GRAY MARKET Electronics: Worth The Price?

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Few consumers know the gray market by that name. The term is industry argot, an insider's designation for a certain part of the marketplace. And yet the audio gray market probably touches the majority of audio equipment purchasers at one time or another--and it touches them in ways that directly affect the worth and usefulness of their investments in both hardware and software.

 

To understand the impact of the gray market, we must first know its scope, dimensions, operations, and, most significantly, its functions-its reason for being.

The gray market arises primarily as a response to the unfulfilled desires of consumers. If some item is desired and desired strongly, and yet is not easily obtainable (either because it is not distributed through a regular market channel or because the price for the item is perceived as unacceptable), then the impetus is there for the formation of some new channel for the delivery of goods. If that new channel is not sanctioned by the manufacturer-and frequently it is not-it can be designated as gray market.

Gray market may be defined very simply as an irregular and unsanctioned mode of distributing a product.

It can be distinguished from the black market by the lack of anything illicit in the transactions. Gray market bypasses a manufacturer's local authorized distributors, but it does not violate any trade laws.

In the manner of broad definitions, this is all quite abstract, but the gray market itself is never without concrete manifestations. Far from being some economist's hypothesis, several removes from the actual movement of goods, the gray market is always firmly rooted in the consumer's cravings for very specific products. Here's an example of what I mean: My first significant audio purchase was made through the gray market, in 1980. At the time I wished to buy a pair of Acoustat Model II electrostatic loudspeakers, a very hot item among knowledgeable consumers. Acoustat speakers were, at that time, esoteric audio components subject to price rigidity-in other words, no authorized dealer was likely to discount them. In 1980 I did not understand the workings of the esoteric wing of the industry, and I felt that the unspoken stricture against discounting was unfair. I was determined to get the speakers at a discount, and I succeeded. I bought them through the gray market.

Today, as then, a minor industry exists for customers who want esoteric goods but who perceive the list prices for such goods to be unfair. The gray market accommodates these customers.

The gray market also accommodates far, far greater numbers of customers interested in fast-selling, low-end items such as boom boxes, portable cassette players, cheap auto radios, and the like. Here availability rather than price is the chief force in stimulating the gray market, and some interesting distortions occur on the wholesale level. At some point, supply through regular distributors does not keep up with demand for a particular product, but prices do not rise as per classical marketing theory because of fierce com petition among retailers, which works to keep retail prices just a few percent age points above dealer cost. Unable to increase their profits by driving prices up, retailers must do high volume just to stay even, and to do volume they must enlarge their supplies.

This they do by patronizing unauthorized distributors-gray marketeers, as it were. The end result of gray-market purchases by ordinary retailers is that significant numbers of consumers buy gray without ever knowing it.

In the low end the gray market is as much the creation of the legitimate retailer as it is of the consumer, while in the high end the established retailer tends to be bypassed. In the high end the customer who buys gray usually has some idea of what he's getting into, whereas the low-end customer is completely in the dark. The distinction is important because, while both types of customer are at risk, the high-end buyer is more likely to have accepted the risk as a condition for obtaining a discount.

No one knows how big the gray market is. Joe Abrams, national sales manager for Sumiko, a high-end company which has suffered considerably at the hands of gray marketeers, estimates the gray-market share in audio at no more than 1%. Jay Frank, a Southern California retailer with extensive experience in buying gray-market goods wholesale, believes that these products account for over 50% in the low-end portable market, but much less in the mass market and in the high end. Mike Detmer, national sales manager for Stax Kogyo, another company which has considerable problems with gray-market distribution, guesses that less than 10% of his company's output passes through the gray market.

In fact, gray-market share varies widely from one level of the market to another and from one company to another. Because the gray market is, by definition, irregular, its market share tends to fluctuate both overall and on each individual level, as new sources of supply open up and established ones constrict or vanish.

Since the consumer is the foundation of the gray market, let's examine him for a moment. In most cases, he's someone who buys on price. Gray market goods are generally considerably cheaper at the retail level than normally distributed products, and discounts can be especially large in the case of high-end and esoteric products. In Los Angeles, for example, Nakamichi Dragon cassette decks were recently selling for approximately $1,100 on the gray market. Normal retail cost is $1,800. In the same city, Esoteric Audio Research 509 vacuum tube, mono amplifiers, which normally sell for $2,600 per pair, retail, were recently going for $1,000 per pair.

