Grey Market Goods and China, Part Two

Grey Market Goods and ChinaIn this projected 4-part series we’ll take a closer look at grey market goods and China. In part 1, we discussed what grey market goods are and why manufacturers get so worked up about them. Today, in part 2, we’ll look at how grey market goods are regulated in China. In part 3, we’ll look at how grey market goods are regulated in the United States. And in part 4, we’ll look at grey market goods and Chinese factories, and what foreign companies can do to protect themselves.

Part 2: How Are Grey Market Goods Regulated in China?

One of the minor mysteries of modern China is how every mall has so many luxury-brand stores that seem never to have anyone shopping inside. I’ve read numerous explanations for this disparity, none of them entirely satisfactory: the shops are loss leaders in an effort to build brand loyalty in China; the shops are highly subsidized by mall owners to bring in other tenants and/or to give them face; all of the sales are made after hours to Party officials’ relatives and mistresses; people just aren’t paying attention at the right time.

But one answer for the empty stores, surely, is the enormous size of China’s grey market for luxury goods. In 2015, Chinese citizens spent $22.5 billion on luxury goods purchased in China – and more than twice that amount abroad.

As noted in part 1, grey market goods exist because there’s a market for them, and that market exists because grey market goods are either cheaper or have better availability. But in China there’s a third driver of the grey market: quality. It’s ironic because in the US, grey market goods have a strong whiff of caveat emptor; if you buy a product outside the normal channels you accept the risk that it might be lower quality. But in China, the calculus is flipped: because counterfeiting is so rampant, the chance of buying a fake is considered to be much lower if the goods come from overseas.

Historically, a significant proportion of grey market luxury goods in China have come via daigou, personal shoppers (usually young Chinese women) who live or travel overseas and purchase luxury goods for well-heeled clients in China. I’ve seen this in action: at Seattle Premium Outlets’ Burberry Store, you sometimes have to wait in line just to get in the store, only to be ignored when it becomes clear you’re not there to drop twenty thousand bucks.

Other grey market goods in China are purchased directly by consumers, either while traveling overseas, or from foreign reseller sites like eBay. Grey market goods can also be found on Chinese e-commerce sites like Taobao and 1688.com; these goods are usually purchased “on spec” overseas and then resold in China. (The daigou as impersonal shopper.) Baby formula and iPhones have, at various times, been extremely popular grey market goods in China.

Grey market goods are legal in China, or at least not an infringement of the brand owner’s IP rights. Indeed, Shanghai’s Free Trade Zone has a car dealership that specializes in grey market automobiles.

But many grey market goods in China run afoul of the law in another way: customs fraud. When the goods are brought into China, they are not declared at all or are declared at lower values. Defrauding Chinese customs is an essential part of many a daigou’s profit margin, because China has historically imposed significant duties on a range of luxury imports.

China has attempted to crack down on illegal grey market importation through a number of means, including (1) higher taxes on goods brought in by travelers as part of their luggage, (2) lower taxes on goods imported through legitimate channels; and (3) increased penalties for those caught falsifying customs declarations.

The effectiveness of these measures is a bit hard to gauge: some reports say the measures are eliminating large-scale daigous; others suggest that the enforcement is both haphazard and overbroad, and that when Chinese people attempt to order directly from overseas retailers, the packages are frequently rejected at the border, with the result being that people are even more reliant on daigous to get the products they want.

On a certain level, foreign brand owners might not be that concerned about grey market imports in China – Christian Louboutin gets paid whether a pair of pumps is bought in Shanghai or in Houston and then taken to Shanghai and resold. But they should be concerned, for several reasons. First, they want to be seen as cooperating with the Chinese government on tax and customs issues. Second, having to deal with so many purchases by Chinese travelers overseas is a drain on resources (staffing, marketing, logistics) and distorts the worldwide revenue stream. Third, sometimes the prices in China, even accounting for taxes and tariffs, are higher than they are abroad — although a number of brands have normalized prices in China in an attempt to dissuade gray market sales. Fourth, the daigou phenomenon increases the amount of intermediation between brands and their consumers, which is exactly the opposite of what companies want. How can you market to customers when you don’t know who they are? And how can you control your brand identity when you are not the seller?

In part 3 of this series, we’ll look at how the United States regulates grey market goods.

Matthew Dresden

Matthew focuses on international and China law, with a focus on technology and entertainment law and Chinese transactional and IP work. He represents a wide range of companies, from start-ups to NYSE-traded companies. His work has included matters for film studios, cable channels, film and television production companies, video game developers, magazines, restaurants, wineries, international design firms, product manufacturers, outsourcing companies, and computer hardware and software companies.