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Oiling or Spoiling?

Parallel Imports in the European Economic Area

Margreet Waterweg Groningen, July 2002

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Oiling or Spoiling?

Parallel Imports in the European Economic Area

Author : M. Waterweg 1st Assessor : Drs. R.L.C.I. Julien 2nd Assessor : Mr. W.M.H. Grooten Date : 19th July 2002

The author is responsible for the contents of the report. All rights reserved.

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Executive summary

Executive summary

The research question of this graduation project is:

‘What are the factors that could explain the emergence of parallel imports in the European Economic Area?’

To answer this question, first the literature was reviewed to define the concept of parallel imports and examine the macro-economic explanations for parallel imports.

No seller is an absolute monopolist, because there is no such thing as a perfectly inelastic demand. Market power can be seen as a matter of degree and is inversely related to elasticity of demand. Price searchers have a certain degree of market power and can raise their prices if they choose, without losing all their sales. A problem with higher prices than marginal costs, is that such prices are a standing invitation to competition. This is the gap where the parallel importers get in. These parallel imports can be driven by free-riding on promotional efforts of authorised distributors, or by international price discrimination. On the basis of this research it is difficult to say when the imports are driven by free-riding and when they are driven by international price discrimination. This differs between sectors and even between products. First the broad explanations for price differences are examined from a macro-economic perspective to understand the background and later we get more detailed on the subject of price differences.

The ability or inability to discriminate is a crucial factor for the price searcher. This is what they probably do and is partly a cause for parallel imports. A certain level of grey market activity is acceptable for the company if it leads to incremental profits, without damaging relationships with the trade or customers’ perception of the product in the high-priced segment. Beyond a certain level, all grey market activities impair the company’s long-term profitability.

Discrimination is however not by definition a bad thing for consumers. Malueg and Schwartz find that uniform pricing by a monopolist yields lower global welfare than third-degree discrimination for a continuum of markets. If demand dispersion across markets is ‘large’:

though uniform pricing avoids output misallocation, too many markets go unserved. The EEA is a special case where price discrimination within the EEA is condemned for allegedly delaying economic integration, not for its distributional impact.

Trade policy setting in most countries is driven by ‘political economy’ factors, not only economic factors. The ‘political economy’ analysis suggests that if governments are motivated by political economy concerns then even high price destinations may choose to prohibit parallel imports. The lower the demand dispersion (in terms of prices), the less likely is prohibition of parallel imports in high-priced countries because of the reduced gains from discrimination and thus lower lobbying expenditures.

Consequently the literature was reviewed to construct a conceptual model with the explanatory factors relative to the emergence of parallel imports. Seven explanatory factors were found:

price differences, opportunistic behaviour in the distribution channel, features of the product, intellectual property rights, product availability and accessibility to information. Interviews with seven parallel importers were conducted to verify and adapt the model.

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Executive summary

After the conduction of the interviews and the examination of the results, it is found that the conceptual model can be redefined as follows:

Figure 1: The redefined conceptual model after the interviews

In this research was found that price differences, opportunistic behaviour in the distribution channel and a good network are absolutely necessary for parallel importers. The network explanatory factor was never mentioned before by researchers. Features of the product, product availability and accessibility to information make parallel imports easier, but are not absolutely necessary. Intellectual property rights can be seen as ‘the rules of the game’. If the rules do not accept parallel imports, there is no game unless you cheat.

The network is as already mentioned, a totally new explanatory factor for parallel imports. This was not named as an explanatory factor relative to parallel imports before, but in this research is found that it is the most important asset of a parallel importer. To be successful in this business you need to have a good network is what every respondent stated. It is a barrier for new entrants. To get useful information, to do fast trading and to find new markets a good and trustworthy network is needed.

A network can be defined as organisations that are a closely interwoven. This kind of relationships are necessary to be able to handle the fast changes in the environment of the parallel importer. To respond flexibly and efficiently to the needs of current and potential partners, the network firm must maintain and enhance its ability.

Trust is important to remain flexible and react quickly. All activated firms add value to their network by sharing information and expertise, demonstrating goodwill and trustworthiness, and making certain their firms meet and exceed all their responsibilities. Parallel imports can be divided into two streams of goods; a continuous stream and an incidental stream. For these different streams, different network are used. A stable network for the continuous stream and a dynamic network for the incidental stream.

Intellectual Property Rights

Necessities Price differences

Opportunistic behaviour in distribution channels

Network

Stimulators Global features of the product

Accessibility to information

Product availability Emergence of

parallel imports

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Executive summary

The discriminatory monopolist and exchange rate differences were found to be the main explanatory factors of price differences. Supplier price policies and odd lots are important as well and differences in excise taxes are only interesting in the liquor imports, since that is the only product in this research with excise taxes. Differences in the Product Life Cycle of a product is a new explanatory factor of price differences that was found in this research.

Lack of control from the trademark owner is named in this research as the most important explanatory factor for opportunistic behaviour. New explanatory factors to co-operate with parallel importers that were found included the high sales targets from the trademark owner for the official distributor, long distribution channels and the fact that the parallel importer is sometimes the same company as the official distributor.

Brand awareness and uniformity were mentioned by the respondents as very important features for a product attractive for parallel imports. Interesting is that two respondents stressed that they do not want to trade in service intensive products. Together with the high degree of brand awareness that is needed for a product does this suggest that there is free-riding on marketing and PR-costs, but not on service costs although this is claimed in the literature. A high rate of circulation, high concentration of value and high margins are other important new features that make a product attractive for parallel imports. Very exclusive products with very high margins appeared to be not attractive, because the demand is too low and the risk too high.

Products that are sold in selective distribution channels are more interesting for parallel imports, because not every distributor is allowed to sell it and thus tries to get it on the parallel market. In contrast to what was asserted in the literature, this was a very important explanatory factor for parallel imports.

Internet was named as an important source of information together with travelling, duty-free fairs and duty-free magazines. However, these sources of information are only useful if the parallel trader possesses a network that provide information, otherwise it is impossible to interpret and find the right information.

