The Jig Is Up!

In reality, though, certain activities--including gray marketing--have acted more like lubricants that keep the wheels of industry turning in IT. When there is a glut of products somewhere, someone is usually amenable to buying the excess from someone with overstock and sending it to someone with understock. Through the years, manufacturers have shown ambivalence to gray marketing, acting one way when the problem weighed on them and another way when gray marketers helped them inject life into their moribund sales.

There are as many permutations to this problem as one can imagine. Some resellers and product brokers take advantage of differing tax rates that exist between neighboring countries. That's why disk drives have been toted through the jungle from tariff-light countries to tariff-heavy Brazil. Others simply cruise reseller Web sites and chat rooms looking for those who bought extra goods in order to qualify for better discounts.

While some in the channel decry these and similar practices, others believe them to be a legitimate form of commerce. One practice, however, that is almost universally despised is known as price arbitraging. This means using price discrepancies in different markets to one's own advantage, and it's costing the industry, by some estimates, hundreds of millions of dollars a year. If you're not familiar with price arbitraging in IT commodities, here's how it works.

Suppose a vendor sells a commodity such as a disk drive to a reseller or distributor for $50. Knowing the volatility of prices on such products, the vendor promises the reseller or distributor some form of price protection. That means if the value of the goods suddenly drops below a point at which the reseller or distributor can sell the product, the manufacturer agrees in advance to make up the difference. Here's where trouble starts: Often an unscrupulous distributor will sell that $50 hard drive for $52 the day after he or she gets it. However, a distributor or reseller who anticipates market conditions to force a price drop may not book the order on that $50 hard disk for a week, a month or even more. That way when street prices drop to, say, $45, the reseller or distributor can pocket an even greater profit than if they booked the product sold on the date of transaction. (In this case, the distributor who sold the $50 drive for $52 would pocket a $2 profit from the customer and as much as a $5 profit from the manufacturer in the form of a price-protection rebate.)

There are, of course, many versions of this practice. Having had their fill of them all, several manufacturers are finally doing something about the problem.

Take Maxtor, for example. In the past three months, it has ceased supporting products that have been shipped between regions. (Its switchboard lit up when it did that, but that's helping to cut down on the transshipment of goods that bypass country-to-country tariffs.) Moreover, the Milpitas, Calif.-based manufacturer has mandated that its distributors be able to show POS reports within 24 hours anytime Maxtor asks for them. Despite the EDI capabilities distributors have had in place for years, many distributors claim to have trouble providing such data at the drop of a hat. But if they cannot do it, steep penalties apply.

"The real test will be to see whether we in the vendor community finally have the guts to take action to stop the problem or will fall on old familiar ways and do nothing about something that impacts us all," says Stephen DiFranco, vice president of corporate marketing and branding at Maxtor.

To date, PC makers including Hewlett-Packard, as well as chip-maker Intel and others, have tried to stem the problem, which impacts disk-drive makers especially. Aiding them, reportedly, are the likes of Donald Bell, CEO of Bell Microproducts, and various trade associations, including the Alliance for Gray Market and Counterfeit Abatement to which Cisco, HP, 3Com and others belong.

At this point, two things remain unclear: whether recent steps taken by manufacturers and distributors to curb the problem will have an impact, and what companies that practice price arbitraging will do in response. Oh, and then there's one other consideration: you.

Let me know where you stand on the issue.

T.C. Doyle is senior executive editor at VARBusiness. You can reach him at [email protected].