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Strategies to detect and reduce counterfeiting activity
Business Horizons (2008) 51, 191–199
Available online at www.sciencedirect.com
www.elsevier.com/locate/bushor
Strategies to detect and reduce counterfeiting activity Barry Berman Hofstra University, 222 Weller Hall, Hempstead, NY 11549, USA
KEYWORDS Counterfeiting; Intellectual property; Safety risks; Track and trace technology; Controlling outsource suppliers
Abstract While at one time counterfeit products were largely restricted to watches, designer apparel, and movies, today counterfeiting is a major problem in such diverse product categories as pharmaceuticals, automotive parts, and computer software. There are four distinct types of counterfeits: knockoffs, counterfeits that are reverse engineered from genuine goods, goods produced by outsourced suppliers on “third shifts,” and goods that do not meet a manufacturer's standards but are not properly labeled as seconds or destroyed. The quality of some counterfeits is so good that some major retailers have unknowingly purchased counterfeits. But while there are new forms of counterfeit goods, there are also new strategies for combating counterfeiting. This article describes how to detect and reduce counterfeiting activity, via a plan which consists of four steps: (1) developing early warning signals of counterfeiting; (2) budgeting to monitor, deter, and remove counterfeits; (3) using demand-side strategies to deter counterfeiting; and (4) using supply-side strategies to deter counterfeiting. © 2008 Kelley School of Business, Indiana University. All rights reserved.
1. Hey mister, want to buy a watch? While at one time counterfeit products were mostly confined to costly watches, designer apparel, movies, and DVDs, today counterfeiting is a major problem in such diverse product categories as pharmaceuticals, medical equipment, baby formula, electrical parts, automotive and aircraft parts, and computer software. According to the cover story from a recent issue of Business Week, one can pick any product from a well-known brand and discover that there is a counterfeit version available (Balfour, Matlack, Barrett, Capell, Roberts, Wheatley, Symonds, Magnusson, & Brady, 2005). In some E-mail address: [email protected]
cases, the appearance of the counterfeit version so closely matches the genuine article that major retailers such as Wal–Mart and Tuesday Morning have unknowingly purchased counterfeits.
1.1. Classifying counterfeits Counterfeit products can be classified into four distinct types. The first type is a “knockoff,” “lookalike,” or “sound-alike” where consumers are aware that they are purchasing an inexpensive copy due to the product's low price relative to the authentic good, the lack of traditional packaging, and/or the unusual distribution channel. This form of counterfeit is common with inexpensive copies of Rolex watches, Louis Vuitton handbags, and Fendi fashion accessories
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192 that can be purchased from street vendors, on New York City's Canal Street, or on the Web. Despite the fact that the consumer has knowingly purchased a counterfeit product, this type of counterfeit is not harmless from a societal and business perspective. The loss in sales to the genuine product owner is indirect in knockoffs, since few genuine goods purchasers would purchase a knockoff. Still, a genuine product's manufacturer can easily lose the distinctiveness of its brand image and design from a constant supply of low-priced knockoffs. In the second type of counterfeit, genuine products are reverse engineered through a “tear down” analysis of the genuine product, or through the use of stolen or copied blueprints or masters. In the case of software, CDs, and DVDs, the copy protection scheme is bypassed. Unlike the “knockoff,” this form of counterfeit is meant to deceive the general public. The loss in sales in this form of counterfeit is direct because the counterfeit goods are sold as genuine. The genuine goods manufacturer can suffer loss in its quality image when consumers complain about a product's quality because they don't know that their item is counterfeit. Examples of this type of counterfeit product include counterfeit Windows XP software, Kiwi shoe polish, Callaway golf clubs, and Bosch power drills (Balfour et al., 2005). A third form of counterfeit products is produced by current or former outsourced suppliers using a “third shift” that the original product manufacturer is unaware of. A well-documented example of this form of counterfeiting was an outsourcer's continued production of New Balance sneakers after its contract had been terminated (Parloff, Chandler, & Fung, 2006). Since these products are produced on the same machinery as the original good, this type of counterfeit good may be difficult to distinguish from the genuine products. The fourth form of counterfeit are goods produced by outsource suppliers that do not meet a manufacturer's standards but were not properly labeled as seconds or destroyed. These goods are reclaimed and resold as first-quality products. Kyocera, for example, filed suit against Hecmma, an outsourcer it had hired to produce cell phone batteries. Kyocera claimed that Hecmma sold batteries prone to overheating bearing Kyocera's brand name after the company terminated its order (Spring, 2006). This type of counterfeit is the most difficult to distinguish at purchase from genuine goods.
1.2. Estimating counterfeiting activity The International Chamber of Commerce in Geneva estimates that worldwide sales of counterfeit products could run as high as $650 billion per year
B. Berman (Kurtenbach, 2006). The International Anti-Counterfeiting Coalition and the US Customs Service calculate that the revenue loss from counterfeiting for US businesses is $200 billion per year (Hyde, 2006). Other estimates place this decrease in the $250 to $300 billion per year range (Nash, 2005). The impact of counterfeiting varies by industry, as well as by country. The World Health Organization estimates that up to 10% of medicines are counterfeit, and that in some countries the counterfeit rate is as high as 25% (“Pfizer Welcomes,” 2006). In the IT industry, software manufacturers lose about $100 billion annually according to research by KPMG and the Alliance for Gray Market and Counterfeit Abatement (Bednarz, 2006).
1.3. The total costs of counterfeiting The true costs of counterfeiting are not limited to the loss in sales revenues. Counterfeiting's total costs also include the manufacturer's long-term sales decline due to a loss in its brand's distinctiveness, or due to a consumer's poor experience with a counterfeit good he/she assumed was genuine. The costs of detecting and controlling counterfeiting activity must also be included in calculating the total costs. Counterfeiters are also unfair competitors in that they do not have expenses associated with promotion, trademark licensing, research and development, design and engineering costs (beyond copying the genuine product), quality control, test marketing, customer support, warranty claims, and product recall expenses. According to the president of the International Counterfeiting Coalition, “After all, counterfeit products are just riding the tails of big advertising and promotional expenses spent over many years by big brands” (Gogoi, 2006). On a societal level, the total costs associated with counterfeiting include losses in employment, lost income and sales tax revenues, and expenses associated with increased trade deficits. According to one estimate, counterfeiting results in the loss of 750,000 US jobs (Anonymous, 2005). An IDC Economic Impact Study estimates that if all global software piracy was lowered 10 percentage points over the next four years, this change would contribute 2.4 million new jobs and $400 billion in economic growth to the global economy (“Microsoft Announces,” 2006). In addition, there can be significant safety issues associated with counterfeits when products such as brake parts and prescription drugs are commonly copied (Fischer, 2006; “Pfizer Welcomes,” 2006).
Strategies to detect and reduce counterfeiting activity
2. Reasons for increased concern over counterfeiting This section focuses on the major reasons for increased concern over counterfeiting. Specific measures to deter counterfeiting will be discussed later in the using demand-side and supply-side strategies sections.
2.1. Increase in counterfeiting activity According to a US Customs Service counterfeiting expert, the value of seized fraudulent tech goods doubled between 2004 and 2005 (Spring, 2006). Another report stated that the US Customs and Border Protection and Immigration and Customs Enforcement made 8022 seizures of counterfeit merchandise in 2005 (with a domestic value of over $93 million), versus 3586 seizures in 2001 (“Passage of Anti-Counterfeiting,” 2006). Counterfeiting has also grown within the European Union. The number of counterfeit items seized at EU borders has increased from 10 million items in 1998 to over 103 million items in 2004 (Gutierrez, Verheugen, Mandelson, & Schwab, 2006). In 2005, the number of seized items was reduced to 75 million counterfeit items. However, for the first time, over 5 million counterfeit foodstuffs, drinks and alcoholic products, and over 500,000 counterfeit medicines, were among the products intercepted.