Intellectual property rights can be seen as ‘the rules of the game’. Within the EU, parallel importing between member states is considered central to promoting a common market. Four respondents knew the law, two did not and one did not want to get into this subject. The fact that the respondents know the law, does however not mean they obey it. Sometimes they take the risk anyway, because products from outside the European Economic Area are far more profitable. Their defence is that trademark law is not meant to prohibit parallel imports, but to defend the consumer against fake products. Parallel imports can be driven by free-riding on promotional efforts of authorised distributors, or by international price discrimination. However, trade policy setting in most countries is driven by ‘political economy’ factors, not only

economic factors. The lower the demand dispersion (in terms of prices), the less likely is prohibition of parallel imports in high-priced countries because of the reduced gains from discrimination and thus lower lobbying expenditures. All these things should be taken into consideration in government policy. However, the EU is a special case where price

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Executive summary

discrimination within the EU is condemned for allegedly delaying economic integration, not for its distributional impact.

The general feeling is that the unification of Europe did not make parallel trade easier. The prices converge more, because there are no exchange rates and trademark owners discriminate less inside the European Economic Area. The trademark owners centralise their headquarters and production in the European union and that makes it easier for them to fight parallel imports.

There are more products with a global product strategy, what makes these products more suitable for parallel import. But since price differences are an absolute necessity for parallel imports, global product strategies do not have a positive influence on the amount of parallel imports if there are no differences in price. The fact that the market is more transparent now, is not considered to be positive for parallel traders as well. The market is more transparent for consumers and trademark owners, the parallel trader is only helped by intransparency.

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Table of Contents

Table of Contents

EXECUTIVE SUMMARY...1

LIST OF TABLES AND FIGURES...8

TABLES...8

FIGURES...8

PREFACE...9

CHAPTER 1: INTRODUCTION...10

CHAPTER 2: RESEARCH DESIGN ...13

2.1 THE PROBLEM STATEMENT...13

2.2 THE RESEARCH MODEL...15

2.3 METHODOLOGY...16

2.3.1 Research philosophy...16

2.3.2 Research Approach...17

2.3.3 Research strategy ...17

2.3.4 Time horizon...18

2.3.5 Data collection method ...18

CHAPTER 3: PARALLEL IMPORTS...20

3.1 INTRODUCTION...20

3.2 DEFINITIONS OF PARALLEL IMPORTS...20

3.3 WHAT ARE THE DIFFERENT TYPES OF PARALLEL IMPORTS? ...21

3.4 CONCLUSION...23

CHAPTER 4: THE MACRO-ECONOMICS OF PARALLEL IMPORTS IN THE EUROPEAN ECONOMIC AREA...26

4.1 INTRODUCTION...26

4.2 WHO IS A MONOPOLIST?...26

4.3 THE LAW OF DEMAND...26

4.4 PRICE SEARCHERS...27

4.5 PRICE DISCRIMINATION...29

4.5.1 Price discrimination in the European Economic Area...31

4.6 POLITICAL ECONOMY CONSIDERATIONS...32

4.7 CONCLUSION...32

CHAPTER 5: WHAT ARE THE EXPLANATORY FACTORS RELATIVE TO THE EMERGE OF PARALLEL IMPORTS MENTIONED IN THE LITERATURE? ...35

