	market
trade, several available private remedies, such as labeling authorized imports
to protect their market shares in the U.S. 	The stature of U.S. competitors
appears to playa role in these decisions. 	For example, Fuji has apparently
raised its prices for film across the world except in the CS. where Kodak
has its most dominant position. 	See "As the Japanese Yen Grows Stronger,
Why Aren't Import Prices Soaring?" Wall Street Journal. J~ly 30, 1986, page
21.
~ 	Some 	veteran 	gray 	market 	importers 	attribute 	gray 	marketing 	to
. higher 	distributor 	profits 	for 	authorized 	dealers 	as 	we1: 	as 	to 	currency
fluctuations. 	See 	"Conversation 	with 	a 	Gray 	Mark:teer," 	Consumer
Electronics. 	July 	1985, 	pages 	49-50. 	Some 	of 	the 	data 	supplied 	for 	the
Commerce Department survey showed both higher wholesale and higher retail
margins in the U.S. 	See question A.6.b.
10 	Some manufacturers present a somewhat split policy on gray market
goods. 	For 	example. although 	Mercedes 	makes 	efforts 	to 	discourage 	gray
market 	goods 	through 	publicity and 	contacts 	with 	financial 	and 	insurance
institutions, it provides a delivery center, factory tours, and dining facilities
for 	U.S. citizens buying their cars at the factory. 	See "A Cheaper Way 	to
Get 	the 	Goods," 	Insight. 	October 	21, 	1983, 	pages 	56-58. 	Camera
manufacturers reportedly 	undertook substantial enforcement efforts to find
and dismiss dealers in Hong Kong who sold to the U.S. gray market during
the mid-1970s. 	Since then, supply sources have shifted to Europe. See "The
$7 	Billion 	Gray 	Market: 	Where 	It 	Stops, 	Nobody 	Knows: 	Business 	Week,
April 	15, 	1986, 	pages 	86-87. 	At 	the 	same 	time, 	the 	presence 	of 	various
export licensing requirements in Japan suggests that Japanese manufacturers
who were intent on monitoring gray market exports from Japan could do so.
See ·Conversation with a Gray Marketeer," Consumer Electronics, July 	1985,
pages 49-50.
Few efforts by authorized importers or manufacturers to use labels to
distinguish authorized imports from gray market imports were reported in the
Commerce 	Department 	survey 	of 	gray 	market 	practices. 	(See 	responses 	to
question 	B.13 	in 	the 	survey.) 	However, 	some 	camera 	manufacturers 	do
require 	that 	retailer 	advertisements 	affirmatively state 	that 	the 	product 	is
guaranteed 	by 	the 	manufacturer 	in 	order 	to 	be 	eligible 	for 	cooperative
advertising incentives. 	See Vivitar Corp. vs United States. 593 F. Supp. 420,
435 (C.l.T. 1984); ·'Gray Market' Fight Isn't Black and White,· National Law
Journal. October 28, 1985, pages 1, 22 and 23; and "'Gray Market in Camera
Imports Starts to 	Undercut 	Official 	Dealers," 	Wall Street Journal, 	April 	I,
1982, page 29. 	Pirelli tire company also reportedly decided to delete all of
the DOT Codes from 	tires not designated 	for distribution in the U.S. 	See
"Pirelli Ends DOT Code on Future non-USA Tires," Tire Review. November
1985, page 19.
4

or 	using different trademarks in 	different countries 	ha\'e 	not been 	widely
utilized.
S. 	Imported 	gray 	market 	products 	are 	usually 	physically 	close
substitutes for the authorized imported products.ll 	The principal differences
involve services sold with the product 12 , 	particularly 	warranties,13 although
slight model differences are common.l •
11 	An exception is European automobiles. 	The automobiles available
in 	Europe 	lack 	emission 	control 	devices 	required 	in 	the 	U.S. 	as 	well 	as
several required safety features. 	All automobiles imported into the U.S. have
to 	be refitted 	to 	include these items. 	Even with 	these adjustments, which
usually 	cost 	several 	thousand 	dollars, 	European 	wholesale 	prices 	were
considerably 	lower 	than 	U.S. 	wholesale 	prices 	during 	the 	early 	to 	middle
1980s. 	See "What Price Mercedes?" Forbes. August 27, 1984, pages 134, 136,
and 139.