These are extreme examples, but they indicate the substantial savings which can be had by buying gray.

In the middle and lower portions of the market, where discounting is usually the rule, price differentials will not be so pronounced. Jay Frank states that gray-market Sony Beta movie cameras have been offered at certain Los Angeles retail establishments at less than dealer cost, though typically margins on video equipment are very low anyway-as little as five retail percentage points above dealer cost. Frank further states that gray-market portables routinely sell at or below dealer cost in the Los Angeles area, though, here again, legitimate retailers normally maintain profit margins of less than 10 points.

In the high end of the gray market, where the dollar differentials are greatest, the customer who patronizes the gray market tends to assume a distinct form. "He's a one-time buyer," says Mike Detmer of Stax Kogyo, who's spent countless unpleasant hours confronting such customers over warranty issues. "He is not the individual who would buy our product ordinarily or who would want to form a lasting relationship with the company." "He's a person after a deal, above all else," says Peter McGrath, owner of the prestigious Sound Advice, a high end salon in Coral Gables, Florida.

"He's a person with no understanding of the importance of dealer support or of the fact that many esoteric products are only as good as the dealer who sold them because of their demanding setup requirements." The gray market also serves the individual impatient to embrace the latest technology. The Japanese audio industry commonly introduces new product categories in the home market as much as two years prior to the North American introductions. Word of the innovations reaches the U.S. and demand builds among the knowledgeable. For example, Compact Discs were available in Japan and Europe some time prior to their appearance in the U.S., and in 1983 many, many gray-market discs appeared in the U.S. to satisfy American demand. Now that CD production has moved Stateside, gray-market CDs have largely disappeared, but in the future we may expect to see gray-market distribution of other as yet unreleased new technologies.

Not surprisingly, the most consistent customer for gray-market goods is the retailer himself-usually the mass-market retailer. The reason is simple. Once gray-market products of a certain brand become readily available in a given geographical area, prices at the retail level are affected radically. Mass market products on the wholesale gray market usually sell for at least 20% below their cost from authorized U.S. distributors, and they're sold to anybody with the money. Unauthorized dealers rush to buy the product, as do dealers who are authorized to sell the same brands as those being sold on the gray market. In other words, dealers will end up selling unauthorized merchandise in the very lines they're authorized to carry.

"You have to do it to survive," says the general manager of one $20 million chain in the deep South. "If your competitors are selling at below your cost, what are you gonna do?" We can certainly sympathize with the retailer in such a predicament, but we must also question his treatment of the consumer who ends up buying a gray-market unit, without valid factory warranty, from a retailer designated as an authorized representative for the brand. Gray-market goods are often meant for use in Asia and are not designed for U.S. line voltages or broadcast standards; selling them as equivalents to models designated for the U.S. seems perilously close to fraud, especially under the auspices of an authorized dealership.

Not all dealers go to the gray market because of price wars, though. Most manufacturers impose some standard requirements on the retailers to whom they sell, such as stated credit ratings, service and installation abilities, whole line orders, minimum monthly orders, position within a given local market, adherence to unspoken pricing structures, etc. Retailers who can't meet manufacturers' requirements, or who are seeking highly desirable restricted lines, have no choice but to go to the gray market.

The wholesale gray market can also include the proprietor of the audio salon, the very individual who often is quickest to decry the activities of the gray market. High-end dealers occasionally buy small specialty items not distributed in the U.S., particularly pho no cartridges. The appearance of nearly unobtainable exotica in his shop lends the retailer a certain distinction, and purchasing such distinction is relatively inexpensive. High=end dealers sometimes also engage in another form of gray marketeering known as transshipping, which I will discuss later in this article.

The gray market is not the mirror image of normal retail distribution structures, and not all products are readily obtainable through it.

The gray market tends to operate only where shortages, rigid pricing structures, and limited authorized distribution result in considerable unmet demand for a product.

By far the greatest amount of gray-

market activity is in the area of blank tape. Tape in the past has been subject to enormous markups by authorized distributors and the pressure for lower prices has been intense. Probably more than a quarter of the blank cassettes sold in the U.S. now are gray market in origin, and they are sold in every imaginable type of retail outlet.

Much of the tape comes from India and Southeast Asia where the cassette is, by far, the dominant audio medium.

