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Tech OEMs: Gray market goods are a growing concern

The gray market revisited: A KPMG report explores whether the sale of gray market products has decreased since 2008 when economic conditions proved conducive to unauthorized sales channels.

A recently published KPMG report on gray market activity in the high-tech supply chain shows that while resellers and distributors have seen reduced levels of branded products being sold by unauthorized dealers, the push to stamp out this activity remains a challenge for OEMs.

According to the OEMs surveyed for the report, sales of gray market goods have increased since 2008, when the recession created an economic climate conducive to gray market activity.

The gray market, which is defined as the practice of diverting branded products from authorized sales channels to unauthorized gray market goods vendors, many of whom are dealers, brokers or others operating in the open market, has long been disruptive for OEMs and their channel partners. When unauthorized gray market vendors sell branded products in the marketplace, OEMs, resellers and distributors not only lose control of product pricing and the ability to deliver quality and service standards, but their reputations are put at risk. Sales and service deals are jeopardized.

With this in mind, KPMG, along with the Alliance for Gray Market and Counterfeit Abatement (AGMA), interviewed nine OEMs, 13 resellers and 18 distributors for the latest report, Gray Markets: An Evolving Concern.

The study, which compares the latest survey results with those from 2008, revealed that 63% of OEMs have seen an increase in gray market activity since 2008. Ninety percent said they've found instances of product availability on the gray market.

Resellers and distributors, however, reported a significant decline in gray market activity. By contrast, 83% of resellers said they source new OEM products from authorized distributors, versus 31% in 2008. In fact, 67% of reseller respondents said they obtain products directly from the OEM, compared with 44% in 2008. Among distributors, 47% said they've seen a decline in the availability of gray market goods, compared to 7% in 2008.

The cause of disparate opinions on the gray market

Matt Behan, principal for KPMG's contract compliance servicesMatt Behan

The discrepancy between OEMs and their reseller and distributor partners' views on the level of gray market activity is thought provoking, said Matt Behan, principal for KPMG's contract compliance services.

"The difference in opinion between the OEMs and channel partners is interesting, especially when the distributors and resellers noted it was still easy to source from the gray market," Behan said. "Therefore, OEMs find it difficult to size their own problem, having to rely on undercover buys and hearsay from both channel partners as well as their own sales teams."

AGMA president Sally Nguyen said her organization hasn't studied the disparity in responses, but noted there could be a number of factors that have contributed to the different perspectives put forward in the study.

"It may be tied to the fact that resellers often operate in a particular market segment or region, offering a narrow set of products and services. Large OEMs cover global geography with multiple product lines across different customer types," Nguyen said.

Arlin Sorensen, founder and CEO of HTG Peer Groups, said partners are buying products where they can get it for the lowest price and a lot of times that's not through the regular distribution channels.

"I hear more and more partners are doing business with online retailers and DMRs (direct market resellers). There are a host of different routes to market, and I know it muddies the water for warranties and a lot of other services," Sorensen said, whose company helps partners develop planning and execution strategies.

Sorensen also said the introduction of cloud computing and sophisticated technologies like virtualization, which require less equipment to run business operations, has resulted in resellers selling less IT equipment than they did five years ago.

"They will spec products for their clients, but they ask them to go and purchase it on their own," he said. "Those that do sell products are probably larger now and more dependent on OEM programs and relationships to be successful, and thus more likely to buy through distribution and leverage their programs."

OEMs tackle incentive program abuse

The KPMG report also found that OEMs suffered from incentive program abuse.

"OEMs use legitimate incentives, such as rebate programs and shared marketing investments, to spur sales, penetrate new markets, increase sales in developing markets and promote brand loyalty among end users," the report stated.

According to the report, most OEMs said incentive programs are susceptible to misuse and inappropriate claims, stating: "Respondents reported incentive program abuse through duplicate claims, fraudulent supporting documents, two resellers claiming discounts on products with the same serial numbers, potential counterfeit products being submitted for incentives, and other suspected abuses."

Unfortunately, as quickly as the OEMs tighten up the program terms and conditions, some channel partners and brokers find ways to game the system.
Matt Behanprincipal for contract compliance services, KPMG

To strengthen the practice of using legitimate incentives, OEMs report that they conduct site visits and perform due diligence checks, as well as credit and trade compliance verification. Of the OEM's surveyed, 100% of them said they have found inappropriate claims made under their discount programs. Additionally, 90% of OEMs said they use serial numbers to identify gray market or counterfeit activity.

OEMs have also turned to the courts to resolve unauthorized sales of their products. In 2008, HP received a settlement from a reseller over alleged gray market activity.

Other measures include OEM contractual provisions to prevent distributing products through unauthorized channel. For example, 89% percent of OEMs said their distributor agreement contains provisions to prevent or discourage the gray marketing of products via sourcing and sales.

Resellers are also taking steps to reduce activity around gray market goods. The KPMG report noted 75% of resellers track serial numbers in a way that can be reported back to the OEM.

The report also said 70% of tech companies have developed formal training programs to help staff and partners identify violations of channel agreements.

Still, even with strong countermeasures in place, Behan said the gray market is difficult to stop. He is calling for greater use of auditing as a way to verify the data being used to calculate incentive programs.

"Unfortunately, as quickly as the OEMs tighten up the program terms and conditions, some channel partners and brokers find ways to game the system," Behan said.

The future of the gray market battle

The battle between OEMs and gray marketers will likely continue for the foreseeable future. Behan predicted the direct reporting from channel partners will expand and the terms and conditions of incentive programs will be strengthened. Additionally, OEMs will increasingly educate distributors, resellers and end users especially about the risks associated with gray market goods.

"The question of whether it is possible to totally trust the channel -- which is the true aim of them being 'partners' -- will continue to be the main driver of tackling the gray market," Behan said. "For almost 10 years, OEMs have been working on eradicating the issue and have not eradicated it yet. Time will tell whether they'll have more success going forward."

Next Steps

Learn five ways for partners to forge closer vendor relationships.

Read tips for avoiding liability issues with channel customer contracts.

MSP decisions: Building a channel vs. referral network.

This was last published in April 2016

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How has gray market activity impacted your business?
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Not well.... A few badly behaved products without valid warranties or paths to a refund. Lookalike equipment that delivers far less than the real thing. We've been burned too many times; we plan to stick with verifiable sources and brands. 
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Thanks for sharing, ncberns. Sounds like you learned a lesson -- and I'm interested to learn more about it. What types of product sources had you been using in the past? You say you plan to stick with verifiable sources and brands; how have those negative experiences affected how you evaluate and verify product sources now? How have you tweaked your vetting process to a system you feel more confident about?
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It's hard enough to stay ahead of BYOD flooding the work space. (Which, so far, has gone relatively smoothly.) Adding the inherent unknowns of gray market goods and we have yet another entry for the Workplace Disaster Award. Given our existing security problems, shopping in the gray market may not be our most cost-saving approach.
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