Fighting grey

Grey product is a global IT channel challenge creating a shadow inventory that makes it difficult for vendors to accurately match supply and demand. Grey will never go away completely but vendors are doing their utmost to minimise its impact.

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By  Stuart Wilson Published  August 25, 2004

Shades of grey|~|greyfeatchristoph.gif|~|Christoph Schell, solutions partner organisation (SPO) manager international sales Europe (ISE) at HP|~|Grey product is categorically not fake product. It is genuine kit manufactured by a vendor that has been diverted from its authorised distribution channel at some point. Once out of the authorised channel, this product can be moved into countries that it was not originally intended for. Gauging the size of the grey market is an arduous task. In early 2003, KPMG compiled a report for the Anti Grey Market Alliance (AGMA) — an IT industry body set up to tackle the grey phenomenon. It concluded that the grey market for IT products was worth a staggering US$40bn in sales each year and resulted in US$5bn in lost profits for IT manufacturers. Grey product can emerge at any point in the channel-to-market when someone sees the opportunity to make a quick buck. Vendors and authorised distributors can fight grey, but understand they will never totally eradicate the problem. “Grey will always be there as long as there is a reason for it to exist,” explained Ali Baghdadi, president and CEO at Aptec. “It happens when you get a product that can flow from one region to another and is not confined to IT. As long as there is a way to make profit because the same product is sold cheaper in one country than another, product will flow. Grey also happens when crooked people become involved and start fiddling customs and the like.” There are many shades of grey and it is impossible to apply a catchall definition. Some vendors draw a distinction between inter-regional grey — think Asia to the Middle East — and intra-regional grey meaning unauthorised movement within a single region. While some industry insiders believe that inter-regional grey is declining in the Middle East and Africa (MEA), issues continue to exist within the region itself. “A few years ago 50% of the product in the Middle East was grey or perhaps even more but it has declined and is becoming less and less every day,” said Mehdi Amjad, group managing director at Almasa IT Distribution. “In this sense, I am talking about grey between regions. Within MEA, there is still grey product because of the role of Jebel Ali. Regional grey happens because of pricing. Sub-distributors and brokers have eyes everywhere, see a discrepancy in pricing, have the product shipped in and try and pick up the margin. When the authorised distributors stop selling to the sub-distributors and brokers within the region they go in defensive mode and try to import product from outside.” The movement of grey product between regions is something that vendors attempt to track as well. With sales teams in place within each region often remunerated based on their sales performance, no one wants to see their efforts being undermined by grey imports. For example, an IT vendor’s Asia sales team could report a massive sales out figure in one quarter and receive fantastic bonuses for their effort. But if a large part of that product is finding its way into the Middle East, it hits that same vendor’s Middle East sales team’s ability to meet its targets and does nothing to increase the vendor’s overall global sales. So regional sales teams hate seeing grey coming in from outside their region. Sometimes they are less scrupulous when it comes to tackling grey problems with the product they themselves have sold into their region. Combating this particular shade of grey does nothing to boost their numbers. Several vendors have admitted that this is seen as less of a problem and they would rather see their grey product sold than a rival vendor’s product. ||**||Barriers to entry|~|greyfeatmaan.gif|~|Maan Ahmadie, channel sales manager Middle East, Turkey and Africa (META) at Intel|~|Christoph Schell, in his new role as solutions partner organisation (SPO) manager international sales Europe (ISE) at HP, is now covering a massive geographic area including the CIS, Africa and Middle East region, and spends much of his time tackling grey channels. “The Middle East is very prominent from a logistics point of view with Jebel Ali,” explained Schell. “There is still some grey product flowing from France to North Africa and from South Africa into the southern African countries. The difficulty is finding out who triggers the grey product. Is it HP Middle East triggering grey product flow into East Africa and North Africa? Or is it Jebel Ali as a trading hub with the units being sold from there coming originally from HP Asia, HP US or HP Europe? This is when it starts getting complex and you look at the serial numbers and start to see some amazing things.” Rather than pointing the finger of blame at the region the grey product is originating from, Schell instead believes