Claims concerning deterioration of quality in unauthorized distribution
channels have been made for several gray market productS including wines,
ski equipment, batteries, records, perfumes, and photographic equipment. See
the Department of Commerce survey, question B.S.
12 	The 	most 	common 	bundling 	is 	with 	warranty 	or 	repair 	work.
Submissions 	to 	the 	Commerce 	Department 	survey 	included 	a 	number 	of
consumer complaints indicating that some consumers apparently assumed that
warranty 	service 	was 	included 	when 	it 	was 	not. 	Consumer 	complaints
received by the Better Business Bureau of Metropolitan New York, the center
of 	U.S. 	gray 	market 	activity, 	have 	also 	focused 	on 	repair 	problems.
Complaints 	of 	this 	type 	have 	involved 	calculators, 	type ..'riters, 	cameras,
electronic 	keyboards, 	and 	electronic 	toys. 	See 	"No 	Guarantees 	for
Guarantees in Gray Market," Wall Street Journal, February 5, 1985, page 33.
Consumer Reports recently reported that retailers stocking gray market
photography 	goods 	now 	routinely 	offer 	products 	both 	,,'ith 	and 	without
manufacturer warranties at different prices. 	See the May 1985 issue, pages
300-301. 	In this way consumers have greater choice with gray market goods
in 	the 	market. 	The 	same 	article 	also 	reported 	that 	a 	convention 	has
emerged 	in 	advertising 	under 	which 	authorized 	imports 	are 	advertised 	as
"U.S. warranty included" while gray market goods do not carry this message.
Gray 	market 	retailers commonly offer their own 	warranties to replace 	the
manufacturer 	warranty. 	See also "The $7 	Billion 	Gray Market: 	Where It
Stops, Nobody Knows," Business Week, April 15, 1985, pages 85-86.
13 	Retail 	chains 	that 	participate 	substantially 	in 	the 	gray 	market
supply 	their 	own 	services 	and 	warranties 	to 	substitute 	for 	those 	of 	the
manufacturerS 	that 	are 	not 	available 	on 	gray 	market 	goods. 	See 	the
Commerce Department survey, op. cit.
14 	Some 	automobile 	gray 	markets, 	in 	particular, 	are 	attributed 	to
manufacturers' 	decisions 	not 	to sell 	a 	particular 	configuration 	in 	the 	U.S.
See 	·Warranty 	War 	Next 	for 	Automobile 	Marketers?" 	Advertising 	Age,
November II, 1985, page 40.
5

6. 	Sufficient 	evidence 	of 	systematic 	nondisclosure 	of material 	facts,
which might 	justify Commission intervention under its Section 5 authority,
has not been found by the Commission staff in any of the investigations of
gray 	market 	goods 	initia ted 	by 	the 	Commission 	in 	the 	1980s. 	Although
authorized 	importers 	have 	shared 	with 	us 	anecdotal 	evidence 	of consumer
injury allegedly resulting from various practices associated vdth the sale of
gray market goods. there was insufficient evidence of a systematic problem
to 	warrant Commission 	action. 	In addition, 	investigations of importers of
gray 	market 	products 	conducted 	by 	the 	FTC's 	Division 	of 	Marketing
Practices in 1983 and 1984 failed to yield sufficient evidcence to substantiate
claims 	of 	consumer 	injury 	resulting 	from 	the 	warranty 	practices 	of 	gra y
market importers.