2.2. Counterfeiters are more difficult to detect and prosecute Counterfeiters commonly use strategies to avoid detection and to minimize losses when caught. Some counterfeiters use “front” companies or “front” personnel to register companies that produce counterfeit products. Payment is also often made to third parties. Counterfeiters have been known to ship products from sub-contractors via freight forwarders so that it is more difficult to tie the counterfeiter to the seized products. Counterfeiters have also used disguised product names in their production, sales, and inventory records so that accounting records seized as part of an investigation are not useful to authorities. Counterfeiters have shipped counterfeit products along with gray market goods (goods purchased through unauthorized channels). This makes prosecution more difficult since counterfeiters can state that they innocently purchased counterfeit goods (Clark, 2006). Since a sample of a counterfeit product is needed in any civil or criminal case, many counterfeiters will not provide samples (they only produce counterfeits to order). Lastly, many counterfeiters minimize losses and penalties by keeping low levels of inventory and by using separate facilities to produce and store counterfeits.
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2.3. Increased Web purchases The increased use of auction sites such as eBay, as well as Web-based sales sites, has expanded the market for counterfeiters. Let's first look at several investigations that provide a sense of the amount of counterfeit merchandise on eBay:
• Test purchases from among 300,000 Dior products
and 150,000 Vuitton items offered on eBay during the first six months of 2006 found that 90% were counterfeits (Matlack & Mullaney, 2006).
• In 2004, Tiffany purchased 186 random items from
eBay and found that only 5% of the items were genuine (Chao, 2006).
• Louis Vuitton and Dior Couture have recently filed suit in French court against eBay. Their suit alleges that nine of every ten Louis Vuitton items on sale at eBay are counterfeit (“eBay Inc.,” 2006).
• In tests conducted by Microsoft on 115 copies of physical media purchased on eBay, 39% were found to be counterfeit and another 12% contained software that was either counterfeit or had been tampered with (“Microsoft Cracks,” 2006).
While eBay's official policy does not permit listing of counterfeits and unauthorized replicas, this is an extremely difficult policy to enforce. Even though eBay can suspend a counterfeiter's account or demote the seller's status, the auction site had 193 million registered users to monitor as of March 2006. Buyers of counterfeit merchandise can leave negative feedback on eBay, but sellers can easily switch identities or reregister their business in a partner's or other family member's name. Counterfeiters can also use their websites to show trademarks of legitimate manufacturers and distributors, make small firms appear to be subsidiaries of major corporations, and even mask the country where the goods are purchased. WorldExpressRX. com, which sold counterfeit pharmaceuticals, operated a website so slick that according to one report, “there would be no reason for a consumer to dispute its authenticity” (Tesoriero, 2004).
2.4. High levels of trade with China A considerable amount of outsourcing activity is conducted in China, a country with a poor record in protecting intellectual property. According to Representative Donald Manzullo, the chairman of the House Committee on Small Business, China's share of counterfeits was ten times greater than that of any other US trading partner (Krause, 2006). Similarly, an
194 EU business survey identified China as the source of two-thirds of all counterfeit goods seized in Europe (Zarocostas, 2006). An analysis by an academic cites three reasons for China's high level of counterfeiting. These include China's high level of organized crime, the willingness of Chinese consumers to purchase counterfeit goods, and the lack of intellectual property rights in China (Chaudhry, 2006). There is extensive agreement among foreign trade experts and US government officials that a large proportion of counterfeiting will continue to flow from China despite the fact that the PRC signed the World Trade Organization's TRIPS (Trade-Related aspects of Intellectual Property Rights). This agreement requires member countries to have an effective intellectual enforcement mechanism. The US Trade Representative measures how well countries protect property rights in its annual Special 301 Report. The report concluded that China has failed to significantly reduce intellectual property rights infringement levels, as required by the US–China Joint Commission on Commerce and Trade (“Out-ofCycle,” 2006). On April 29, 2005, the office of the US Trade Representative placed China on the Special 301 Priority Watch List due to its failure to improve intellectual property rights protection (“Statement of Senator Carl Levin,” 2006). According to Michigan Senator Levin, “China may have IPR [intellectual property rights] laws that appear reasonable on the books, but it is not enforcing them” (Krause, 2006). One barrier to enforcement of property rights in China is the way the Chinese government values seized counterfeit goods. China appraises seized goods at the price the counterfeiter meant to sell them, not at the retail price of the genuine products which is the standard in many other countries. As a result, the value of the seized goods often falls below the 50,000 yuan (about $6250) level which is the minimum threshold for criminal prosecution (Zamiska, 2006).
3. Developing a plan to reduce counterfeiting This section discusses the steps in developing a plan to reduce counterfeiting: (1) developing early warning signals of counterfeiting; (2) budgeting to monitor, deter, and remove counterfeits; (3) demand-side strategies to deter counterfeiting; and (4) supplyside strategies to deter counterfeiting.
3.1. Developing early warning signals of counterfeiting The presence of counterfeit merchandise often goes undetected for a significant time period. For exam-
B. Berman ple, golf equipment manufacturer Callaway became aware of a significant counterfeit problem only after its customers returned golf clubs due to broken shafts. Other manufacturers, including Hewlett Packard, Kingston, and Motorola, have also learned about counterfeiting through consumer complaints and warranty claims (Spring, 2006). The first step in reducing counterfeiting activity is to make sure the targeted firm is aware of counterfeiting activity as early as possible. Among the early warning symptoms of increased counterfeiting activity that a targeted firm should monitor are a significant decrease in sales; a large amount of its products available at discounters, on eBay, or on other Internet auctions and websites; an increase in orders for proprietary components; an increase in gray market activity; an increase in returns and warranty claims; and an increase in product failure rates (KPMG, 2006). Firms need to pay particular attention to those products that are considered at “high risk” for counterfeiting activity. For pharmaceuticals, the National Association of Boards of Pharmacy has established a list of “susceptible products” that is listed on www. napb.net. Luxury brands, products with a past history of high levels of counterfeiting, a firm's key products, and products with a high degree of safety risk, should be screened most often. An important component of an early warning system is the provision of a simple means for final consumers and resellers to report suspected goods. Microsoft uses a tool (accessible at www.microsoft. com/genuine) to enable customers to determine whether they have a genuine Microsoft product. This software will activate popups if the program determines that a consumer's version of Windows, for example, is counterfeit.
3.2. Budgeting to monitor, deter, and remove counterfeits The costs of monitoring, deterring, and removing counterfeit merchandise from the marketplace are high. Some Fortune 500 companies have reportedly spent an average of $2 to $4 million per year to combat counterfeiting. Others reportedly spend as much as $10 million to foil counterfeit products (Monks, 2004). LVMH Möet Hennessy Louis Vuitton spent over $16 million in 2004 on investigations, busts, and legal fees (Balfour et al., 2005). Entertainment and luxury goods companies often hire private investigators to track down counterfeiters and then pass on the information to law enforcement officials (Palmer, 2006). Private investigation firms typically establish fake companies to purchase counterfeit goods (Becker, 2003). Other firms have a staff of internal investigators dedicated to purchasing counterfeit merchandise and using
Strategies to detect and reduce counterfeiting activity this evidence in legal proceedings. GM has seven staff personnel that monitor counterfeiting, and Pfizer has five anti-counterfeit personnel in Asia alone (Balfour et al., 2005). An intellectual property owner needs to have legal protections and registrations in place to build a case against a counterfeiter. Intellectual property can be protected by trademarks, copyrights, design patents, utility patents, and trade secrets. With the exception of the European Union, each country requires its own trademark registration. Trademark registration costs as much as $20,000 per country and involves millions of dollars on a worldwide basis (Tucker & Casabona, 2006). Trademark litigation can also be costly. According to one attorney with experience in this area, “A straightforward trademark litigation case in the US can be done for $50,000. But a full-fledged, knockdown, drag-out litigation is a million-dollar fight” (Tucker & Casabona, 2006). The budget to deter counterfeiting must anticipate necessary actions on both demand and supply sides. Demand-side budget actions focus on reducing demand by making counterfeit merchandise easier to identify, and on educational initiatives that make consumers more aware of the risks associated with counterfeit purchases. Supply-side budget items reducing the supply of merchandise through better controlling of outsource suppliers, monitoring websites to search for counterfeits, legal actions, reducing gray market activity, and using track and trace technologies.
