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A Leitz by any other name...

Bottom feeding in the grey market.

Everyone talks about the grey market as being so cheap. They also like to act like you're chump for actually buying a product through the "official importer" in the United States. The grey market is not much more than lowering prices by shifting warranty risks and costs. Over the long run, especially with economy products involving large numbers of moving parts, the long-term cost of a grey market product can be the same as — or higher than — an official import.

1. What is the grey market?

Although it sounds oh-so-cloak-and-dagger, the grey market is a rather mundane phenomenon.

As an official matter, it refers to any importation of a product outside the manufacturer's official channels. Many manufacturers who export goods choose an official sales agent in the target country. This sales agent cultivates the market, performs advertising functions, and sometimes holds the trademarks. Typically, the sales agent provides warranty repairs and absorbs some (but usually all) associated costs.

Sometimes the sales agent is an independent corporation or individual. Other times, it is a wholly-owned subsidiary of the manufacturer. Grey marketeers (the politically-correct term is parallel importers) are those who bring in products outside the manufacturer's official channels and sell them to the public.

2. So why does grey market cost less?

Contrary to what US distributors like to tell you, products sold abroad are not subjected to less intense inspection at the factory (some offcial importers, such as Kiev USA, advertise that they do so here). Do you really believe that Nikon has separate production lines for products it sells in the U.S. and in Japan? Their image is equally tarnished wherever a product fails.

Nor do grey marketers typically get product at lower prices than the U.S. distributor. Although this may be hard to believe, grey market goods often start with a factory net price that is actually greater than the price the official importer pays the factory. This is due to two things. First is the volume and most-favored-nation advantages for the primary importer. The second is that many grey operations are too small to buy directly from the manufacturer and buy from a wholesaler instead.

Grey marketeers make up their net price handicap by marking up the product less (in absolute dollar terms). They can do this by avoiding several types of overhead that get rolled into the price your dealer pays for "USA" goods:

o Maintaining repair facilities, equipment and technicians;

o Participating (financially) in national advertising campaigns;

o Maintaining credit facilities and creating incentives for dealers; and

o Abosrbing warranty costs and product dropout.

This last item is very significant from the consumer's point of view, because with many low-end goods, it can add up to a significant expense at the time of purchase.

3. What are warranty costs?

Warranty costs are reserved costs that an importer derives by actuarial principles. If, for example, you are giving a one-year warranty, you have to make a per-unit analysis based on factors like the following:

o Probability of major mechanical failure within one year;

o Cost of major mechanical failure;

o Probability of minor mechanical failure within one year;

o Cost of minor mechanical failure;

o Probability of total replacement within one year;

o Replacement cost;

o Variable costs associated with number of repairs; and

o Allocated fixed costs associated with warranty repairs.

Let's take simple example. Product X (assume that this a complex machine, like a camera body) costs $100 to make (or $100 FOB you). Ignore all overhead costs.  We will assume only one failure mode — complete mechanical failure necessitating replacement. Assume it has the following probabilities of failure.  

5% in the first 14 days
7% in the first 30 days
10% in the first 3 months
25% in the first 6 months
50% in the first year
100% in three years

To give a 6-month warranty, the warranty cost is (25% x $100 = $25), making your cost $125
To give a 1-year warranty, the warranty cost is (50% x 100 = $50), making your cost $150
To give a 3-year warranty, the warranty is $100, making it $200

To get a good idea of warranty costs in a complex product, you would need a more complicated model (warranty-cost modeling is high art in the auto industry, where cars are made from as many as 12,000 parts, each of which has it s own failure modes). By contrast, a simple product like Product Y (let's say a lens) might have the following failure rate (and lens repairs are more likely minor due to the nature and low complexity of the product)

2% in the first 14 days
5% in the first 30 days
5% by the end of one year
10% in three years

Unlike the Product X, the cost for offering a 3-year warranty for Product Y would be slight in addition to the costs associated with a 30-day warranty.  In fact, if this were a lens it would probably cost very little more to offer a 10-year w arranty, except that consumer abuse, lubricant breakdown and fungus could lead to a lot of disputed warranty claims.

As you can imagine, the shorter the warranty, ceteris paribus, the closer you can sell to manufacturing cost cost (this is of course ignoring markup and most forms of overhead).  The longer the warranty gets, the more expensive.  At some point, progressively longer warranties become prohibitively expensive.

So who bears the costs of warranties?  Usually the importer/distributor, and ultimately, you.  If it is a wholly owned sub (like Leica NJ or Konica USA), the costs typically get charged back to the German or Japanese operations.  If it is an independent operation like Kindermann, they just have to reserve warranty costs in the price to the dealer. 

Just as an aside, B&H and Adorama sell warranties for used equipment, whose prices are computed using actuarial principles of failure.  This is just like buying a service contract for your car. In essence, it's an insurance policy.

4. How does the grey market get around warranty costs?

You can manipulate warranty costs in a number of ways. Here are three important ones.

(1) shorten warranties - shifting actuarial risks to the customer

(2) limit warranties - limiting frivolous warranty claims

(3) hire your own repair staff - making things a fixed cost, to a point

(4) charge restocking fees.

All of these techniques are in play at the various mail-order camera shops. You can do the math.

5. Why won't Nikon USA service my grey F5 — even if I pay?

It is obvious why, say, a Kindermann would not provide warranty service for Leicas sold outside of Canada. Kindermann would have to absorb costs for units it did not sell. What is not obvious is why Nikon USA and Leica USA (wholly owned subs of the factory) get bent out of shape if you send a grey camera in for warranty service — after all, we're one happy corporate family, right?

They don't like you to do that because it facilitates arbitrage between their markets. They key concept here is price discrimination. Nikons, for example, sell for a lot more in the U.S. than they do in Hong Kong, because people can spend more in the United States. Nikon will sell at a lower price abroad to keep their volume up. But any sale abroad that takes away a sale in the United States costs them money.

Nikon USA has adopted a particularly powerful disincentive to the grey market in the United States. If you buy a camera on the grey market, Nikon USA will not service it at all — in or out of warranty. This forces you to send your camera for service abroad (the cost and inconvenience of which cancel any benefit from buying grey in the first place). Leica deters cross-border sales by offering you that $300 CLA.

6. How could Leica possibly offer a Passport Warranty?

Thinking about the factors above, you might see why Passport warranties are such a great deal for Leica.  Probably 95% of the repairs over the 3-year period are RF adjustments requiring no disassembly.  The other 5% of failures are probably major mechanical failures.  Destruction of cameras (especially in circumstances where the serial number part is preserved) is probably so rare that it doesn't even show up on the radar. And since Passports are not transferable, and Leicas are highly transferable, Leica probably skates out of its obligations in a large number of cases due to sales of M bodies before the expiration of the Passport period.

7. Is the grey market for me?

A lot of whether or not you gravitate toward the grey market depends on your perception of a product's quality and whether or not you are risk-averse. In essence, grey market buyers assume some of the risk of product failure in exchange for a lower price. This is entirely a matter of personal preference. If you like high-deductibles on car insurance, you will probably like grey market cameras. It all boils down to your taste for self-insurance.

So is it a sin to buy Product X used for the same price as Product X new on the grey market?  

Personally, I prefer buying used complex equipment like bodies (1 year or older) to new equipment without warranties, because someone has already "broken in" the product and exposed (and presumably corrected) any of the short-term failures (gross internal mechanical defects).  I think that it is far easier to buy lenses on the grey market, because they don't tend to have latent failures to the same degree.

DAST

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