6

Appendix A
Figure I
Consistency of Facts· and Explanations
explanations
industry
characteristics
positive correl.
with exch. rates
no gray market
prior to 198 I
primarily highly
differentia ted
products
extensive promo-
tional activities
at the
national distr.
level
wholesale prices
different
higher U.S.
retail margins
low manufacturer
enforcement in some
industries
no systema tic
cons. deception
free
ride
Yes
No
Yes
Yes
No
Yes
No
NPR
cons.
decpt.
Yes
No
?
Yes
No
No
?
No
price
discr.
Yes
?
Yes
Yes
Yes
?
?
NPR
col-
lusion
Yes
?
?
?
Yes
NPR
discip.
ret!.
Yes
Yes
Yes
Yes
No
Yes
Yes
NPR
reg.
ineL
?
No
?
Yes
?
Yes
Yes
NPR
exch.
lags
Yes
Yes
Yes
?
Yes
Yes
Yes
NPR
The individual celJs in this matrix indicate whether the particular fact about gray market
imports is generalJy consistent with the matching explanation. 	A question mark 	is used
when the fact is not uniformly consistent or inconsistent with the explanation.
• 	As 	noted 	in 	Section 	III, 	the available 	information 	on 	gray 	market 	goods 	is 	neither
complete 	nor 	particularly systematic. 	Hence, the empirical analysis is subject 	to error.
Although 	the 	exact 	distribution 	of 	gray 	market 	goods 	among 	various 	potential
characteristics is unknown, the available information is sufficient to conclude that there
is diversity in the characteristics of gray market goods. 	A question mark appears in the
table where the 	fact 	has mixed association with the explanation. 	"NPR" appears where
the fact does not have a predictable relationship to the explanation.
7

"
Appendix B
WhoJesale·· and Retail· Prices of Some Gray Market Goods
Prices Paid by Post Exchange··
Authorized 	Gray 	U.S. 	Japan 	W. Germany
Retailer 	Mark.et 	Whole- 	Whole- 	Whole-
Product 	Date Price- 	Price- 	sale 	sale 	sale
Gucci
Watch 	9/86 	167.88 	167.88 	167.88
(9000) 	9/85 295.00 	145.00
Opium
Perfume 	9/86 	37.30 	21.00
0/4 oz.) 	9/85 	32.50 	30.00 	36.00 	21.00
9/83 	30.00
Minolta
Rangefin. 9/86 	discon t. 	99.13
(Frdm.lI) 	9/85 169.99 	69.99 	94.95 	66.09
Nikon
FE-2 	9/86 	discont. 	274.99
(body) 	9/85 239.00 	209.00 	discont. 	179.59
9/83 	276.84 	172.55
Seiko Wt.
(522JI8) 	9/86 	121.00
(522048) 	9/85 	121.00
(xux06) 	9/83 	110.00 	1J0.00 	110.00
Olympus
OM4 	9/86 	385.88
(body) 	9/85 315.00 	289.00 	294.00
• 	Retail 	prices 	reported 	for 	the 	Washington 	area 	by 	Insig1t 	magazine, "A
Cheaper Way to Get the Goods," October 21, 1985, pages 56-58.
•• 	Price 	paid 	by 	buyers 	for 	the 	Army 	and 	Air 	Force 	Exchange Service.
These buyers purchase goods in each country for 	use in the exchange posts
at 	U.S. 	military 	bases 	in 	each 	country. 	They 	report 	the 	prices 	that 	they
have 	paid 	to 	the 	Dallas 	headquarters of the exchange service. 	Buyers are
instructed 	not 	to 	purchase any 	goods that they 	have reason to 	believe are
gray 	market 	goods. 	They 	purchase 	exclusively 	from 	local 	authorized
distributors 	in 	each 	country. 	The 	exchange 	service 	undertakes 	no
international trading of its own. 	Data were made available by G.L. Haynie,
Deputy Chief, Public Affairs, Headquarters Army and Air Force Exchange
Service, Dallas, Texas.