3.3. Demand-side strategies to deter counterfeiting A firm can attempt to deter counterfeiting through consumer education programs that make both resellers and final consumers aware that they are purchasing counterfeits, as well as publicizing the dangers and the social costs connected with counterfeiting. Consumers also need to be educated to not only recognize, but also to quickly report counterfeit goods. For example, Microsoft advertises its anti-piracy hotline number (800) RU–LEGIT so final and reseller consumers can divulge the names of pirated software providers. Authentication technology has both supply and demand considerations. On a demand side, this technology makes it easier for final consumers and resellers to more readily identify counterfeit products. These labels are very difficult for counterfeiters to copy. On a supply side, “track and trace” technologies such as radio frequency identification devices (RFID) enable individual products to be tracked as they move from one location to another. RFID may replace older barcode technology.
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Anheuser–Busch, which was confronted with many counterfeit Budweiser beer products in China, now uses imported foil for its packaging in China which is difficult for counterfeiters to obtain; the foil changes to red when cold (Balfour et al., 2005). Similarly, 3Com uses a four-dimensional holographic label on its switches that is also hard for counterfeiters to copy (Bednarz, 2006). A second part of the education process is to make the public aware of signs of counterfeits: prices too low to be true, the lack of holograms, poor packaging, and broken seals on shipping containers. Callaway, a leading golf club manufacturer, has a section of its website labeled “Nine Ways to Avoid Being Fooled by Counterfeits.” Its hints that a suspected good may be counterfeit include: the dealer is not authorized, the deal looks too good to be true, the absence of serial numbers on key parts, and metal painted to resemble a carbon composite (Callaway, 2007). Lastly, marketers need to develop advertising campaigns that focus on the significant safety, performance, and financial risks associated with the purchase of counterfeit merchandise. Microsoft has tried to make final consumers more aware of the risks of purchasing counterfeit software. These risks include software that contains spyware, viruses, and hidden components that can place their personal and business security information at risk via credit card and identity theft. Resellers also need to be better informed about the risks of selling counterfeits. Purchasers of defective or unsafe counterfeit goods can sue wholesalers and retailers on the basis of negligence, breach of implied warranty (such as a product's fitness for a particular purpose), fraudulent concealment, and consumer fraud. In cases involving counterfeit pharmaceuticals, consumers often sue both wholesalers and retailers on the grounds that the drug did not match the prescription or label, the pharmacy did not correctly fill the prescription, the pharmaceutical was misbranded under the Food & Drug Cosmetic Act, or the reseller's breach of a representation that it was selling an authentic drug (Wala, 2005). These educational programs can be funded by single manufacturers, as in the case of Callaway and Microsoft, through trade associations, and by governmental agencies. The Better Business Bureau recently launched a six-month Counter/Act campaign in eastern Massachusetts, Maine, and Vermont to increase the public's awareness of counterfeiting. Using the slogan “Don't Let Counterfeit Products Make You a Victim!” the campaign emphasized the threats to health and safety caused by counterfeiting. The program was underwritten by The Gillette Company and United States Customs (World Intellectual Property Organization, 2006).
196 The FDA has also developed public service announcements about the dangers of counterfeit drugs. It prepared 4.6 million leaflets aimed at distribution by pharmacists along with the patient's prescription, as well as a website, www.fda.gov/ counterfeit (“Statement of Randall W. Lutter,” 2005).
3.4. Supply-side strategies to deter counterfeiting While demand-side strategies attempt to deter consumers from purchasing counterfeit goods, supplyside strategies seek to limit the supply of counterfeits by better controlling outsource suppliers, monitoring websites to search for counterfeits, legal actions to reduce counterfeits, reducing gray market activity, and using track and trace authentication technologies. 3.4.1. Controlling outsource suppliers A multi-part strategy is needed to effectively control outsource partners. This strategy needs to be based on human resource strategies that stress the need to protect a firm's core capabilities, legal issues (patents and contractual mechanisms), and alliance processes that protect information flows and partner access to information (Norman, 2001). Shoe manufacturer New Balance recently had a major problem with a outsource supplier located in China who did not return confidential production, sales, and marketing information upon termination of their contract. The supplier also kept New Balance's molds, specifications, signs, labels, wrappers, and ads (Parloff et al., 2006). A Chinese court ultimately awarded New Balance $9.9 million in damages for the former outsourcer's production of at least 200,000 shoes after their contract was terminated. In addition to this legal action, New Balance reduced the number of outsource suppliers, carefully monitored the flow of materials to better control production, and changed to a “high-tech” label that was more difficult for counterfeiters to copy (Kahn, 2002). Other strategies to reduce the quantity of thirdshift goods produced by outsourcers include: (1) carefully selecting outsourced service providers based on past honest relationships with other firms; (2) monitoring outsourcers through surprise inspections; (3) ensuring that outsourcers return all confidential technical, production, sales, and marketing information when the outsourcing relationship ends (Parloff et al., 2006); and (4) using multiple outsourcers for the same good so that one firm does not have the resources to copy a manufacturer's good. A firm may also wish to complete the production itself using a secret process or proprietary machinery (Kurtenbach, 2006).
