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As phony goods flood the market, companies fight to protect their brands.
Randy Myers, CFO Magazine
June 1, 2008
Most retailers want you to come to their checkout lines with as much merchandise as you can carry. Not Abercrombie & Fitch. The $3.75 billion apparel retailer actually limits the number of items customers can buy to 20, bumping it up to 50 only during the Christmas and back-to-school shopping seasons. Why the restriction? Unauthorized resellers, the company learned a few years ago, were buying its goods in bulk at retail, shipping them to fake A&F storefronts in Asia, and mixing the real goods with counterfeits to lend their operations an air of authenticity.
New Balance Athletic Shoe Inc. wages a similar battle against counterfeiters, one that also leads to some seemingly counterintuitive behaviors. For example, while most manufacturers want to draw as many potential customers as they can to their trade-show booths, New Balance carefully monitors access to its displays. "Too many people were coming in and taking samples and pictures of our products," explains Ed Haddad, vice president of intellectual property and licensed products for the $1.3 billion Boston-based shoemaker. "Sometimes counterfeit versions would be on the street before our real products."
Once an annoying distraction, counterfeiting has become a global scourge. The International Anti-Counterfeiting Coalition, a global trade group, estimates that counterfeiting — defined as willfully violating trademark laws by making a product designed to mimic, in appearance, a branded product — has grown more than 10,000 percent over the past two decades. According to the World Customs Organization, knockoffs now account for 7 percent, or $600 billion, of all goods sold globally. The U.S. Customs and Border Protection agency blames counterfeit merchandise for the loss of more than 750,000 American jobs. Last year, the agency seized counterfeit and pirated goods valued at $196.7 million, up from $155.3 million in fiscal 2006.
"Counterfeiting has taken an even more insidious turn in the past few years," says Howard E. Japlon Sr., senior vice president and general counsel for the North American division of Schneider Electric SA, an $18.1 billion French electrical-equipment manufacturer whose brands include Merlin Gerin and Square D. "We've discovered counterfeit medicines, counterfeit automotive products, and, in our case, counterfeit electrical components, all of which present substantial safety issues."
The direct economic impact of counterfeiting on individual merchants and manufacturers can be hard to measure; it's entirely possible if not probable that someone who buys a fake Rolex watch for $100 would never purchase the real thing for $10,000. But many companies worry less about the impact on today's sales and more about the long-term ramifications for their brands, which can become fatally diluted if knockoffs, often cheap and inferior, become commonplace. "Any CFO focused on the sustainability of their brand needs to worry about this," says A&F finance chief Michael Kramer.
Footwear leads the list of merchandise seized last year by U.S. Customs officials, with apparel in second place. Other commonly counterfeited goods include consumer electronics, luxury handbags and watches, pharmaceuticals, computer hardware, and designer sunglasses. But the complete list runs the gamut from golf clubs, cigarette lighters, and circuit breakers to automotive components and aerospace parts. Pirated music CDs and movie DVDs, which represent a violation of copyright rather than trademark laws, are another major category.
Made in China, Sold Everywhere
China is widely acknowledged to be ground zero for the production of counterfeit products, accounting for 80 percent of all the items confiscated last year by U.S. Customs authorities. Consumption is less centralized, showing its face on street corners and in storefronts around the world. "Every major city has its locale," says attorney Brian Brokate, a partner with Gibney, Anthony & Flaherty LLP in New York. "In New York City it's Chinatown, in Los Angeles it's Santee Alley, in Houston it's the Harwin District."
And, of course, it's online. "The Internet is the Wild West for counterfeiters and pirates because of the anonymity," says Caroline Joiner, executive director of the Global Intellectual Property Center, an initiative of the U.S. Chamber of Commerce. Even legitimate Web auction sites have been caught up in the issue, as evidenced by the lawsuit that luxury jeweler Tiffany & Co. filed in 2004 against eBay Inc. for trademark violations. The suit, which has yet to be resolved, contends that most of the jewelry being sold on eBay's Website as genuine Tiffany goods is fake.
While law-enforcement authorities fight counterfeiting to varying degrees (an effort that involves everyone from local police departments to the Department of Homeland Security, the Federal Bureau of Investigation, the Justice Department, the Federal Aviation Administration, and the Food & Drug Administration), it's an uphill battle, often lacking sufficient coordination and resources. Federal lawmakers are trying to bring more muscle to the fight, in the form of H.R. 4279, a bill sponsored by Rep. John Conyers Jr. (D–Mich.) and Rep. Howard Berman (D–Calif.). The bill would, among other things, create an intellectual-property enforcement post within the federal executive branch and an IP enforcement division within the Department of Justice.
In the meantime, companies must act as their own first line of defense against trademark and copyright counterfeiters. Three years ago, A&F began its efforts by hiring Shane Berry, a former special supervising agent with the FBI's global intellectual-property program, as its senior director for brand protection, reporting to CFO Kramer. Today the company doesn't just go after people making and selling counterfeit versions of its apparel (although it does so aggressively), it also has changed the way in which it works with the contract manufacturers that produce its goods.