5.1 INTRODUCTION...35

5.2 LITERATURE REVIEW...35

5.2.1 Descriptive and strategic studies...35

5.2.2 The legal aspects of grey market activity ...38

5.2.3 Trade publications...39

5.3 THE CONCEPTUAL MODEL...40

5.3.1 The model...40

5.3.2 Relevant variables ...40

5.4 CONCLUSION...41

CHAPTER 6: PRICE DIFFERENCES ...44

6.1 INTRODUCTION...44

6.2 WHAT TYPES OF PRICE DIFFERENCES DO EXIST? ...45

6.3 WHEN IS THE PRICE DIFFERENCE BIG ENOUGH TO BE INTERESTING FOR PARALLEL IMPORTS?...45

6.4 EXPLANATORY FACTORS OF PRICE DIFFERENCES...46

6.4.1 Differences in production costs ...47

6.4.2 High promotional expenditures by the authorised channel in target country...47

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Table of Contents

6.4.3 Product quality differences between source and target country...47

6.4.4 Over-production in the source country ...48

6.4.5 Exchange rate differences ...48

6.4.6 The power of the discriminating monopolist ...49

6.4.7 Supplier price policies ...50

6.4.8 National price regulations ...50

6.4.9 Differences in excise taxes ...51

6.5 THE EURO...51

6.6 CONCLUSION...52

CHAPTER 7: OPPORTUNISTIC BEHAVIOUR IN THE DISTRIBUTION CHANNEL ...54

7.1 INTRODUCTION...54

7.2 EXPLANATORY FACTORS OF OPPORTUNISTIC BEHAVIOUR...55

7.3 WHAT IS THE POSITION OF THE PARALLEL IMPORTER IN THE DISTRIBUTION CHANNEL? ...57

7.4 WHAT KIND OF DISTRIBUTION CHANNEL WILL THE TRADEMARK OWNER USE? ...57

7.4.1 Control over the distribution channel ...58

7.5 THE FREE-RIDE PROBLEM...59

7.6 WHAT IS THE ROLE OF THE OFFICIAL DISTRIBUTOR? ...61

7.6.1 Pre Sales Service ...61

7.6.2 After Sales Service ...61

7.7 WHAT IS THE ROLE OF THE RETAILER?...62

7.8 ON WHAT CHARACTERISTICS DO CONSUMERS BASE THEIR PURCHASING DECISION?...62

7.8.1 Price ...62

7.8.2 Availability...63

7.8.3 Quality ...63

7.8.4 After sales service ...63

7.9 CONCLUSION...63

CHAPTER 8: FEATURES OF THE GLOBAL PRODUCT...66

8.1 INTRODUCTION...66

8.2 HIGH DEGREE OF BRAND AWARENESS...66

8.3 UNIFORMITY...67

8.3.1 The core component...67

8.3.2 The packaging component...68

8.3.3 The support services component...68

8.4 CONCLUSION...68

CHAPTER 9: INTELLECTUAL PROPERTY RIGHTS ...71

9.1 INTRODUCTION...71

9.2 FREE MOVEMENT OF GOODS IN THE EUROPEAN ECONOMIC AREA...72

9.3 INTELLECTUAL PROPERTY RIGHTS IN THE EUROPEAN ECONOMIC AREA...72

9.4 WHAT IS THE RELATIONSHIP BETWEEN INTELLECTUAL PROPERTY RIGHTS AND THE RULES ON THE FREE MOVEMENT OF GOODS?...73

9.5 WHAT IS THE LEGISLATION IN THE FIELD OF TRADEMARKS IN THE EUROPEAN ECONOMIC AREA?.74 9.5.1 The Trademark Directive ...74

9.5.2 The Trademark Regulation...75

9.6 WHAT IS THE EXHAUSTION PRINCIPLE? ...76

9.6.1 National Exhaustion ...76

9.6.2 International Exhaustion...76

9.6.3 Regional Exhaustion...76

9.7 TO WHAT EXTENT CAN TRADEMARK OWNERS PREVENT PARALLEL IMPORTS FROM OTHER MEMBER STATES WITHIN THE EEA?...77

9.8 TO WHAT EXTENT CAN TRADEMARK OWNERS PREVENT PARALLEL IMPORTS FROM OUTSIDE THE EUROPEAN ECONOMIC AREA?...79

9.9 WHEN HAS THE TRADEMARK OWNER ALLEGED CONSENT?...80

9.10 CONCLUSION...80

CHAPTER 10: METHODOLOGY FOR THE COLLECTION OF PRIMARY DATA. ...83

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Table of Contents

10.2.1 Setting...83

10.2.2 Participants...84

10.2.3 Recording...84

10.2.4 Structure of the interview...84

10.3 DATA QUALITY ISSUES...85

10.3.1 Reliability...85

10.3.2 Validity ...85

10.3.3 Generalisability...86

10.4 CONCLUSION...86

CHAPTER 11: RESULTS OF THE INTERVIEWS ...88

11.1 INTRODUCTION...88

11.2 QUALITATIVE ANALYSIS...88

11.3 EXPLANATORY FACTORS FOR PARALLEL IMPORTS...88

11.4 PRICE DIFFERENCES...89

11.5 OPPORTUNISTIC BEHAVIOUR IN THE DISTRIBUTION CHANNEL...94

11.6 FEATURES OF THE GLOBAL PRODUCT...97

11.7 PRODUCT AVAILABILITY...101

11.8 ACCESSIBILITY TO INFORMATION...102

11.9 INTELLECTUAL PROPERTY RIGHTS...103

11.10 NETWORK...104

11.11 NEW MARKETS...105

11.12 THE SINGLE EUROPEAN MARKET...105

11.13 CONCLUSION...106

CHAPTER 12: THE NETWORK ...110

12.1 INTRODUCTION...110

12.2 WHAT IS A NETWORK? ...110

12.3 WHAT ARE THE MAJOR DIFFERENCES BETWEEN A TRADITIONAL AND A NETWORK ORGANISATION? ...111

12.4 ANALYSIS OF THE NETWORK OF A PARALLEL TRADER...112

12.4.1 Actors...113

12.4.2 Activities ...114

12.4.3 Resources ...114

12.4.4 Links that bind the three networks together ...115

12.4.5 Weaknesses of the network model...115

12.5 WHAT IS THE INFLUENCE OF THE ENVIRONMENT? ...116

12.6 WHAT INTERNAL FORCES DRIVE THE NETWORK FORM? ...117

12.7 WHAT DIFFERENT FORMS OF NETWORKS ARE USED IN PARALLEL BUSINESS? ...119

12.8 CONCLUSION...121

CHAPTER 13: CONCLUSIONS...124

REFERENCES...129

APPENDICES………..135 APPENDIX 1: CASES IN BRANDS AND TRADEMARKS REFERRED TO PARALLEL IMPORTS APPENDIX 2: OVERVIEW OF INTERNATIONAL TRADEMARK RIGHTS

APPENDIX 3: POSSIBILITY OF EXHAUSTION OF TRADEMARK RIGHTS IN THE EU APPENDIX 4: TRADE BARRIERS

APPENDIX 5: INTERVIEW

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List of Tables and Figures

List of Tables and Figures

Tables

1: Extent of parallel trade within the EU 9

2: Price differences observed for branded goods within the EU 43

3: A price comparison survey 43

4: Explanatory factors for price differences in EU and non-EU countries 45

5: Vertical relationships within sector 53

6: Modelling the rational authorised distributor’s decision 54

7: Relative importance of IPR driven investment 58

8: Relative importance of different Intellectual property rights 70

9: Legality of products in the EEA 74

10: Explanations of price differences between countries 88 11: International changes during a Product’s Life Cycle 92

12: Reasons for opportunistic behaviour 93

13: Features of the global product 96

14: Sources of information 101

15: How TCG governs its network organisation 117

Figures

1: The redefined conceptual model after the interviews 2

2: The research model 14

3: The research process ‘onion’ 15

4: Example 1 of types of parallel imports 20

5: Example 2 of types of parallel imports 21

6: Example 3 of types of parallel imports 22

7: Different elasticity’s of demand 26

8: Marginal revenue is less than price 27

9: The temptation for competition 27

10: Substituting and complementary grey imports 28

11: Conceptual model Meyers 36

12: Conceptual model for the emergence of parallel imports distracted from the

literature 39

13: The position of the parallel importer in the distribution channel 55

14: Product component model 66

15: Development of production units 91

16: The redefined conceptual model after the interviews 105

17: A complete network organisation 111

18: Network model 114

19: Uncertainty in the environment 116

20: The stable network 119

21: The dynamic network 119

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Preface

Preface

This report marks the end of a period of learning. During these five years of study I developed academic skills, but also social skills. The development of my academic skills resulted in this graduation project and the development of my social skills resulted in a lot of good friendships and many good experiences during my study time.