B. Berman 3.4.2. Monitoring websites to search for counterfeits Several software products, such as Brandimensions, Cyveillance, GenuOne, and MarkMonitor, are able to monitor websites (including domain names, chat rooms, and auctions) that illegally use a firm's name or identity. GenuOne uses keyword searches including suspicious keyword combinations such as “100 percent authentic” or “deep discount,” and pricing indicators to monitor auctions, chat rooms, and websites. This helps intellectual property owners identify sellers of counterfeit products. GenuOne provides a similar service through VeRO, eBay's Verified Rights Owner Program. Over 12,000 brands are members of VeRO, including Xerox, Cartier, Bacardi, Kodak, and Montblanc (Steiner, 2003). According to GenuOne's chief executive officer, 36,000 individual auctions were closed down in less than a year through the use of the company's products (“Counterfeiting Challenges,” 2006). Microsoft monitors auction sites to identify counterfeit software, and then seeks to shut those sites down. In 2002, Microsoft asked for takedowns of almost 50,000 individual auction sites that offered pirated software (“Microsoft Files,” 2006). 3.4.3. Legal actions to reduce counterfeits While software products can help identify sellers of counterfeit goods, the genuine manufacturer owner still needs legal action to close down the counterfeiter's operation and to seize its products. US patent and trademark rights are governed by the Tariff Act of 1930, the Lanham Act of 1946, the Trademark Counterfeiting Act of 1984, the Anticounterfeiting Consumer Protection Act of 1996, and the Anticybersquatting Consumer Protection Act of 1999. Two loopholes that counterfeiters had exploited have been closed by the Stop Counterfeiting in Manufactured Goods Act signed by President Bush in March 2006. Law enforcement agencies now have the right to seize and destroy any tools used to make counterfeit products, and counterfeiters can be forced to pay damages and fines as high as $15 million. Previously, counterfeiters could be forced to surrender their goods, but were still allowed to keep the equipment used to produce and package the goods, as well as any profits from their counterfeiting activity (Hyde, 2006). Another important provision in this law prohibits trafficking in counterfeit labels, stickers, and other markings. This was enacted as a result of a 2000 federal appeals court ruling that trafficking in trademarks that are not attached to the product does not violate the trademark statute (Zwaniecki, 2006). Recent lawsuits against counterfeiters have been extended to those who knowingly sell counterfeit
Strategies to detect and reduce counterfeiting activity merchandise, as well as those who aid counterfeiters such as property owners. In a recent case, Louis Vuitton reached an agreement in federal court that required property owners to take legal action against sellers of counterfeit merchandise located in their building (Bleyer, 2006). 3.4.4. Reducing gray market activity Since counterfeit products often enter the supply chain from unauthorized resellers, a major way of reducing the supply of counterfeits is to reduce the level of goods entering through gray market activity. The levels of goods entering the market through unauthorized channels vary by product, as well as country. One estimate is that a drug can travel through as many as 20 to 30 hands in European markets before use by the final consumer (“Pfizer Welcomes,” 2006). This gives counterfeiters 20 to 30 point-of-entry opportunities to open, alter, or switch each drug product. In the United States, while primary drug wholesalers buy the majority of their drugs from manufacturers, they also purchase selected drugs in the secondary market such as from hospitals and nursing homes, even though these institutions are not authorized by manufacturers to resell drugs(Tesoriero, 2005a). There are two major ways to reduce counterfeiting associated with gray market activity. First, distributors can withhold payment until they have verified that the products are legitimate. A second, more drastic strategy is to refuse to purchase products from wholesalers who participate in any gray market activity. For example, CVS recently announced that it will no longer purchase drugs from wholesalers that trade in the secondary market. As a result, Cardinal Health Inc., a major drug wholesaler, stated it will only purchase drugs from manufacturers or authorized sources. CVS is Cardinal's largest customer, accounting for 18% of Cardinal's revenue (Tesoriero, 2005a). The nation's top three wholesalers that account for over 90% of medicines distributed in the United States have also taken steps to reduce purchases from secondary wholesalers (Tesoriero, 2005b). 3.4.5. Using track and trace authentication technology RFID technology has the potential to be used worldwide as a counterfeiting deterrent. While RFID tags look like ordinary labels, they are actually computer chips with antennas wrapped around them. As a product passes through the supply chain, each supplier or vendor writes an additional product code on that chip. Sensors at the distribution center use radio waves to activate the tags, which are read electronically and stamped with a record of where they have been. Since legitimate products are manufactured at select locations, and sold through authorized
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distributors, concern should be raised when an incomplete or incorrect set of locations are listed on a tag. Despite the existence of these technological developments, an Ernst & Young survey of 225 pharmaceutical industry executives found that just 25% of those surveyed were using technology to address supply chain challenges such as counterfeiting drug products (Jarvis, 2005). North American companies favored auditing and validating their partners, while European firms felt that cutting off business with questionable partners was a more effective deterrent.
4. A review Studies that gauge the economic impact of counterfeit activity by measuring sales of counterfeit products have clearly underestimated the magnitude of the problem. A true picture needs to include the short-term loss in sales to genuine manufacturers, the long-term sales loss due to deterioration of a product's distinctiveness, as well as the user's potential poor product-related experience with a product he/she assumed was genuine. On a societal level, the total costs associated with counterfeiting include losses in employment, lost income and sales tax revenues, and expenses associated with increased trade deficits. Today safety concerns associated with counterfeiting can also be a major issue due to the significant number of counterfeit products with high safety risks, such as brake parts, pharmaceuticals, and baby formula sold in the United States and abroad. Obviously, these total costs are much more difficult to estimate. An effective strategy to detect and reduce counterfeiting activity has several key components. First, the importance of the early detection of counterfeiting needs to be stressed. Early detection reduces the loss in sales and image to the intellectual property owner, as well as minimizing social costs associated with counterfeiting. Second, a firm needs to adequately budget to deter and remove counterfeit merchandise from the marketplace. These expenses may include monitoring, investigating, the cost of establishing intellectual property registrations and protections, new packaging, public relations, and other issues associated with supply or demand. Third, an anti-counterfeiting strategy needs to focus on demand-side initiatives such as consumer education, authentication or “track and trace” technologies, and advertising that communicates the risks associated with counterfeit merchandise. Fourth, a firm needs to implement supply-side measures such as controlling outsource suppliers, monitoring websites, legal actions, reducing the entry of products through unauthorized
198 channels, and utilizing technology to monitor the supply chain. It can also be noted that a firm's anti-counterfeiting strategy must be tailored to the type of counterfeiting activity. For example, a central part of the strategy in dealing with knockoffs is to extend the legal sanctions to property owners where these goods are sold. In contrast, controlling access to blueprints, trade secrets, and production processes is critical in reducing reverse engineered products. Likewise, using multiple outsource suppliers can reduce third-shift goods, while ensuring that outsourcers return all seconds for disposal is important in reducing the amount of second-quality goods sold.
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B. Berman 2007, from www.agmaglobal.org/press_events/press_docs/ Counterfeit_WhitePaper_Final.pdf Krause, S. (2006, June 12). Legislators detail concerns about counterfeit goods from China. US Department of State. Retrieved February 12, 2007, from http://usinfo.state.gov/eap/Archive/ 2006/Jun/12-293325.html Kurtenbach, E. (2006, July 2). Companies fight back against China piracy. Retrieved February 12, 2007, from http://www.sfgate. com/cgi-bin/article.cgi?f=/n/a/2006/07/02/financial/ f134855D88.DTL Matlack, C., & Mullaney, T. (2006). Fed up with fakes. Business Week, 4004,56. Microsoft announces a new initiative to combat counterfeit software and piracy. (2006, March 9). Microsoft Corporation. Retrieved February 12, 2007, from www.microsoft.com/ presspass/press/2006/Mar06/03-09GSIPR.mspx Microsoft cracks down on counterfeit software auctions worldwide. (2006, October 31). Microsoft Corporation. Retrieved February 12, 2007, from www.microsoft.com/presspass/ press/2006/oct06/10-31AuctionEnforcementPR.mspx Microsoft files lawsuits against online sellers to help protect consumers from illegal software. (2006, March 15). Microsoft Corporation. Retrieved February 12, 2007, from www.microsoft. com/presspass/press/2006/mar06/03-15LawsuitsPR.mspx Monks, B. (2004). Counterfeiting: A crime that affects us all. IAEI News. Retrieved February 12, 2007, from www.iaei.org/ subscriber/magazine/04_c/monks.htm Nash, T. (2005, July). US House passes anticounterfeiting bill. Motor, 50−51. Norman, P. M. (2001). Are your secrets safe? Knowledge protection in strategic alliances. Business Horizons, 44(6), 51−60. Out-of-cycle review results: China. (2006). Office of the United States Trade Representative. Retrieved February 10, 2007, from http://www.ustr.gov Palmer, K. (2006). Fake busters. Government Executive, 38(6), 48−55. Parloff, R., Chandler, C., & Fung, A. (2006). Not exactly counterfeit. Fortune, 153(8), 108−116. Passage of anti-counterfeiting law strengthens CBP's efforts to seize counterfeit goods. (2006, April 3). US Customs and Border Protection. Retrieved February 12, 2007, from www.cbp.gov/xp/ cgov/newsroom/news_releases/archives/2006_news_releases/ 042006/04032006_5.xml Pfizer welcomes European Commission warning about counterfeit medicines putting patients at risk. (2006, April 26). Pharma Business Week, 115. Spring, T. (2006). Fakes! PC World, 24(2), 105−110. Statement of Randall W. Lutter. (2005, November 1). US Food and Drug Administration. Retrieved February 12, 2007, from www. fda.gov/ola/2005/counterfeit1101.html Statement of Senator Carl Levin. (2006, June 7). States News Service. Retrieved February 12, 2007, from www.senate.gov/ ~levin/newsroom/release.cfm?id=256574 Steiner, I. (2003). GenuOne helps rid eBay of counterfeit goods. Auctionbytes. Retrieved February 12, 2007, from http:// auctionbytes.com/cab/abn/y03/m05/i07/s02 Tesoriero, H. W. (2004, August 10). Fake-drug sites keep a step ahead, one is busted for selling bogus pharmaceuticals; New vendor grabs address. Wall Street Journal, p. D4. Tesoriero, H. W. (2005a, May 25). CVS will try to close one gap where counterfeit drugs enter. Wall Street Journal, p. D4. Tesoriero, H. W. (2005b, November 14). McKesson takes step on curbing fake drugs; Wholesaler adopts policy to stop buying products from secondary sources. Wall Street Journal, p. B5.
