The Impact of Gray Markets on Product Quality and Profitability

Gray markets, the selling of genuine products via unauthorized channels, have grown in importance for both manufacturers and retailers and have thus been studied extensively since the 1980s. Recently, consumers have shown a greater willingness to patronize unauthorized retailers for different foreign products (electronics, clothes, cosmetics, and so on). Increasing consumers’ demand for gray market products has influenced both manufacturing and marketing decisions. This paper investigates the impact of gray markets on manufacturers’ and retailers’ profits and the quality of the offered products. We show that when the manufacturer sells directly to consumers, gray markets have a negative effect on both price and quality of products as well as manufacturer profits. However, when the manufacturer sells through a distribution channel, the quality of the offered products and the manufacturer’s and retailers’ profits can all increase regardless of the source of the gray market goods. Our study further shows, as expected, that gray markets always increase the total consumer surplus.