I would like to thank my parents for supporting me during my studies, it would have been a lot harder without this support. I would also like to thank Maartje, Judith, Renske, Laura, Mirjam, Marleen en Jessie for cheering me up whenever needed and motivating me to go on. This was really necessary sometimes as you all know. My gratitude also goes to Anneke, Sjoerd-Jan and Willem for reading and discussing this project and giving me advice whenever possible. Further I would like to thank my graphic editors for this graduation project: Ruth López and Jeroen de Haan. It would not have looked the same without you!

Finally I would like to thank my assessors of the university: Drs. R.L.C.I. Julien and Mr.

W.M.H. Grooten for the advice and support they gave me during this research. Especially Rob Julien choose to go beyond his duty in supporting me during difficult times at the company where I did my internship and discussing and reading my graduation project. It was a big help for me and I appreciated this very much.

Margreet Waterweg July, 2002

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Introduction

Chapter 1: Introduction

Parallel imports are goods brought into the market without the authorisation of the original trademark or copyright owner, after those goods have been placed into circulation legitimately in another market.1

The free movement of goods in a common market, not fragmented or affected by artificial divisions, is one of the prime aims of the Treaty establishing the European Community. EU law dictates thus that a manufacturer has no right to restrict the subsequent sale of trademarked goods within the EU after their initial sale. This means that between countries within the EU’s single market, parallel imports are legal.

Despite significant policy interest in parallel imports, there has been very limited economic analysis on this issue. Empirical studies on parallel importation in the international context are sparse. Importers do not report parallel imports as such, and customs authorities do not collect data on the phenomenon. According to some recent estimates, parallel imports account for somewhere between 5-20 % of trade within the European Union for goods such as musical recordings, consumer electronics, cosmetics and perfumes, and soft drinks.2 Table one gives an overview of the extent of parallel trade within the EU.

Sector Assessment Comment

Footwear and leather goods Small < 5%

Musical recordings Large Overall 5 to 10%: some releases up to 20%

Motorcars Small Estimates of up to 5%

Consumer electronics Small Around 5%

Domestic appliances Small < 5%

Cosmetics and perfumes Large Around 13% for upper end of market

Clothing Intermediate Survey mentions range 5 to 10%

Soft drinks Intermediate Between 0 and 15% of market

Confectionery Small/intermediate < 10%

Alcoholic drinks Small < 5%

Table 1: Extent of parallel trade within the EU

Source: The Economic Consequences of the Choice of a Regime of Exhaustion in the Area of Trademarks, Final report for DGXV of the European Commission, London: National Economic Research Associates, 1999

The subject of parallel imports involves a broad range of issues: the balancing of the interests of producers and consumers, the free market versus the regulated market, free riding versus smart trading etceteras. This makes it an economic question in the broad sense of that term and a topical subject which is very interesting as a graduation subject for business studies.

We will start with a research design in chapter two and in chapter three and four the concept of parallel import will be examined, as it is for many people a very ambiguous concept. In chapter five the explanatory factors for the emergence of parallel imports will be defined and a

conceptual model is constructed. Seven different explanatory factors are distracted from the

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Introduction

explanatory factors product availability and accessibility to information do need any more in depth examination. In chapter ten the methodology for the collection of primary data will be explained and in the next chapter the results of this data collection will be discussed. A new variable that emerges from the results of the research is the network, this explanatory factor is discussed and explained in chapter thirteen. Finally a conclusion will be drawn.

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Introduction

1 Chen, Y. and K.E. Maskus, ‘Vertical Pricing and Parallel Imports’, Department of Economics, University of Colorado at Boulder, July 2000.

2 The Economic Consequences of the Choice of a Regime of Exhaustion in the Area of Trademarks, Final Report for DGXV of the European Commission, London: National Economic Research Associates, 1999

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Research Design

Chapter 2: Research Design

2.1 The problem statement

Research objective:

The main objective for this research is to determine the explanatory factors relative to the emergence of parallel imports in the European Economic Area.

Research question:

What are the factors that could explain the emergence of parallel imports in the European Economic Area?

Sub questions:

• What is parallel import?

• What are the macro-economic aspects of parallel imports?

• What are the explanatory factors relative to the emergence of parallel imports in the European Economic Area mentioned in the literature?

• What new explanatory factors relative to the emergence of parallel imports in the European Economic Area can be identified?

• What are the consequences of the unification of the European Market relative to the emergence of parallel imports according to parallel importers?

Limitations:

• The scope of the research is the European Economic Area.

• The focus of this research will be on fast moving consumer goods, because there is a limit to the number of sectors that can be covered in this graduation project. Fast moving consumer goods are chosen, because these goods account for the main part of the parallel trade in the European Economic Area.

• The research is from the view of the parallel importers.

• Since it is a graduation project the research time is limited to six months.

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Research Design Definitions:

Single European Market

One of the most important aims of the Treaty of Rome is to establish a common market in the European Union within which goods, once lawfully marketed, may circulate freely and also across national boundaries. In this Treaty there is a statement that it is prohibited quantitative restrictions or any similar measure that has the same effect on imports between Member states.1

European Union (EU)

The European Union (EU) was set up after the 2nd World War. The process of European integration was launched on 9 May 1950 when France officially proposed to create 'the first concrete foundation of a European federation'. Six countries (Belgium, Germany, France, Italy, Luxembourg and the Netherlands) joined from the very beginning. Today, after four waves of accessions (1973: Denmark, Ireland and the United Kingdom; 1981: Greece;

1986: Spain and Portugal; 1995: Austria, Finland and Sweden) the EU has 15 Member States and is preparing for the accession of 13 eastern and southern European countries.2

European Economic Area (EEA)

The Agreement on the European Economic Area (EEA) extends the Single Market of the European Union to three out of the four EFTA countries, namely Norway, Iceland and Liechtenstein. Switzerland, while being a member of EFTA is not a Party to the EEA, having voted against membership in December 1992. The EEA agreement extended the four basic freedoms of the European Community to all EEA members, namely Freedom of movement of services, Freedom of movement of capital, Freedom of movement of goods and Freedom of movement of workers.3

Fast moving consumer goods

A term used in reference to frequently purchased consumer goods, such as foodstuffs, toiletries, etceteras.4

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Research Design

What is parallel import?