Strategies to detect and reduce counterfeiting activity Tucker, R., & Casabona, L. (2006). Fighting knockoffs by protecting a brand. Women's Wear Daily, 191(1), 12. Wala, L. I. (2005). How to cut your counterfeit risk. Drug Topics, 149(16), 16. World Intellectual Property Organization. (2006). Anti-piracy outreach aimed at consumers. Retrieved February 9, 2007, from http://www.wipo.int/ip-outreach/en/guides/examples/ ip_respect/consumers/ Zamiska, N. (2006, June 2). A question of value; Zippo case sparks clash: Does China's low value of fake goods coddle counterfeiters? Wall Street Journal, p. A13.
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Zarocostas, J. (2006). EU survey cites China as primary source of counterfeits. Women's Wear Daily, 192(79), 12. Zwaniecki, A. (2006, March 8). House bill closing loopholes in anti-counterfeiting laws. US Federal News Service. Retrieved February 12, 2007, from http://usinfo.state.gov/ei/Archive/ 2006/Mar/09-615647.html
Available online at www.sciencedirect.com
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Strategies to detect and reduce counterfeiting activity Barry Berman Hofstra University, 222 Weller Hall, Hempstead, NY 11549, USA
KEYWORDS Counterfeiting; Intellectual property; Safety risks; Track and trace technology; Controlling outsource suppliers
Abstract While at one time counterfeit products were largely restricted to watches, designer apparel, and movies, today counterfeiting is a major problem in such diverse product categories as pharmaceuticals, automotive parts, and computer software. There are four distinct types of counterfeits: knockoffs, counterfeits that are reverse engineered from genuine goods, goods produced by outsourced suppliers on “third shifts,” and goods that do not meet a manufacturer's standards but are not properly labeled as seconds or destroyed. The quality of some counterfeits is so good that some major retailers have unknowingly purchased counterfeits. But while there are new forms of counterfeit goods, there are also new strategies for combating counterfeiting. This article describes how to detect and reduce counterfeiting activity, via a plan which consists of four steps: (1) developing early warning signals of counterfeiting; (2) budgeting to monitor, deter, and remove counterfeits; (3) using demand-side strategies to deter counterfeiting; and (4) using supply-side strategies to deter counterfeiting. © 2008 Kelley School of Business, Indiana University. All rights reserved.
1. Hey mister, want to buy a watch? While at one time counterfeit products were mostly confined to costly watches, designer apparel, movies, and DVDs, today counterfeiting is a major problem in such diverse product categories as pharmaceuticals, medical equipment, baby formula, electrical parts, automotive and aircraft parts, and computer software. According to the cover story from a recent issue of Business Week, one can pick any product from a well-known brand and discover that there is a counterfeit version available (Balfour, Matlack, Barrett, Capell, Roberts, Wheatley, Symonds, Magnusson, & Brady, 2005). In some E-mail address: [email protected]
cases, the appearance of the counterfeit version so closely matches the genuine article that major retailers such as Wal–Mart and Tuesday Morning have unknowingly purchased counterfeits.
1.1. Classifying counterfeits Counterfeit products can be classified into four distinct types. The first type is a “knockoff,” “lookalike,” or “sound-alike” where consumers are aware that they are purchasing an inexpensive copy due to the product's low price relative to the authentic good, the lack of traditional packaging, and/or the unusual distribution channel. This form of counterfeit is common with inexpensive copies of Rolex watches, Louis Vuitton handbags, and Fendi fashion accessories
0007-6813/$ - see front matter © 2008 Kelley School of Business, Indiana University. All rights reserved. doi:10.1016/j.bushor.2008.01.002
192 that can be purchased from street vendors, on New York City's Canal Street, or on the Web. Despite the fact that the consumer has knowingly purchased a counterfeit product, this type of counterfeit is not harmless from a societal and business perspective. The loss in sales to the genuine product owner is indirect in knockoffs, since few genuine goods purchasers would purchase a knockoff. Still, a genuine product's manufacturer can easily lose the distinctiveness of its brand image and design from a constant supply of low-priced knockoffs. In the second type of counterfeit, genuine products are reverse engineered through a “tear down” analysis of the genuine product, or through the use of stolen or copied blueprints or masters. In the case of software, CDs, and DVDs, the copy protection scheme is bypassed. Unlike the “knockoff,” this form of counterfeit is meant to deceive the general public. The loss in sales in this form of counterfeit is direct because the counterfeit goods are sold as genuine. The genuine goods manufacturer can suffer loss in its quality image when consumers complain about a product's quality because they don't know that their item is counterfeit. Examples of this type of counterfeit product include counterfeit Windows XP software, Kiwi shoe polish, Callaway golf clubs, and Bosch power drills (Balfour et al., 2005). A third form of counterfeit products is produced by current or former outsourced suppliers using a “third shift” that the original product manufacturer is unaware of. A well-documented example of this form of counterfeiting was an outsourcer's continued production of New Balance sneakers after its contract had been terminated (Parloff, Chandler, & Fung, 2006). Since these products are produced on the same machinery as the original good, this type of counterfeit good may be difficult to distinguish from the genuine products. The fourth form of counterfeit are goods produced by outsource suppliers that do not meet a manufacturer's standards but were not properly labeled as seconds or destroyed. These goods are reclaimed and resold as first-quality products. Kyocera, for example, filed suit against Hecmma, an outsourcer it had hired to produce cell phone batteries. Kyocera claimed that Hecmma sold batteries prone to overheating bearing Kyocera's brand name after the company terminated its order (Spring, 2006). This type of counterfeit is the most difficult to distinguish at purchase from genuine goods.
1.2. Estimating counterfeiting activity The International Chamber of Commerce in Geneva estimates that worldwide sales of counterfeit products could run as high as $650 billion per year
B. Berman (Kurtenbach, 2006). The International Anti-Counterfeiting Coalition and the US Customs Service calculate that the revenue loss from counterfeiting for US businesses is $200 billion per year (Hyde, 2006). Other estimates place this decrease in the $250 to $300 billion per year range (Nash, 2005). The impact of counterfeiting varies by industry, as well as by country. The World Health Organization estimates that up to 10% of medicines are counterfeit, and that in some countries the counterfeit rate is as high as 25% (“Pfizer Welcomes,” 2006). In the IT industry, software manufacturers lose about $100 billion annually according to research by KPMG and the Alliance for Gray Market and Counterfeit Abatement (Bednarz, 2006).
