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The Pervasive Problems of Product Counterfeiting and Diversion

April 25, 2019 |

Intellectual property, such as a business’s brand, can be as valuable – or even more valuable – than physical property. According to Tim Phillips, author of the book Knockoff: The Deadly Trade in Counterfeit Goods, intellectual property represents anywhere from 45 to 75 percent of the market value of many Fortune 500 companies. Though companies invest a great deal of time and resources into patents, trademarks and brand identities, these efforts may be undermined by the fraudulent practices of counterfeiting and diversion.

What is counterfeiting?

Counterfeiting is akin to identity theft. Commercial counterfeiting occurs when a good is made or sold using another’s brand name without authorization from the brand owner. These counterfeit goods are made to seem identical to the legitimate product for the purpose of tricking consumers into purchasing the counterfeit product, which is usually of second-rate quality compared to their legitimately trademarked counterparts.

What is diversion?

Product diversion refers to the practice of selling merchandise through a distribution channel or geography that is unintended or unauthorized by the legal brand owner. Diverted goods are genuine but pirated. Diversion can happen when a contract manufacturer produces more than the customer ordered and then siphons the excess through other channels. It can also occur when a distributor buys a large quantity of merchandise and then sells the surplus goods elsewhere.

What products can be counterfeited or diverted?

Counterfeiting and diversion pose a problem to multiple industries, including:

  • Luxury goods
  • Beauty products
  • Clothing
  • Consumer packaged goods
  • Electronics
  • Music
  • Pharmaceuticals
  • Textbooks
  • Automobiles
  • Military equipment
  • And more

What is the scope of the counterfeiting problem?

According to The International Chamber of Commerce, the negative impacts of counterfeiting and piracy are projected to drain $4.2 trillion from the global economy and put 5.4 million legitimate jobs at risk by 2022. The U.S. Chamber of Commerce put out numbers estimating that counterfeit goods cost the American economy as much as $250 billion a year and are responsible for the loss of 750,000 American jobs.

According to Charles Randolph, Deputy Director of the Office of Intellectual Property Enforcement, “Over 45 million American workers have some connection with intellectual property related industries.” That’s nearly one-third of the American workforce!

What is the impact of counterfeiting and diversion?

Counterfeit products impose significant risk to both consumers and businesses in several ways:

Product safety

Consumers are tricked into spending their money on low-quality, poor-functioning counterfeits that can result in dissatisfaction or even death, as in the case of Maxine Blount of Saint Charles, Missouri, who died after taking counterfeit cancer drugs in 2002.

Reduced revenue

For businesses, counterfeit and diverted merchandise undercut the price of legitimate goods, introducing competition that results in lowered sales and market share.

Brand erosion

Counterfeiters take advantage of a company’s R&D and marketing efforts, leeching off their brand while causing the loss of consumer trust and goodwill. Dissatisfied consumers may stop purchasing the product and/or complain to others about it.

Warranty and legal liability

Counterfeits result in a higher number of warranty claims since consumers feel that it’s the company’s responsibility to service the product. Even worse, counterfeit merchandise can cause legal liability, as consumers injured by a counterfeit product may still hold producers of legitimate goods accountable – even if they had no knowledge of illicit activity.

Supply chain confusion

Furthermore, diverted or fake products can interfere with a brand’s legitimate distribution channel, undermining the trust between suppliers and buyers. In the event of a product recall, lack of supply chain visibility can cause concerns about product authentication and traceability.

“At the end of the day, all counterfeiters really care about is your money,” says Candace Li, VP for global public affairs of the International AntiCounterfeiting Coalition. “They don’t care if they give consumers a bad product — or no product whatsoever.”

What can be done to limit counterfeiting and diversion?

As a global issue, there are ongoing efforts by governments to try to control gray market and counterfeit goods, for example, the seizing of illegitimate products by customs officials. But there are things that companies and consumers do to limit the impact of counterfeiting and diversion. Stay tuned for next week’s blog post, where we explore some of these options in depth.