New explaining factors relative to the emergence of parallel imports Explaining factors relative to the emergence of parallel import mentioned

in the literature 2.2 The research model

Figure 2: Research model

This research model shows the different stages of the research. We start at a high aggregation level and as the research progresses, we get to an answer of the research question. First we will investigate the concept of parallel import and look at the macro-economic background. After this first step we will focus on the European Economic Area, as can be seen in the conceptual model. Since the unification of the European Market probably has influence on the emergence of parallel imports in the European Economic Area, this will be addressed on the side. The factors that could explain the emergence of parallel imports are consequently identified from the literature. The fact that these conditions exist does not automatically mean that parallel import will emerge, but only that it is possible. The last stage is verifying the conditions from the literature and identifying new explanatory factors.

European Economic Area

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Research Design

2.3 Methodology

In this section the process of finding the best method to answer the research question will be discussed. In their book Saunders, Lewis and Thornhill offer the following ‘onion’ of the research process:5

Figure 3: The research process ‘onion’

Source: Saunders, M. N. K. , P. Lewis and A. Thornhill, ‘Research Methods for Business Students’, Harlow: Pearson Education Limited, 2nd edition 2000.

I think this theory offers a good method to structure the research process, because there are underlying issues in the choice of a data collection method that need to be examined before it is possible to actually start the research. Another advantage is that it is specifically designed for business research.

2.3.1 Research philosophy

The research philosophy depends on the way that you think about the development of knowledge, this affects the way the research is done. It gives understanding of the underlying assumptions we have about the way the world works. Only if we have such an understanding can we examine these assumptions, challenge them if we think it is appropriate, and behave in a different way. Two views about the research process dominate the literature: positivism and phenomenology. This research has a phenomenology philosophy. This philosophy argues that the social world of business and management is far too complex to lend itself to theorising by

Positivism

Phenomenology

Deductive

Inductive Experiment

Survey

Case study Cross

sectional

Longitudinal

Research philosophy

Research approaches

Research strategies

Time horizons

Data collection methods Sampling

Secondary data Observation Interviews

Questionnaires Grounded

theory

Ethnography Action research

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Research Design

are lost if such complexity is reduced entirely to a series of law-like generalisations. The researcher affects or is affected by the subject of the research.

In this graduation project the different explanatory factors for the emergence of parallel import are examined. It will be tried to construct a cause-effect model of the different variables, but not a static model. We will be concerned to understand the meanings which respondents ascribe to various phenomena.

2.3.2 Research Approach

The extent to which the theory is clear at the beginning of the research raises an important question concerning the design of the research project. When a deductive approach is used, a theory and hypotheses and a research strategy to test these hypotheses are developed. In this research a combination of the deductive and inductive approach is used. The purpose of this graduation project is to understand the nature of parallel import better and examine the explanatory factors for the emergence of parallel imports in the European Economic Area. The result of this analysis will be the formulation of a theory.

Preliminary research and literature on this topic will be studied and be used to develop a first draft of the final model. Consequently, data will be collected and a theory will be further developed as a result of the data analysis and the first draft of the model. This makes this approach less rigid than the deductive approach. The absence of a lot of literature and research on the topic of parallel import, encourages the choice for this research approach.

2.3.3 Research strategy

The research strategy is a general plan of how the research question will be answered. The strategies that are considered are: experiment, survey, case study, grounded theory, ethnography and action research. The research strategy that will be used in this graduation project is mainly grounded theory. This can be seen as ‘theory building’ through a combination of induction and deduction.

In grounded theory, data collection starts without the formation of an initial theoretical framework. Theory is developed from data generated by a series of observations. These data lead to the generations of predictions that are then tested in further observations that may confirm, or otherwise, the predictions.

In this study an initial theoretical framework is developed by using the data generated in previous research on this subject. This framework will be tested and sophisticated by further observations of the researcher. These observations will come from case studies. Robson defines case study as ‘the development of detailed, intensive knowledge about a single “case”, or a small number of related “cases”.6 It is a very worthwhile way of exploring existing theory.

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Research Design

2.3.4 Time horizon

Since this research is a graduation project, it is time constraint. That is why is chosen for a cross sectional study instead of a longitudinal study.

2.3.5 Data collection method

Enquiries can be classified in terms of their purpose as well as by the research strategy used.7 The classification most often used is the three-fold one of exploratory, descriptive and

explanatory. This study is exploratory, because the objective of the research is to provide more insight into the explanatory factors on the emergence of parallel imports in the European Economic Area.

There are three principal ways of conducting exploratory research:

• A search of the literature

• Talking to experts in the subjects

• Conducting focus group interviews

In this study the first two methods will be used. A search of the literature (desk research) for a general theoretical framework and talking to experts in the subjects (field research) as a basis for the redefinition of the model. Focus group interviews are not used, because this is far more difficult to achieve. This is not desirable, since there are constraints in time, skills and resources.

The interviews will be semi-structured and in depth. Non-standardised interviews are used when it is necessary to understand the reasons for the decisions which the research participants take, or the reasons for their attitudes and opinions. In depth interviews are unstructured, there is no predetermined list of questions to work through in this situation. These interviews were held in the company where the researcher did an internship.

For the semi-structured interviews a list of themes and questions to be covered will be designed.

The literature and the in depth interviews will be used for the construction of this list. The interviews will be face-to-face or by telephone, this depends on the availability of the interviewee.

