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The Impact of Gray Markets on Product Quality and Profitability

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A Correction to this article was published on 09 December 2020

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Abstract

Gray markets, the selling of genuine products via unauthorized channels, have grown in importance for both manufacturers and retailers and have thus been studied extensively since the 1980s. Recently, consumers have shown a greater willingness to patronize unauthorized retailers for different foreign products (electronics, clothes, cosmetics, and so on). Increasing consumers’ demand for gray market products has influenced both manufacturing and marketing decisions. This paper investigates the impact of gray markets on manufacturers’ and retailers’ profits and the quality of the offered products. We show that when the manufacturer sells directly to consumers, gray markets have a negative effect on both price and quality of products as well as manufacturer profits. However, when the manufacturer sells through a distribution channel, the quality of the offered products and the manufacturer’s and retailers’ profits can all increase regardless of the source of the gray market goods. Our study further shows, as expected, that gray markets always increase the total consumer surplus.

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Change history

  • 09 December 2020

    A Correction to this paper has been published: <ExternalRef><RefSource>https://doi.org/10.1007/s40547-020-00113-6</RefSource><RefTarget Address="10.1007/s40547-020-00113-6" TargetType="DOI"/></ExternalRef>

Notes

  1. Duhan and Sheffet [11] discuss in detail the existence and legal status of the gray markets in the USA.

  2. The full details of the survey are in online Appendix B.

  3. Prices were verified on the official websites in November 2018.

  4. The quality index q is a summary score of all more-is-better attributes of the product.

  5. We present a situation where some Mmarket 1 consumers will end up buying from the manufacturer, some will buy from the gray marketers, and some will not buy at all. Clearly, our analysis considers cases where prices are such that all Mmarket 1 consumers buy from the manufacturer, or all of them buy from the gray marketer.

  6. In order to concentrate on the direct impact of gray markets, we assume that the gray marketer does not incur any costs to transport the goods from one market to the other. All the results presented here hold in the presence of small per unit transportation costs and are available from the authors.

  7. It is straight forward though tedious to show that Proposition 1 holds even when we assume that products of higher quality incur not only additional fixed costs but also higher marginal cost of production as well.

  8. It is straightforward to show that a quality optimizing manufacturer would make the highest profit when selling directly in both markets, a lower profit when selling through one retailer and the lowest profit when selling through two retailers.

  9. Clearly when the retailer in market 1 (Taiwan) acts as a gray marketer importing the good from market 2, there exists a set of parameters for which all retailers and the manufacturer are better off.

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  1. Jones Graduate School of Business, Rice University, Office 412, 334 McNair Hall, Houston, TX, USA

    Xueying Liu & Amit Pazgal

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  1. Xueying Liu
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  2. Amit Pazgal
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Correspondence to Xueying Liu.

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Liu, X., Pazgal, A. The Impact of Gray Markets on Product Quality and Profitability. Cust. Need. and Solut. 7, 62–73 (2020). https://doi.org/10.1007/s40547-020-00105-6

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