1.3. The total costs of counterfeiting The true costs of counterfeiting are not limited to the loss in sales revenues. Counterfeiting's total costs also include the manufacturer's long-term sales decline due to a loss in its brand's distinctiveness, or due to a consumer's poor experience with a counterfeit good he/she assumed was genuine. The costs of detecting and controlling counterfeiting activity must also be included in calculating the total costs. Counterfeiters are also unfair competitors in that they do not have expenses associated with promotion, trademark licensing, research and development, design and engineering costs (beyond copying the genuine product), quality control, test marketing, customer support, warranty claims, and product recall expenses. According to the president of the International Counterfeiting Coalition, “After all, counterfeit products are just riding the tails of big advertising and promotional expenses spent over many years by big brands” (Gogoi, 2006). On a societal level, the total costs associated with counterfeiting include losses in employment, lost income and sales tax revenues, and expenses associated with increased trade deficits. According to one estimate, counterfeiting results in the loss of 750,000 US jobs (Anonymous, 2005). An IDC Economic Impact Study estimates that if all global software piracy was lowered 10 percentage points over the next four years, this change would contribute 2.4 million new jobs and $400 billion in economic growth to the global economy (“Microsoft Announces,” 2006). In addition, there can be significant safety issues associated with counterfeits when products such as brake parts and prescription drugs are commonly copied (Fischer, 2006; “Pfizer Welcomes,” 2006).
Strategies to detect and reduce counterfeiting activity
2. Reasons for increased concern over counterfeiting This section focuses on the major reasons for increased concern over counterfeiting. Specific measures to deter counterfeiting will be discussed later in the using demand-side and supply-side strategies sections.
2.1. Increase in counterfeiting activity According to a US Customs Service counterfeiting expert, the value of seized fraudulent tech goods doubled between 2004 and 2005 (Spring, 2006). Another report stated that the US Customs and Border Protection and Immigration and Customs Enforcement made 8022 seizures of counterfeit merchandise in 2005 (with a domestic value of over $93 million), versus 3586 seizures in 2001 (“Passage of Anti-Counterfeiting,” 2006). Counterfeiting has also grown within the European Union. The number of counterfeit items seized at EU borders has increased from 10 million items in 1998 to over 103 million items in 2004 (Gutierrez, Verheugen, Mandelson, & Schwab, 2006). In 2005, the number of seized items was reduced to 75 million counterfeit items. However, for the first time, over 5 million counterfeit foodstuffs, drinks and alcoholic products, and over 500,000 counterfeit medicines, were among the products intercepted.
2.2. Counterfeiters are more difficult to detect and prosecute Counterfeiters commonly use strategies to avoid detection and to minimize losses when caught. Some counterfeiters use “front” companies or “front” personnel to register companies that produce counterfeit products. Payment is also often made to third parties. Counterfeiters have been known to ship products from sub-contractors via freight forwarders so that it is more difficult to tie the counterfeiter to the seized products. Counterfeiters have also used disguised product names in their production, sales, and inventory records so that accounting records seized as part of an investigation are not useful to authorities. Counterfeiters have shipped counterfeit products along with gray market goods (goods purchased through unauthorized channels). This makes prosecution more difficult since counterfeiters can state that they innocently purchased counterfeit goods (Clark, 2006). Since a sample of a counterfeit product is needed in any civil or criminal case, many counterfeiters will not provide samples (they only produce counterfeits to order). Lastly, many counterfeiters minimize losses and penalties by keeping low levels of inventory and by using separate facilities to produce and store counterfeits.
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2.3. Increased Web purchases The increased use of auction sites such as eBay, as well as Web-based sales sites, has expanded the market for counterfeiters. Let's first look at several investigations that provide a sense of the amount of counterfeit merchandise on eBay:
• Test purchases from among 300,000 Dior products
and 150,000 Vuitton items offered on eBay during the first six months of 2006 found that 90% were counterfeits (Matlack & Mullaney, 2006).
• In 2004, Tiffany purchased 186 random items from
eBay and found that only 5% of the items were genuine (Chao, 2006).
• Louis Vuitton and Dior Couture have recently filed suit in French court against eBay. Their suit alleges that nine of every ten Louis Vuitton items on sale at eBay are counterfeit (“eBay Inc.,” 2006).
• In tests conducted by Microsoft on 115 copies of physical media purchased on eBay, 39% were found to be counterfeit and another 12% contained software that was either counterfeit or had been tampered with (“Microsoft Cracks,” 2006).
While eBay's official policy does not permit listing of counterfeits and unauthorized replicas, this is an extremely difficult policy to enforce. Even though eBay can suspend a counterfeiter's account or demote the seller's status, the auction site had 193 million registered users to monitor as of March 2006. Buyers of counterfeit merchandise can leave negative feedback on eBay, but sellers can easily switch identities or reregister their business in a partner's or other family member's name. Counterfeiters can also use their websites to show trademarks of legitimate manufacturers and distributors, make small firms appear to be subsidiaries of major corporations, and even mask the country where the goods are purchased. WorldExpressRX. com, which sold counterfeit pharmaceuticals, operated a website so slick that according to one report, “there would be no reason for a consumer to dispute its authenticity” (Tesoriero, 2004).
2.4. High levels of trade with China A considerable amount of outsourcing activity is conducted in China, a country with a poor record in protecting intellectual property. According to Representative Donald Manzullo, the chairman of the House Committee on Small Business, China's share of counterfeits was ten times greater than that of any other US trading partner (Krause, 2006). Similarly, an
194 EU business survey identified China as the source of two-thirds of all counterfeit goods seized in Europe (Zarocostas, 2006). An analysis by an academic cites three reasons for China's high level of counterfeiting. These include China's high level of organized crime, the willingness of Chinese consumers to purchase counterfeit goods, and the lack of intellectual property rights in China (Chaudhry, 2006). There is extensive agreement among foreign trade experts and US government officials that a large proportion of counterfeiting will continue to flow from China despite the fact that the PRC signed the World Trade Organization's TRIPS (Trade-Related aspects of Intellectual Property Rights). This agreement requires member countries to have an effective intellectual enforcement mechanism. The US Trade Representative measures how well countries protect property rights in its annual Special 301 Report. The report concluded that China has failed to significantly reduce intellectual property rights infringement levels, as required by the US–China Joint Commission on Commerce and Trade (“Out-ofCycle,” 2006). On April 29, 2005, the office of the US Trade Representative placed China on the Special 301 Priority Watch List due to its failure to improve intellectual property rights protection (“Statement of Senator Carl Levin,” 2006). According to Michigan Senator Levin, “China may have IPR [intellectual property rights] laws that appear reasonable on the books, but it is not enforcing them” (Krause, 2006). One barrier to enforcement of property rights in China is the way the Chinese government values seized counterfeit goods. China appraises seized goods at the price the counterfeiter meant to sell them, not at the retail price of the genuine products which is the standard in many other countries. As a result, the value of the seized goods often falls below the 50,000 yuan (about $6250) level which is the minimum threshold for criminal prosecution (Zamiska, 2006).
3. Developing a plan to reduce counterfeiting This section discusses the steps in developing a plan to reduce counterfeiting: (1) developing early warning signals of counterfeiting; (2) budgeting to monitor, deter, and remove counterfeits; (3) demand-side strategies to deter counterfeiting; and (4) supplyside strategies to deter counterfeiting.