Research using the inductive approach is particularly concerned with the context in which events take place. We want to explore the topic in all its facets. Therefore the study of a small sample of subjects may be more appropriate than a large number. Another reason for this decision is that conducting and elaborate interviews is very time-consuming, and only limited time is available.

In chapter ten the methodology for the collection of primary data is discussed more in-depth.

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Research Design

1 Treaty of Rome, Part III: Community Policies, Title I, Chapter 2 Art. 30.

2 Http://europa.eu.int.

3 Kapteyn, P.J.G. and P. VerLoren van Themaat, ‘Introduction to the Law of the European Communities’, London: Kluwer Law International, 3rd edition 1998.

4 Marketing Dictionary, Monash University, 2000

5 Saunders, M. N. K. , P. Lewis and A. Thornhill, ‘Research Methods for Business Students’, Harlow:

Pearson Education Limited, 2nd edition 2000.

6 Robson, C., ‘Real World Research: a Resource for Social Scientists and Practitioner-Researchers’, Oxford: Blackwell, 1993.

7 Robson, C., 1993A OC.

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Parallel Imports

Chapter 3: Parallel Imports

3.1 Introduction

Parallel import is for many people a very ambiguous concept. It can take many forms and use many different channels and routes, which are not always very transparent. That is why this concept will be clarified first. First different definitions of parallel import will be given, next the different types of parallel imports that exist will be explored, and we will end with a conclusion.

3.2 Definitions of parallel imports

Parallel imports are products that are lawfully put in the market by the trademark owner. The goods are sold at quite disparate prices in two different countries: a low priced country and a high priced country. Taking advantage of the lower price, some enterprising middleman buys stocks in the cheaper country and imports them into the higher priced country. Hence the imports may be described as being imported ‘parallel’ to the authorised distribution network.

There are various definitions of parallel import to be found in the literature, being the following as an example:

‘Parallel imports, also called grey-market imports, are goods genuinely under protection of a trademark, patent, or copyright, placed into circulation in one market, and then imported into a second market without the authorisation of the local owner of the intellectual property right. This owner is typically a licensed local dealer’.1

‘Parallel imports, or ‘grey-market’ imports, are genuine products- not counterfeits- imported by unauthorised resellers. A common situation is where one firm owns the national trademarks in several countries, each trademark conferring the exclusive distribution right in that country, but another party obtains the product in one country (typically from wholesalers rather than the trademark holder) and diverts it to another country without the authorisation of the trademark holder’2

So we see parallel trade consists of trade in genuine trademark (or other intellectual property) protected goods that takes place without the consent of the trademark owner. Official channel goods reach the final consumer through the intermediaries and distribution networks that are designated by the trademark owner. Parallel traders acquire goods, typically without the consent of the trademark owner, from some layer of the authorised channel. This can either be directly from the manufacturer, from an intermediary (wholesaler or middleman) or from authorised distributors and retailers. Occasionally a trademark owner may give tacit consent to the disposal of some part of production through parallel traders. Parallel traders are sometimes used as a mechanism to shift surplus goods to new markets. Although it will never be acknowledged publicly, parallel trade is an integral part of many brand owners’ corporate strategy.

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Parallel Imports

LOCAL MARKET

of the official Chanel distributor (wholesaler) and sells them in Japan where the prices are higher, making therefore a profit. This is parallel trade.

3.3 What are the different types of parallel imports?

The different types of parallel trade are always based on the economical advantage sourced from the price difference between two markets. When the official price of the product is higher than in foreign markets and the unofficial distributor can import this product for a lower price, parallel trade will happen from the low priced market to the high priced market.

The three distinct situations in which parallel imports can occur are3:

1. Goods are produced locally for export, which are subsequently re-imported without the authorisation of the territorial licence holder

2. Unauthorised imports compete with authorised domestically produced good 3. Unauthorised imports compete with authorised imports

Although there is no end to the imaginative ways used to bring parallel imports to the market, these three methods represent the bulk of the grey market imports and are the focus of much of the legal attention.

EXPORTING COUNTRY

IMPORTING COUNTRY

Figure 4: Example 1 of types of parallel imports

Source: The Economic Consequences of the Choice of a Regime of Exhaustion in the Area of Trademarks, Final report for DGXV of the European Commission, London: National Economic Research Associates, 1999

Example 1 shows the situation where a manufacturer sells in his local market through an authorised channel. The manufacturer also exports and uses an authorised dealer to distribute his product in the foreign market. At the same time a parallel trade flow takes place, from the local to the foreign country. This trade takes place parallel to the trade that goes through the

AUTHORISED CHANNEL MANUFACTURER

GREY MARKET CHANNEL

GREY MARKET CHANNEL AUTHORISED

CHANNEL

FOREIGN MARKET

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Parallel Imports

LOCAL MARKET

authorised channels. In the home market a local grey market channel buys goods from the manufacturer or the authorised channel, without the consent of the trademark owner. The local grey market channel (wholesalers, intermediaries or retailers) then sells to a grey market channel in the foreign market.

It is of course also possible that the foreign grey market channels buy directly in the manufacturer’s home market without using a grey market intermediary. Example 1 would typically occur if prices in the local market were lower than in the foreign market.

EXPORTING COUNTRY

IMPORTING COUNTRY

Figure 5: Example 2 of types of parallel imports

Source: The Economic Consequences of the Choice of a Regime of Exhaustion in the Area of Trademarks, Final report for DGXV of the European Commission, London: National Economic Research Associates, 1999

Example 2 would typically occur if prices in the foreign market are lower than in the local market. A grey market channel buys from the authorised channel in the foreign market and sells to the grey market channel located in the country from which the products were exported in the first place.

AUTHORISED CHANNEL MANUFACTURER

GREY MARKET CHANNEL

GREY MARKET CHANNEL AUTHORISED

CHANNEL

FOREIGN MARKET

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Parallel Imports

LOCAL MARKET

EXPORTING COUNTRY

IMPORTING COUNTRY 1

IMPORTING COUNTRY 2

Figure 6: Example 3 of types of parallel imports

Source: The Economic Consequences of the Choice of a Regime of Exhaustion in the Area of Trademarks, Final report for DGXV of the European Commission, London: National Economic Research Associates, 1999

Example 3 illustrates that parallel trade can be indirect and take place through third countries.

