March 4th, 2010
Recently I met with a team of senior research scientists from a major US corporation. Known for its innovativeness, its products are used by most of us.
I thanked them for their creativity, perseverance, and hard work. Then I told them the bad news (which was actually why I’d been invited)…that other people had figured out how to reverse engineer all their hard work, and produce look-alike products being sold as “same as PRODUCT”, or “as good as PRODUCT”, or even as PRODUCT itself.
Innovation is hard work. It can take years of research, experimentation, testing, and development to bring a new product to market.
Because accounting works the way it does, these costs can be capitalized as an asset, then amortized over the economic life of the product. This asset is called intellectual property (IP), and it’s literally the coin of the realm in the Knowledge Economy.
In the United States, IP is protected by law as patents, trademarks, trade secrets, and copyrights. In fact, it’s so fundamental to our economy that it’s mentioned in the Constitution. In other countries, laws and enforcement vary widely.
What follows is an article I drafted five years ago, shortly after a client asked us to look into trading irregularities in their product. The situation has not changed significantly since then. The only substantive thing that needed revising is the estimated amount of economic damage from “brand piracy”…upward…a telling commentary on how pervasive and intractable this problem is.
Sometime late in the 20th Century, counterfeiting made the leap from currency to everyday products. Now the Golden Age of product counterfeiting is upon us. No longer confined to knockoffs of luxury watches and handbags, product counterfeiters have moved aggressively into items as diverse as pharmaceuticals, cigarettes, auto and aircraft parts, entertainment products, and software.
Leading brands tend to be the targets. For example, the heart drug Lipitor and Marlboro cigarettes have consistently been the targets of counterfeiters. (In both cases, the manufacturers, Pfizer and Altria, respectively, have successfully taken actions against the offenders.)
Readily-available technologies such as digital scanners and cameras allow near-perfect copies of product packaging, labels, and printed materials to be made, very inexpensively. Some production technologies, such as pill-making machines, can be bought inexpensively on the second-hand market. Good copies are almost impossible to detect without laboratory tests.
A source of funds
For illicit operators, the economics are very attractive. A carton of premium-priced cigarettes that retails for $75 in New York City can be copied for less than $5, then shipped for even less, yielding a gross margin around 90 percent. No marketing or R&D costs are incurred, and no taxes or duties are paid. The normal wholesale and retail distribution channels may even be involved as unwitting accessories.
This economic engine is reportedly being used by terrorist and outlaw groups—including Al Qaeda and Eastern European organized criminals—to fund their activities. And because many legitimate U.S. and European manufacturers now outsource much of their production to countries where intellectual property (IP) laws are weak and/or not rigorously enforced, there are enhanced opportunities to exploit these de facto loopholes.
This hijacking of brand identities for illicit gain is known as “brand piracy”. It costs legitimate manufacturers around $600 billion per year, according to the International Chamber of Commerce—though by definition, no one can precisely measure the extent of the problem. Typically, a target company is not even aware it’s being victimized. Counterfeiting is a slow bleed on a company’s revenues and reputation that only occasionally erupts into adverse newspapers headlines. (Google on “counterfeit” plus the name of your favorite brand to see if it is known to be a target.)
Counterfeits in some categories (such as luxury goods) are relatively harmless, though rarely up to the quality standards of the genuine article. In other sectors, however, counterfeits can be dangerous, or even deadly—like the fake cell phone batteries that explode in your face without warning, or counterfeit auto brake shoes made from sawdust. One of the most widely pirated products, pharmaceuticals, is certainly in this latter category.
The role of the Internet
The Internet has enabled a global black market for counterfeit goods that allows brand pirates to operate efficiently and in secret, bypassing all government quality controls and standards, and eluding taxing authorities. In a market such as pharmaceuticals where prices are unregulated in some countries (including the U.S.), and regulated in most others, the Internet functions as a massive “arbitrage” market. Goods intended for more-regulated markets are diverted into less- regulated markets where they command higher prices.
The Internet is not the only way that compromised products—those that are counterfeit, stolen, or diverted—enter the distribution chain. But the Internet is by far the fastest-growing outlet for illegitimate goods. Since it operates direct-to-consumer, the Internet bypasses the validation mechanisms of traditional channels—basic thing like knowing whom you’re trading with.
Brand pirates may be as highly organized and sophisticated as any legitimate business. They use the Internet to take orders, coordinate production and subcontracting, and manage logistics and shipping. Their operations are often geographically dispersed to evade detection.
What can be done?
U.S. federal agents have conducted successful interdiction efforts in several categories, including cigarettes, pharmaceuticals, and recorded entertainment—but they cannot keep up with the cascading levels of illicit activity. Governments in places like the Far East, where much of the activity originates, may be similarly well-intentioned, but are ill-equipped to deal with the problem on a pre-emptive basis.
Companies, whether acting alone or in concert as an industry, need to take the initiative to manage this threat for themselves. A successful mitigation effort must include four key elements:
- Intelligence programs include the systematic monitoring of brand-relevant Internet activities. This is best accomplished by human analysts working with intensive technology support. It should be accompanied by initiatives to acquire and test suspect product.
- Internal coordination requires the creation of an internal anti-counterfeiting team, typically including representatives from brand management, legal counsel, and corporate security.
- External coordination may involve on- and off-shore federal agencies (including regulatory, law enforcement, and taxation), local and municipal authorities, and even international agencies such as Interpol.
- Countermeasures include legal initiatives such as cease-and-desist letters and DMCA takedown notices, as well as the law enforcement actions mentioned above. Communications and educational initiatives also should be created to inform retail consumers and distribution channels on to how to recognize and report possible counterfeit products. Technologies to better identify legitimate products can also be effective. These include active identification (radio frequency ID, for example), passive identification (such as holograms), and “track and trace” systems that integrate several technologies.
Are you at risk?
How can you tell if you’re being targeted? Start by answering a few simple questions:
- Is my product a brand leader?
- Is it relatively high value?
- Does it ship relatively easily?
- Do we outsource substantial amounts of the manufacturing?
- Are we failing to act aggressively on the problem?
If you answered “yes” to even one or two of these, you’re potentially a target. Take the next step by developing a couple of basic metrics:
- What is the potential level of loss exposure for my brand?
- What level of activity does there appear to be that targets my brand?
- What is the trend in activity levels?
If the indications are high here as well, then begin to formulate a mitigation plan as described above.
Sorry, the Rolex pictured at the top is not for sale from us. Google “BUY ROLEX” and you’re sure to find it.