The Southeast Asian demand for blank tapes is enormous and insatiable. Diverted shipments in the millions of units scarcely affect the supply, and Japanese manufacturers may well lack the ability, and perhaps the will, to regulate distribution closely in that market.

In the area of hardware, gray-market goods appear at every level but they predominate in the low-end portable market, where gray marketeering is ubiquitous. In brand-name component stereo, supplies of gray-market goods are apt to be very erratic, and many brands virtually never make it through the gray-market pipeline due to tight control by manufacturers over retailers and distributors alike.

The principal branded components appearing on the gray market are either Japanese or British in origin. In general, American audio products, now consisting chiefly of branded loudspeakers and high-end electronics, seldom appear on the gray market because American manufacturers are able to trace sales to unauthorized dealers and to cut off distributors or retailers who make such sales.

As might be expected, Japanese components form the biggest presence on the gray market, but they vary in availability considerably from one brand to another. Yamaha has begun to appear on the gray market recently, and Kenwood is common there, while Pioneer, once prevalent, is now entirely absent. The giant Sony Corporation has long had serious problems from gray-market distribution in the U.S. Perhaps the hardest hit have been Nakamichi and Stax, both of which are relatively small companies marketing select, high-priced components and neither of which has sufficient staff to effectively police its Far East dealer network.

Among Japanese components, phono cartridges have been especially numerous on the gray market in the past, probably because they are easy to transport. But the declining demand for cartridges and many manufacturers' practice of bringing out special, U.S.-designed models seem to have reduced activity in this area.

English audio equipment accounts for a relatively tiny percentage of g ray market sales in the U.S., but since English products are important in the enthusiast market, English gray goods deserve some attention. The English gray market operates chiefly in the area of loudspeakers, and in that respect it is unique. (Asian branded loudspeakers are not a factor in the gray market, and American speakers are an insignificant factor.) Secondary gray markets for English turntables and English vacuum-tube electronics exist as well.

The gray market in English goods is chiefly a result of the very high price differential between retail lists in England and in the U.S. Imported English components are principally high-end products and carry typically high dealer markups here. Distributors generally take a healthy cut as well, with the result that English retail prices are usually lower than U.S. dealer cost and often substantially lower. On high-priced objects like vacuum tube amps, savings to the consumer who buys gray can run in four figures.

Aside from English products, limited numbers of European audio components appear on the gray market from time to time. Revox components are available at present, and Blaupunkt automotive audio components have appeared occasionally in the past.

Generally, however, the European gray market is limited to being an English phenomenon.

Gray marketeers are as various as their products and customers. Many sorts of entrepreneurs inhabit the gray market and many, if not most, also work through normal distribution channels.

The biggest of the gray marketeers, the captains of industry, as it were, handle only mass merchandise and operate exclusively at the distributor or wholesale level. E.N.S. in Los Angeles is a prime example of the type, a well established, well-financed gray-market operation that serves retailers all over the country.

The workings of such gray-market giants are somewhat obscure. For reasons that will become obvious, they are not inclined to identify their sources, but from hearsay evidence supplied by retailers and manufacturers, I have been able to develop a model for the gray-market network in the Far East.

Gray-market distributors, essentially, exist at the sufferance of the manufacturers. Japanese electronics manufacturers, particularly the big ones, tend to be ambivalent about the gray market.

Most Japanese corporations place a premium on full employment and high production, so that gaining even a small additional market share is a primary goal. At the same time they know that if the gray market becomes too extensive their American marketing arms will wither away. Many end up temporizing and tolerating a sort of controlled gray market.

The heavyweight gray marketeers take advantage of this manufacturer temporizing. They very often bypass the American distributor and buy from wholesalers in the Orient, sometimes in Japan, sometimes in Hong Kong or Taiwan. Speculation has it that some gray marketeers buy factory direct.

Some definitely buy at slightly above dealer cost from major retailers. Essentially, they buy product where they can get it, and they buy big orders for cash. The goods are usually intended for Asian markets and often have model designations and numbers that indicate as much.

The gray-market distributor, once he has secured his goods, will generally sell to any retailer who has cash in hand. He does not maintain a dealer network as such. Such gray-market wholesalers operate chiefly out of Los Angeles and New York. Some activity occurs in Seattle and San Francisco as well. Big, established gray marketeers ship goods to their customers anywhere in the country, but smaller operators sometimes travel from city to city with truckloads of gear, selling their merchandise as they go.