The source country for the grey market channel is the second foreign country to which the manufacturer exports does not need to be the local manufacturer’s market but may well be a country to which he exports (in this case the foreign market). This situation could arise if the price in foreign market 1 is lower than in foreign market 2, while at the same time the local market is not a source market. For example, because prices are higher than in foreign market 1, or if more effective distribution controls take place.

So we see parallel import can take several different forms, yet their effects are generally the same, namely, reduced or cannibalised sales for the manufacturer in countries where prices are higher, and jeopardised relationships with authorised distributors who possess contractual rights for their markets.4

3.4 Conclusion

Parallel trade consists of trade in genuine trademark (or other intellectual property) protected goods that takes place without the consent of the trademark owner. Parallel traders acquire goods from some layer of the authorised channel. This can either be directly from the

AUTHORISED CHANNEL MANUFACTURER

GREY MARKET CHANNEL AUTHORISED

CHANNEL

FOREIGN MARKET

GREY MARKET CHANNEL AUTHORISED

CHANNEL

FOREIGN MARKET

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Parallel Imports

manufacturer, from an intermediary (wholesaler or middleman) or from authorised retailers.

Occasionally a trademark owner may give tacit consent. The different types of parallel trade are always based on the economical advantage sourced from the price difference between two markets.

The three distinct situations in which parallel imports can occur are5:

1. Goods are produced locally for export, which are subsequently re-imported without the authorisation of the territorial licence holder

2. Unauthorised imports compete with authorised domestically produced good 3. Unauthorised imports compete with authorised imports

Although there is no end to the imaginative ways used to bring parallel imports to the market, these three methods represent the bulk of the grey market imports.

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Parallel Imports

1 Maskus, K.E., ‘Parallel Imports’, World Economy, 23 (2000), 9, pp. 1269-1285.

2 Malueg, D.A. and M. Schwartz, Parallel imports, Demand Dispersion, and International Price Discrimination, Journal of International Economics, (1994), 37, pp.167-195

3 Chard, J.S. and C. J. Mellor, ‘Intellectual Property Rights and Parallel Imports’, World Economy, 12 (1989), pp. 69-84.

4 Assmus, G. and C. Wiese, ‘How to address the Gray Market Threat using Price Coordination’, Sloan Management Review, 36 (1995), 3, pp. 31-41.

5 Chard, J.S. and C. J. Mellor, 1989A OC

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Macro-economics

Chapter 4: The macro-economics of parallel imports in the European Economic Area

4.1 Introduction

To understand the concept of parallel imports better, it is necessary to know what the macro- economic explanations of parallel import are. This will broadly explain why price differences exist and how the parallel importers make use of this, in chapter six we will get more detailed on the subject of price differences. When we say that prices are set by supply and demand, we are employing a metaphor. It is more realistic to say that sellers set the majority of prices, buyers set most of the rest, and a few are set by negotiations between sellers and buyers. How much freedom do sellers and buyers have when they set their prices? This is determined by their market power. In this chapter we will have a closer look at why parallel imports arise from the macro-economic point of view. We will start with defining the monopolist, then have a closer look at the price searcher and examine the concept of price discrimination more thoroughly. In 4.6 political economy considerations are addressed and finally a conclusion will be drawn.

4.2 Who is a monopolist?

No seller is a monopolist in the strictest sense of the word, because there is no such thing as a perfectly inelastic demand. The reader is referred to figure seven for more explanation.

Elasticity’s of demand reflect the availability’s of substitutes; other things remaining equal, the more good substitutes there are for anything, the more elastic will be the demand for it. Market power is thus seen to be a matter of degree and to be inversely related to elasticity of demand.1 A different meaning of monopoly is one related to acts of the state. If the state allows some to engage in an activity, but prosecutes others for doing so, or if it taxes or restricts some sellers but not others, or if it grants protection or assistance to some while compelling others to make their own way unaided, the state is creating exclusive privileges. Many business organisation operate with monopoly grants of this kind.2 The beneficiaries of these restrictions always include the parties who can escape them. These parties will rarely admit that they enjoy a grant of monopoly power. But the effect of the restrictions nonetheless is to prevent some from competing who would otherwise do so. This does not mean that restrictions on entry into a market are always to be condemned.

4.3 The law of demand

The law of demand asserts that there is a negative relation between the amount of anything that people will want to purchase and the price (sacrifice) they must pay to obtain it. It has

sometimes been argued that certain prestige goods (that are attractive for parallel imports) are

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Macro-economics

better information, judge quality by price, so that over a limited range at least, their willingness to purchase may be positively rather than negatively related to price. But these seeming exceptions can readily be explained in a way consistent with the law of demand. People are purchasing prestige rather than the product, or judging quality by price, because they have no better information.3 I think this could be a reason why prestige goods are more interesting for parallel imports; you buy the same amount of prestige for less money.

Figure 7: Different elasticity’s of demand

Source: Heyne, P.T., The Economic Way of Thinking, Upper Saddle River: Prentice-Hall Inc., 8th edition 1997.

4.4 Price searchers

Who actually sets the prices and how much freedom do they have? There are two types: price takers and price searchers. A price taker cannot affect the price by his own actions. The price is determined by the actions of many buyers and sellers. Price takers face perfectly elastic demand curves. The reader is referred to figure seven for more explanation. Price searchers can raise their prices if they choose, without losing all their sales. At higher prices they will sell less; at lower prices they are able to sell more. They must choose a price or set of prices. Price searchers all have some market power, but it is a matter of degree inversely related to the elasticity of the demand the seller faces. Economists applied the term monopolist to a price searcher and markets in which all buyers and sellers are price takers are graced with the term competitive markets.4 Price searchers estimate marginal costs and marginal revenues and then try to set prices that will enable them to sell all those units of their product- and only those units- for which marginal revenue is higher than marginal costs. Marginal costs is the additional costs a seller expects to incur as a result of a contemplated action. Marginal revenue is the additional revenue expected from an action under construction. When price is greater than marginal costs, some goods are not going to be produced and sold despite the fact that the monetary value buyers place on acquiring them is higher than the monetary cost to suppliers of making them available. Competition tends to push production in price taker’s markets to the point where price and marginal cost are equal.