it is the responsibility for each in-country HP organisation to put up the highest barriers to entry possible. “The first responsibility lies with the country that the grey imports are happening into because they could be doing more to cover their market,” explained Schell. “Ensuring that product is available and that financing is in place for the second tier channel encourages resellers to buy from authorised in-country distributors.” Grey market product is cheaper than authorised product purchased in-country. This means that vendors have to ensure that the benefits resellers receive by purchasing from authorised distributors — be it credit, services, warranties, rebates or marketing funds — outweighs the up-front price advantage that grey offers. This is the equation that defines whether a reseller will go grey or buy from authorised channels. “Credit is definitely part of it,” said Maan Ahmadie, channel sales manager Middle East, Turkey and Africa (META) at Intel. “It is all about showing the value-add proposition to the customer. When they buy from the authorised channel they get the full support of the Intel channel programmes. Grey is decreasing and we know this because sales out from our authorised distributors is growing much faster than the overall market is growing. This means customers are buying more authorised product and less grey.” The value-adds that the authorised channel can offer only go so far in combating grey. If the difference in price is large enough, resellers will continue to buy grey product. Amjad at Almasa explained: “Channel initiatives to incentivise second tier resellers definitely help. If the price delta is too big, resellers will still buy grey. The gap has narrowed and it is becoming more beneficial for resellers to buy from the authorised channel in order to qualify for rebates and incentives that they would not receive if they opted for parallel imports.” ||**||Tricks of the trade|~|greyfeatMehdi.gif|~|Mehdi Amjad, group managing director at Almasa IT Distribution|~|Despite the best efforts of vendors and distributors on a global basis to encourage purchasing from authorised channels, certain factors remain outside their control. Vast differences in taxes and import duties across the Middle East and Africa keep grey market players in business. By avoiding these levies, sub-distributors and brokers can carve out a market niche through their own unique brand of value-added logistics. “If the customs and import regulations were not there, distributors like Almasa could easily open a warehouse in every single country, cover all the resellers and get rid of the sub-distributors moving product in grey channels,” added Amjad. “Many of them are importing product into countries in a way that gives them a better cost structure than authorised distributors.” If you buy components from Jebel Ali and move them into Egypt (avoiding tax and duty) a canny smuggler already has a 25% price advantage over the authorised channel — a difference that local assemblers will find hard to resist no matter what value-adds authorised distributors offer them in-country. While such huge import and tax charges are becoming increasingly rare in the MEA region, their very existence prevents authorised distributors moving in-country and stops vendors from drop-shipping product directly. “Intel is working closely with governments on these issues,” commented Ahmadie. “To stop people shipping into their countries from outside to save a few dollars on imports and enable goods to enter directly into the country through the authorised channel. If you have 0% tax on components imports local customers can start dealing with authorised distributors allowing IT industries to develop in-country.” In Kenya, there is 0% tax on importing a fully assembled PC while components imports are subject to a 15% tax. Quite logically, the local assembly market in Kenya suffers as people see the financial benefits of shipping finished goods in instead of components. Some of the benefits of buying from authorised distributors mean very little to resellers in the more far-flung locations in MEA. “Some people just say tell me the price,” said Mario Veljovic, sales and marketing manager at Aptec. “They don’t care about RMA and support because they are not able to do it from their country or it is too costly.” The existence of grey channels, the variations in taxes and duty across MEA and vendors’ overriding desire to sell as much of their product as possible, has created a complex scenario. The grey channel serves a purpose in reaching the markets that cannot be reached through in-country distribution and vendor offices. Vendors can appoint a distributor in Jebel Ali to serve East Africa but have no real control if that partner looks for opportunities closer to home. “I have a case where one of the vendors I work with has authorised a distributor in Dubai for a region not in the Middle East,” said Veljovic. “These guys are selling in my market even though they are not authorised to and I have evidence of that. I will inform the vendor and see if he takes action. If he doesn’t, I’ll