Below the wholesalers are the one-step gray marketeers, the horde of individuals who import goods directly and sell to end users. Such individuals deal predominantly in the high end.

Most specialize in particular types of products and sell either Japanese or English, but not both. Jim Miller of Analogue Excellence in Los Angeles is the dean of the Japanese importers. He specializes in high-end and esoteric Japanese tonearms, cartridges and turntables and is the authorized distributor for a number of lines such as SAEC and Micro Seiki. The now-defunct mail-order operation called The Source, located in New Jersey, was the leading authorized importer of British goods, particularly loudspeakers, and no clear-cut successor has emerged since its demise.

Both Analogue Excellence and The Source do, or have done, considerable dollar volume, but most one-step high end gray marketeers are utterly marginal. Many acquire a single shipment of goods, take out classified ads in the audio press, dispose of their inventories, and leave the business. An example of the latter is Michael Sanders, president of Quicksilver Audio, who consented to be interviewed for this article. Sanders,-himself the manufacturer of highly acclaimed tube-type amplifiers, acquired a shipment of English vacuum-tube components which he sold at less than half their usual retail price points. He subsequently stopped selling British products. (In mentioning this, I intend in no way to impugn Sanders' integrity, for he took the trouble of rebuilding each amp with premium passive components before offering it for sale, and made it clear to customers that he was not, in fact, an authorized distributor.) Below the one-steppers is still another tier of gray marketeers with no direct access to foreign suppliers and who avoid wholesalers as well. They buy, instead, from other retailers, and, in fact, much gray-market activity in the U.S. involves horizontal rather than vertical movements of goods. Usually the term transshipping is used to describe the practice where an authorized dealer sells to an unauthorized one. Transshipping generally occurs in the high end, though it's not confined to that portion of the market. High-end stuff is more frequently transshipped simply because expensive audio products tend to move slowly, and one high-end retailer may find himself with excessive inventory and cash-flow problems while another has an eager buyer with cash. The heavy profit margins of high end goods permit a retailer to sell above his cost to a discounter-often a mail-order discounter-who will then sell the gear below list to the end user and still make a profit.

Some retailers transship regularly to make a profit rather than to escape a cash-flow predicament, but manufacturers are quick to notice the increase in orders, and the practice is risky for the retailer. In other instances, isolated components are transshipped simply as a favor to another dealer, and the dealer accepting the transshipped merchandise does not discount.

Transshipping from retailer to retailer is virtually the only way that American made audio products enter the gray market. The pair of Acoustat speakers I obtained were transshipped.

On the distribution level, gray marketeers tend to be clearly identifiable types of businessmen, but on the retail level there are no hard and fast distinctions between those who sell gray and those who avoid the practice.

A high percentage of retailers on every level of the industry, from box-house, mass-market operations to appointment-only, high-end salons, will buy and sell gray if an individual transaction offers sufficient profit incentive and if the risk of retaliation from manufacturers is low. But gray marketeering is most widespread in the mass market, if only because the audio gray market itself is predominantly a mass-market phenomenon. In this respect, gray market audio differs markedly from other gray markets, such as that for automobiles, where high-priced exotics form the bulk of the business.

Assessing the effects of the gray market is difficult. No one tabulates its sales or charts its development; any conclusions about its impact on either the industry itself or on the consumer can only be tentative.

On the manufacturing end of the industry, the effect of the gray market is likely pretty negligible across the board. Our unnamed $20 million retailer made this observation on the impact of the gray market in Japan: "It's just another market to them [Japanese manufacturers]. The only time they care is when it's big enough to cripple their American subsidiaries. They can crack down any time they want. They just trace the goods back to an Oriental distributor and nail him." All other retailers interviewed reiterated this, and the sporadic appearances of various brands on the gray market-Kenwood one year, Sony the next-seem to indicate that major manufacturers are quite capable of curtailing gray market activity at any time. Smaller, specialist manufacturers, such as Nakamichi, Stax, Revox, etc., are probably not capable of exerting sufficient control to totally dry up the gray goods.

Gray market is of more concern in the extreme high-end and esoteric segments of the industry. Here, the gray market appears to threaten the very existence of the sector.

In the U.S., at least since the late 60s, limited-production audio components have generally been sold in small specialist shops or audio salons.