3.1. Developing early warning signals of counterfeiting The presence of counterfeit merchandise often goes undetected for a significant time period. For exam-
B. Berman ple, golf equipment manufacturer Callaway became aware of a significant counterfeit problem only after its customers returned golf clubs due to broken shafts. Other manufacturers, including Hewlett Packard, Kingston, and Motorola, have also learned about counterfeiting through consumer complaints and warranty claims (Spring, 2006). The first step in reducing counterfeiting activity is to make sure the targeted firm is aware of counterfeiting activity as early as possible. Among the early warning symptoms of increased counterfeiting activity that a targeted firm should monitor are a significant decrease in sales; a large amount of its products available at discounters, on eBay, or on other Internet auctions and websites; an increase in orders for proprietary components; an increase in gray market activity; an increase in returns and warranty claims; and an increase in product failure rates (KPMG, 2006). Firms need to pay particular attention to those products that are considered at “high risk” for counterfeiting activity. For pharmaceuticals, the National Association of Boards of Pharmacy has established a list of “susceptible products” that is listed on www. napb.net. Luxury brands, products with a past history of high levels of counterfeiting, a firm's key products, and products with a high degree of safety risk, should be screened most often. An important component of an early warning system is the provision of a simple means for final consumers and resellers to report suspected goods. Microsoft uses a tool (accessible at www.microsoft. com/genuine) to enable customers to determine whether they have a genuine Microsoft product. This software will activate popups if the program determines that a consumer's version of Windows, for example, is counterfeit.
3.2. Budgeting to monitor, deter, and remove counterfeits The costs of monitoring, deterring, and removing counterfeit merchandise from the marketplace are high. Some Fortune 500 companies have reportedly spent an average of $2 to $4 million per year to combat counterfeiting. Others reportedly spend as much as $10 million to foil counterfeit products (Monks, 2004). LVMH Möet Hennessy Louis Vuitton spent over $16 million in 2004 on investigations, busts, and legal fees (Balfour et al., 2005). Entertainment and luxury goods companies often hire private investigators to track down counterfeiters and then pass on the information to law enforcement officials (Palmer, 2006). Private investigation firms typically establish fake companies to purchase counterfeit goods (Becker, 2003). Other firms have a staff of internal investigators dedicated to purchasing counterfeit merchandise and using
Strategies to detect and reduce counterfeiting activity this evidence in legal proceedings. GM has seven staff personnel that monitor counterfeiting, and Pfizer has five anti-counterfeit personnel in Asia alone (Balfour et al., 2005). An intellectual property owner needs to have legal protections and registrations in place to build a case against a counterfeiter. Intellectual property can be protected by trademarks, copyrights, design patents, utility patents, and trade secrets. With the exception of the European Union, each country requires its own trademark registration. Trademark registration costs as much as $20,000 per country and involves millions of dollars on a worldwide basis (Tucker & Casabona, 2006). Trademark litigation can also be costly. According to one attorney with experience in this area, “A straightforward trademark litigation case in the US can be done for $50,000. But a full-fledged, knockdown, drag-out litigation is a million-dollar fight” (Tucker & Casabona, 2006). The budget to deter counterfeiting must anticipate necessary actions on both demand and supply sides. Demand-side budget actions focus on reducing demand by making counterfeit merchandise easier to identify, and on educational initiatives that make consumers more aware of the risks associated with counterfeit purchases. Supply-side budget items reducing the supply of merchandise through better controlling of outsource suppliers, monitoring websites to search for counterfeits, legal actions, reducing gray market activity, and using track and trace technologies.
3.3. Demand-side strategies to deter counterfeiting A firm can attempt to deter counterfeiting through consumer education programs that make both resellers and final consumers aware that they are purchasing counterfeits, as well as publicizing the dangers and the social costs connected with counterfeiting. Consumers also need to be educated to not only recognize, but also to quickly report counterfeit goods. For example, Microsoft advertises its anti-piracy hotline number (800) RU–LEGIT so final and reseller consumers can divulge the names of pirated software providers. Authentication technology has both supply and demand considerations. On a demand side, this technology makes it easier for final consumers and resellers to more readily identify counterfeit products. These labels are very difficult for counterfeiters to copy. On a supply side, “track and trace” technologies such as radio frequency identification devices (RFID) enable individual products to be tracked as they move from one location to another. RFID may replace older barcode technology.
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Anheuser–Busch, which was confronted with many counterfeit Budweiser beer products in China, now uses imported foil for its packaging in China which is difficult for counterfeiters to obtain; the foil changes to red when cold (Balfour et al., 2005). Similarly, 3Com uses a four-dimensional holographic label on its switches that is also hard for counterfeiters to copy (Bednarz, 2006). A second part of the education process is to make the public aware of signs of counterfeits: prices too low to be true, the lack of holograms, poor packaging, and broken seals on shipping containers. Callaway, a leading golf club manufacturer, has a section of its website labeled “Nine Ways to Avoid Being Fooled by Counterfeits.” Its hints that a suspected good may be counterfeit include: the dealer is not authorized, the deal looks too good to be true, the absence of serial numbers on key parts, and metal painted to resemble a carbon composite (Callaway, 2007). Lastly, marketers need to develop advertising campaigns that focus on the significant safety, performance, and financial risks associated with the purchase of counterfeit merchandise. Microsoft has tried to make final consumers more aware of the risks of purchasing counterfeit software. These risks include software that contains spyware, viruses, and hidden components that can place their personal and business security information at risk via credit card and identity theft. Resellers also need to be better informed about the risks of selling counterfeits. Purchasers of defective or unsafe counterfeit goods can sue wholesalers and retailers on the basis of negligence, breach of implied warranty (such as a product's fitness for a particular purpose), fraudulent concealment, and consumer fraud. In cases involving counterfeit pharmaceuticals, consumers often sue both wholesalers and retailers on the grounds that the drug did not match the prescription or label, the pharmacy did not correctly fill the prescription, the pharmaceutical was misbranded under the Food & Drug Cosmetic Act, or the reseller's breach of a representation that it was selling an authentic drug (Wala, 2005). These educational programs can be funded by single manufacturers, as in the case of Callaway and Microsoft, through trade associations, and by governmental agencies. The Better Business Bureau recently launched a six-month Counter/Act campaign in eastern Massachusetts, Maine, and Vermont to increase the public's awareness of counterfeiting. Using the slogan “Don't Let Counterfeit Products Make You a Victim!” the campaign emphasized the threats to health and safety caused by counterfeiting. The program was underwritten by The Gillette Company and United States Customs (World Intellectual Property Organization, 2006).
196 The FDA has also developed public service announcements about the dangers of counterfeit drugs. It prepared 4.6 million leaflets aimed at distribution by pharmacists along with the patient's prescription, as well as a website, www.fda.gov/ counterfeit (“Statement of Randall W. Lutter,” 2005).
3.4. Supply-side strategies to deter counterfeiting While demand-side strategies attempt to deter consumers from purchasing counterfeit goods, supplyside strategies seek to limit the supply of counterfeits by better controlling outsource suppliers, monitoring websites to search for counterfeits, legal actions to reduce counterfeits, reducing gray market activity, and using track and trace authentication technologies. 3.4.1. Controlling outsource suppliers A multi-part strategy is needed to effectively control outsource partners. This strategy needs to be based on human resource strategies that stress the need to protect a firm's core capabilities, legal issues (patents and contractual mechanisms), and alliance processes that protect information flows and partner access to information (Norman, 2001). Shoe manufacturer New Balance recently had a major problem with a outsource supplier located in China who did not return confidential production, sales, and marketing information upon termination of their contract. The supplier also kept New Balance's molds, specifications, signs, labels, wrappers, and ads (Parloff et al., 2006). A Chinese court ultimately awarded New Balance $9.9 million in damages for the former outsourcer's production of at least 200,000 shoes after their contract was terminated. In addition to this legal action, New Balance reduced the number of outsource suppliers, carefully monitored the flow of materials to better control production, and changed to a “high-tech” label that was more difficult for counterfeiters to copy (Kahn, 2002). Other strategies to reduce the quantity of thirdshift goods produced by outsourcers include: (1) carefully selecting outsourced service providers based on past honest relationships with other firms; (2) monitoring outsourcers through surprise inspections; (3) ensuring that outsourcers return all confidential technical, production, sales, and marketing information when the outsourcing relationship ends (Parloff et al., 2006); and (4) using multiple outsourcers for the same good so that one firm does not have the resources to copy a manufacturer's good. A firm may also wish to complete the production itself using a secret process or proprietary machinery (Kurtenbach, 2006).