stop riding a dead horse and look for a better vendor.” ||**||Clamping down|~|greyfeatmario.gif|~|Mario Veljovic, sales and marketing manager at Aptec|~|With serial numbers on every product and resellers happy to point out where grey product is hitting the channel, vendors have the tools at their disposal to locate the culprits. Throw in the detailed sell-out data many require from distribution partners and it looks a simple task. Some vendors take a stricter line than others on dealing with the companies going grey. With HP staff compensated based on sell-out reports, Schell has excellent visibility of the 98% of HP product moving through indirect channels in the Middle East. The company has worked hard to stamp down on the supply of HP product to second-tier resellers doing a little bit of smuggling on the side. Other vendors are not so thorough and are happy as long as their product is selling in the region regardless of the channels it is moving through. “You starve them and make sure they do not see any cashflow by blacklisting them,” says Schell. “That is what we have been doing for the last three years. You meet them, you talk to them, you give them warnings and you blacklist them. We then tell our distributors that if you sell to this guy, first you are risking your rebates, then you are risking your contract.” This type of vendor approach is intended to eradicate the players involved in organised grey marketing. Preventing distributors from selling to them is one method of cracking down, but unless a vendor tracks its products right through to the end user, there is no guarantee that its kit isn’t switching to the grey side further down the channel. To prevent this from happening, vendors need to reach as far down the channel as possible and minimise the role of the middlemen beyond the authorised distributor level. “From Intel’s perspective, the authorised distributors should provide the logistics — not a middleman,” said Ahmadie. “We want a direct relationship between the distributor and the smaller customer. That is part of the channel health message from Intel: distributors bringing to life their relationship with the assemblers through logistics, coverage and product availability.” Vendors want to work with a small number of authorised distributors reaching out to a wide base of second tier resellers. This scenario is still some way off in MEA because moving goods throughout the region is a challenge. Even when logistics is a simple process, grey product can still hit the market due to currency fluctuations. There is also the issue of special pricing to consider. This occurs when vendors give partners a special one-off reduced price for a large deal or negotiate an OEM deal and not all the products are used in the intended way. “We saw this in the first two quarters for hard drives where OEMs were floating product back into the channel. Traders and brokers were bringing the product back into distribution,” commented Veljovic at Aptec. With rigorous controls in place for global OEMs, this activity is limited to smaller OEM partners. Clever assemblers building three thousand PCs a quarter can claim to be using hard disk drives from all three major vendors. This enables them to buy 9,000 drives per quarter at a special price and put 6,000 back into the distribution channel. With each vendor believing its 3,000 drives are being built into assembled machines, it is not always obvious that these products are actually becoming grey channel fodder. HP has already taken steps to prevent special pricing abuse. Strict end-user verification procedures have been put in place to ensure that if a partner gets a discount to supply 1,000 PCs to a large enterprise account, they all make it to the intended end-user and do not find their way into the grey channel. The MEA market is approaching a critical inflection point where vendors reach a critical mass that allows them to invest the resources needed to clamp down on grey channel activity. It is no coincidence that traders depending on grey channels to sustain their business are starting to feel the heat. The grey market will not disappear, but those companies relying on it to make a profit will feel the pressure grow. A-brand vendors are taking the grey market seriously and so are the authorised distributors they trust to ensure sales are only made to resellers with desirable business models. Admittedly, the tax and duty situation in some countries will conspire to produce a margin opportunity for those resellers committed to grey marketing, but it will become harder and harder for them to source the product their customers want. Even in countries such as Egypt, the grey importers are actually in competition with one another. Rather than enjoying lucrative 25% margins, they are pulling each other down to much lower profit levels. This example is fast becoming the exception to the rule in the MEA market. Vendors, distributors and resellers have a stark choice: embrace grey in all its forms or reject it out of hand. There is no middle ground. ||**||

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