Distribution is often deliberately limited o one shop per designated market area, and retailers are strongly discouraged from discounting-not that most of them would want to, anyway.

Each retailer has his own market area, and he's safe from competition within t, at least as regards a given brand.

No authorized retailer outside his area can discount to lure away customers, and everyone has his own piece of the high-end pie.

Manufacturers and retailers alike agree-at least off the record-that such an arrangement is necessary for the survival of the high end. High-end products sell in limited quantities, so the argument goes, and the individual sales of such products demand relatively large amounts of time and effort on the part of the retailer. Without high profit margins and "protected" retail prices, no retailer would bother to sell the high end, and the really premium goods simply wouldn't find a market.

Some dispute this theory. Jim Miller of Analogue Excellence points out that esoteric components are discounted in Japan and claims they sell far better there than here. He believes that de facto price control actually stunts the growth of the high end in the U.S., but few others in the high end appear to agree with him.

"Gray marketeers don't compete fairly," says Mike Detmer of Stax in rebuttal. "Most of them have mail-order operations and don't demonstrate product. They refer the customer to an authorized dealer, the customer hears the product there, and then buys it from the mail-order discounter. The legitimate dealer is doing all the work in representing the product, and he isn't getting the profits that are due him." Naturally, most customers are more concerned with their own finances than about the condition of the industry as such. If they can save money on the gray market, then it would appear to be to their benefit, at least in the short term, to shop there.

The consumer's situation isn't so simple though. Most gray-market items are designed for different line voltages than products intended for the U.S. The nominal Japanese line voltage is 100 volts rather than 120-not a gross mismatch, but enough to throw off the biasing of items such as Stax electrostatic speakers and headphones, with a resultant decrease in reliability. In the case of tuners and receivers, the problems can be more profound. Gray-market radios are sometimes calibrated to entirely different broadcast standards and function poorly in the U.S. At the very least, operating instructions are likely to be in a foreign tongue and therefore useless to most English-speaking consumers.

But the biggest problem confronting the consumer is in getting warranty work. American subsidiaries of Japanese and European manufacturers are understandably reluctant to provide support for products from which they derive no revenue. Many refuse to honor Japanese warranties, and they've protected themselves by pressuring their own parent companies to issue U.S.-only products while keeping Asian-market models separate. A few companies, e.g. Panasonic, make a practice of providing warranty work on any product regardless of country of origin. Others, such as Sony, are inconsistent. Some, like Nakamichi, provide service for a fee, but many refuse service and direct the customer to send the product to its country of origin for repair.

At this time, the future of the gray market is unclear. European automotive manufacturers are lobbying vigorously to get legislation that actively outlaws the gray market and makes it black. On the consumer electronics front, Panasonic has sued a gray marketeer, claiming that gray marketeering misrepresents the manufacturer and ultimately damages his reputation. In addition, the New York State legislature has passed a gray goods law that requires stores selling these goods to notify customers prior to sale about the nature of any warranty. Similar legislation is under consideration in New York City, and according to a New York Times story quoting Gary Walker, spokesman for New York City's Department of Consumer Affairs, the local laws are likely to be tougher than the State regulations. There are, of course, many, many electronics stores in New York City, and a large percentage of them do an active trade by mail. The various Sony Walkman models are hot items in this market, and some of these stores give a tip on the nature of the contest by including "Sold With Original Headphones" in the ad copy. Whether or not a salesman has, over the telephone, given his verbal assurance about a warranty, it may well be worth the trouble to insist on a valid U.S. warranty in the case of more expensive hi-fi gear.

The Times article gives a special consumer telephone number for folks who are having a problem with what they believe are gray goods: (212) 577-0111. Additionally, they can write the New York City Dept. of Consumer Affairs, 80 Lafayette St., New York, N.Y. 10013.

While the State legislation has not been signed by Governor Cuomo, it is likely to go forward. As written, it would give a consumer 20 days to seek a refund if disclosure was not made, and the Attorney General could impose a $500 fine for violations. Additionally, the Attorney General's office offers help in settling disputes. Write to the Attorney General, Consumer Frauds Bureau, 23 World Trade Center, New York, N.Y. 10047.

No one can predict the effect of the legal and legislative assault on the gray market, but it can't help but inhibit unauthorized distributors.

(Source: Audio magazine, Sept. 1985, DANIEL C. SWEENEY)

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Updated: Saturday, 2016-10-15 10:05 PST