Quantity Price

Quantity Price

Demand Demand

Perfectly elastic demand curve

Perfectly inelastic demand curve

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Macro-economics

Marginal revenue is less than price. If we look at figure eight we see that lowering the price from A to B gains some revenue from additional sales, but also loses some revenue, because all buyers now pay the lower price.

Figure 8: Marginal revenue is less than price

Source: Heyne, P.T., The Economic Way of Thinking, Upper Saddle River: Prentice-Hall Inc., 8th edition 1997.

One problem from the seller’s viewpoint with higher prices than marginal costs, is that such prices are a standing invitation to competition and parallel importers. The reader is referred to figure nine for an illustration of this statement.

Figure 9: The temptation for competition

Source: Heyne, P.T., The Economic Way of Thinking, Upper Saddle River: Prentice-Hall Inc., 8th edition 1997.

This is the gap the parallel importers get in. By offering the same product for a lower price, they get the extra demand that comes with this higher price. This can be positive if they open access to more price sensitive segments in a high-price country, but also negative if the grey imports substitute the trademark owners’ product in the segment that already buys the product. The reader is referred to figure ten for an illustration of this statement.

Price

Quantity Lost

Gained

Lowering the price from A to B gains some revenue from additional sales but also loses some revenue because all buyers now pay the lower price.

A B

Marginal cost Temptation!

Price

Quantity Demand Price

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Macro-economics Substituting Grey Imports (negative) Complimentary Grey Imports (positive)

Figure 10: Substituting and complimentary grey imports Source: Simon Kucher & Partners, 2000

In reality, sellers do not exactly know what the demand is for their product. They must usually probe for information on the demand for their product and try to stimulate and maintain it by advertising and by offering reliable services.

4.5 Price discrimination

A crucial factor for the price searcher is the ability or inability to discriminate: to charge high prices for units that are in high demand and low prices for units that would not otherwise be purchased, without allowing the sales at lower prices to ‘spoil the market’ for high price sales.

There are three conditions for successful price discrimination, the seller must be able to5:

1. Distinguish buyers with different elasticity’s of demand.

2. Prevent low-price buyers from reselling to high price buyers.

3. Control resentment.

All sellers facing demand curves that are less than perfectly elastic maximise net revenue by restricting sales or output and keeping the sales price above marginal costs. Successful discrimination increases the wealth of sellers, but it also increases the wealth of those buyers who can obtain goods that would not otherwise be available to them. Price discrimination eliminates some of the “waste” that occurs when A and B cannot arrange a transaction despite the fact that A wants what B has to offer and is more than willing to pay B’s cost of supplying it.6

This is where we see that a certain level of parallel imports may be attractive for trademark owners. If the grey goods serve and additional market segment that would not buy the product at the higher price, grey markets can result in higher profits for the company, even if the supply of grey goods cannibalises some demand in the high-priced countries. It is also interesting for the trademark owner when he produces superfluous stock, that would not be sold otherwise.

However, the company must consider a number of factors. First, it must weigh the benefits of the incremental sales to the lower-priced segment against the losses, attributable to

cannibalisation in the higher-priced segments. Then the company must consider the authorised distributors’ reactions to losing sales in the grey market. If their business is harmed, the manufacturer’s relationship with them could become more difficult. Finally, the company must

Market A

Grey Imports

Market A

Grey Imports

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Macro-economics

consider the impact of the grey market imports on the product’s and trademark’s image in the higher-priced countries.7

The parallel importers stress in the interviews that they do not want to disturb the market, in that case they would not make as much profit as they do now. It is only possible for them to make money when they will be the ones who take care of the “discriminatory” sales. As soon as they become too big for the trademark owner, he will lower the prices himself and it will be impossible for the parallel importer to make profit. Beyond a certain level, however, all grey market activities impair the company’s long-term profitability.

Generally, policies world-wide firmly support parallel imports. For example, parallel imports between the member states of the European Economic Area are allowed. This support stems largely form a belief that parallel imports are driven not so much by free-riding on promotional efforts of authorised distributors, but by international price discrimination. Why has the price discrimination view generated such strong support for parallel imports, whereas use of exclusive territories within a country typically elicits much less hostility? There are two likely

explanations8:

1. The scope for price discrimination is probably greater internationally; disparities in demand elasticity’s across countries are likely to be greater than across regions within a country, most obviously because of the greater differences in per capita incomes between countries than regional within countries.

2. Relative to uniform pricing, geographic price discrimination within a country typically harms consumers in some regions, but benefits others. In contrast, countries facing relatively high prices under international price discrimination tend to ignore the gains from discrimination to consumers in low-price countries. Thus high-price countries generally perceive that their welfare will be higher under uniform pricing.

Price discrimination is often viewed as anti-competitive in that it permits firms to set the price according to market power in each country. This market power is sustained by restrictions against parallel import, which leads some observers to view such controls as non-tariff barriers to trade in goods that have legitimately escaped the control of Intellectual Property Right owners.9 The claim that price discrimination across segmented markets is harmful and promotes collusion must be heavily qualified. First, the market power associated with

Intellectual Property right owners may be slight if there is extensive inter-brand competition in each location. Second, under certain assumptions on demand and costs, price discrimination can provide positive economic benefits to society. A necessary, but not sufficient condition for a welfare increase is that output rises under a regime of discrimination in comparison with a regime of uniform pricing. In this case, the firm can supply more consumers with lower valuations for a product while extracting additional surplus from consumers with higher

valuations. The surplus gained in the newly served market segments outweigh the surplus lost in the higher-priced segments.10

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