B. Berman 3.4.2. Monitoring websites to search for counterfeits Several software products, such as Brandimensions, Cyveillance, GenuOne, and MarkMonitor, are able to monitor websites (including domain names, chat rooms, and auctions) that illegally use a firm's name or identity. GenuOne uses keyword searches including suspicious keyword combinations such as “100 percent authentic” or “deep discount,” and pricing indicators to monitor auctions, chat rooms, and websites. This helps intellectual property owners identify sellers of counterfeit products. GenuOne provides a similar service through VeRO, eBay's Verified Rights Owner Program. Over 12,000 brands are members of VeRO, including Xerox, Cartier, Bacardi, Kodak, and Montblanc (Steiner, 2003). According to GenuOne's chief executive officer, 36,000 individual auctions were closed down in less than a year through the use of the company's products (“Counterfeiting Challenges,” 2006). Microsoft monitors auction sites to identify counterfeit software, and then seeks to shut those sites down. In 2002, Microsoft asked for takedowns of almost 50,000 individual auction sites that offered pirated software (“Microsoft Files,” 2006). 3.4.3. Legal actions to reduce counterfeits While software products can help identify sellers of counterfeit goods, the genuine manufacturer owner still needs legal action to close down the counterfeiter's operation and to seize its products. US patent and trademark rights are governed by the Tariff Act of 1930, the Lanham Act of 1946, the Trademark Counterfeiting Act of 1984, the Anticounterfeiting Consumer Protection Act of 1996, and the Anticybersquatting Consumer Protection Act of 1999. Two loopholes that counterfeiters had exploited have been closed by the Stop Counterfeiting in Manufactured Goods Act signed by President Bush in March 2006. Law enforcement agencies now have the right to seize and destroy any tools used to make counterfeit products, and counterfeiters can be forced to pay damages and fines as high as $15 million. Previously, counterfeiters could be forced to surrender their goods, but were still allowed to keep the equipment used to produce and package the goods, as well as any profits from their counterfeiting activity (Hyde, 2006). Another important provision in this law prohibits trafficking in counterfeit labels, stickers, and other markings. This was enacted as a result of a 2000 federal appeals court ruling that trafficking in trademarks that are not attached to the product does not violate the trademark statute (Zwaniecki, 2006). Recent lawsuits against counterfeiters have been extended to those who knowingly sell counterfeit
Strategies to detect and reduce counterfeiting activity merchandise, as well as those who aid counterfeiters such as property owners. In a recent case, Louis Vuitton reached an agreement in federal court that required property owners to take legal action against sellers of counterfeit merchandise located in their building (Bleyer, 2006). 3.4.4. Reducing gray market activity Since counterfeit products often enter the supply chain from unauthorized resellers, a major way of reducing the supply of counterfeits is to reduce the level of goods entering through gray market activity. The levels of goods entering the market through unauthorized channels vary by product, as well as country. One estimate is that a drug can travel through as many as 20 to 30 hands in European markets before use by the final consumer (“Pfizer Welcomes,” 2006). This gives counterfeiters 20 to 30 point-of-entry opportunities to open, alter, or switch each drug product. In the United States, while primary drug wholesalers buy the majority of their drugs from manufacturers, they also purchase selected drugs in the secondary market such as from hospitals and nursing homes, even though these institutions are not authorized by manufacturers to resell drugs(Tesoriero, 2005a). There are two major ways to reduce counterfeiting associated with gray market activity. First, distributors can withhold payment until they have verified that the products are legitimate. A second, more drastic strategy is to refuse to purchase products from wholesalers who participate in any gray market activity. For example, CVS recently announced that it will no longer purchase drugs from wholesalers that trade in the secondary market. As a result, Cardinal Health Inc., a major drug wholesaler, stated it will only purchase drugs from manufacturers or authorized sources. CVS is Cardinal's largest customer, accounting for 18% of Cardinal's revenue (Tesoriero, 2005a). The nation's top three wholesalers that account for over 90% of medicines distributed in the United States have also taken steps to reduce purchases from secondary wholesalers (Tesoriero, 2005b). 3.4.5. Using track and trace authentication technology RFID technology has the potential to be used worldwide as a counterfeiting deterrent. While RFID tags look like ordinary labels, they are actually computer chips with antennas wrapped around them. As a product passes through the supply chain, each supplier or vendor writes an additional product code on that chip. Sensors at the distribution center use radio waves to activate the tags, which are read electronically and stamped with a record of where they have been. Since legitimate products are manufactured at select locations, and sold through authorized
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distributors, concern should be raised when an incomplete or incorrect set of locations are listed on a tag. Despite the existence of these technological developments, an Ernst & Young survey of 225 pharmaceutical industry executives found that just 25% of those surveyed were using technology to address supply chain challenges such as counterfeiting drug products (Jarvis, 2005). North American companies favored auditing and validating their partners, while European firms felt that cutting off business with questionable partners was a more effective deterrent.
4. A review Studies that gauge the economic impact of counterfeit activity by measuring sales of counterfeit products have clearly underestimated the magnitude of the problem. A true picture needs to include the short-term loss in sales to genuine manufacturers, the long-term sales loss due to deterioration of a product's distinctiveness, as well as the user's potential poor product-related experience with a product he/she assumed was genuine. On a societal level, the total costs associated with counterfeiting include losses in employment, lost income and sales tax revenues, and expenses associated with increased trade deficits. Today safety concerns associated with counterfeiting can also be a major issue due to the significant number of counterfeit products with high safety risks, such as brake parts, pharmaceuticals, and baby formula sold in the United States and abroad. Obviously, these total costs are much more difficult to estimate. An effective strategy to detect and reduce counterfeiting activity has several key components. First, the importance of the early detection of counterfeiting needs to be stressed. Early detection reduces the loss in sales and image to the intellectual property owner, as well as minimizing social costs associated with counterfeiting. Second, a firm needs to adequately budget to deter and remove counterfeit merchandise from the marketplace. These expenses may include monitoring, investigating, the cost of establishing intellectual property registrations and protections, new packaging, public relations, and other issues associated with supply or demand. Third, an anti-counterfeiting strategy needs to focus on demand-side initiatives such as consumer education, authentication or “track and trace” technologies, and advertising that communicates the risks associated with counterfeit merchandise. Fourth, a firm needs to implement supply-side measures such as controlling outsource suppliers, monitoring websites, legal actions, reducing the entry of products through unauthorized
198 channels, and utilizing technology to monitor the supply chain. It can also be noted that a firm's anti-counterfeiting strategy must be tailored to the type of counterfeiting activity. For example, a central part of the strategy in dealing with knockoffs is to extend the legal sanctions to property owners where these goods are sold. In contrast, controlling access to blueprints, trade secrets, and production processes is critical in reducing reverse engineered products. Likewise, using multiple outsource suppliers can reduce third-shift goods, while ensuring that outsourcers return all seconds for disposal is important in reducing the amount of second-quality goods sold.
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