"Most of the manufacturing partners we do business with also do business with folks who could be considered our competitors," Berry explains. "The technical specifications for our apparel, the actual physical makeup of the garments, the special stitching techniques we employ, the special hand-feel that distinguishes our clothes, are all things that we'd consider trade secrets valuable to our competitors."
To protect them, he says, A&F incorporates tight controls over the use of its IP in its contracts with its vendors, including language that prescribes who is allowed access to their facilities and how excess labels, buttons, logos, and other trademarked identifiers are stored and managed. "Our biggest asset as a company is our brand, and even though it is intangible and hard to quantify, we're going to protect it and the public's perception of it," Berry says.
How to Fight Back
Keeping a company's secrets safe isn't cheap. A&F doesn't disclose its costs, but New Balance, which employs a similar approach, says it typically spends $1 million to $2 million a year on anticounterfeiting and brand-protection activities.
A broad-based anticounterfeiting effort entails managing the supply chain to avoid misappropriation of information and materials; pursuing those counterfeiters who are discovered through civil or criminal prosecutions; leveraging technology to make it harder for counterfeiters to copy products; and educating business partners and consumers about the risks of piracy and counterfeiting. Those risks range from lost revenues and jobs to the possibility, raised by law-enforcement authorities, that some counterfeiting profits may fund terrorist organizations.
Companies should register their trademarks and copyrights with customs officials around the world, many of whom will alert companies when suspected counterfeits are discovered. At a more granular level, New Balance says it has learned to ship to its contract manufacturers only enough of its labels to produce the exact number of shoes they have been asked to make. "Smaller companies sometimes don't know about that," Haddad says. "They send their purchase order overseas, and it becomes an authorization for the manufacturer to make as many of their items as they want."
Companies also should consider creating a mechanism for consumers to report fake products. "There's no point in having these trademarks and copyrights if you're not going to enforce them," says Stuart Adams, deputy chief executive of Rouse & Co. International, an IP consultancy headquartered in London. "Otherwise, they're nothing more than a 'Keep Off the Grass' sign that the local kids soon ignore if you don't chase them off."
Technology is a tool in the fight against counterfeiting, albeit an imperfect one. Juniper Networks Inc., a $2.8 billion maker of computer networking gear, has taken to incorporating technology into some of its products that detects counterfeit and other illegitimate hardware and software that may compromise the network, says Brad Minnis, director of security for the Sunnyvale, California-based firm. Incorporating holograms and other unique identifying marks into goods can help authorized distributors and resellers distinguish between genuine and counterfeit goods but aren't of much use with consumers who knowingly buy knockoffs. And even when consumers do care, they are often fooled because counterfeiters have access to the same sophisticated technology used by legitimate manufacturers.
Going for the Knockout
Once fakes are in the marketplace, companies that want to protect their brands have little alternative but to try to get them out. Typically, that means hiring a law firm and its investigators to gather evidence. The goal, at a minimum, is to shut down the counterfeiting operation and seize its inventory and assets. That can be accomplished through a civil claim or a criminal complaint.
Either way, it can be costly. While a simple search and seizure might cost $150,000, says attorney Peter Vogl, a partner with law firm Jones Day in New York, a full-blown investigation that leads to discovery — with document requests, depositions, and ultimately a trial — can easily cost $1 million or more. Lurking behind that rack of counterfeit handbags on a street corner is a loosely federated collection of manufacturers, distributors, and even marketing operations. Getting the evidence to pursue a case all the way to the ultimate kingpin can be very difficult.
"The people at the factory who might help us aren't going to talk, because they know they are in much worse trouble from Mr. Big than from these lawyers who just showed up," says Rouse's Adams. "Companies need to set their expectations right: you're looking to control the problem rather than solve it."
Deciding whether to pursue civil or criminal relief may depend on the size and nature of the problem. "If I were dealing with a street vendor selling 50 units, I wouldn't bother law enforcement," says Berry, the former FBI agent, acknowledging that authorities will usually have bigger fish to fry. But don't assume they won't be interested in your case, especially if public safety or the possibility of terrorist backing is involved. "I've noticed a real upswing in the amount of interest we can generate with law-enforcement authorities, even on relatively mundane product categories, because they recognize terrorists are funding themselves through these counterfeit sales," Vogl says.
When bigger dollars are at stake, of course, authorities are often eager to join the fray. In February, New York City police and Mayor Michael Bloomberg's Office of Special Enforcement raided and closed down 32 retail shops in an area of Chinatown that Bloomberg called the "Counterfeit Triangle," which includes sections of Canal, Walker, Baxter, and Centre streets. The crackdown followed an investigation, prompted by complaints from Swiss watchmaker Rolex SA and others, in which undercover officers and agents purchased more than $1 million worth of counterfeit goods, many of them luxury items.
Companies that find evidence of counterfeit manufacturing in China have two avenues of recourse. One is to appeal to China's Administration for Industry and Commerce (AIC), which is charged with protecting trademarks within the Chinese legal system. "Investigators can go to them, lodge a complaint, show an infringing product, show proof of their registered trademark, and the agency will raid the establishment and confiscate the counterfeit goods," says Haddad of New Balance. "It's a fast, very efficient process." The only problem, he says, is that there is no real penalty for counterfeiters caught by the AIC. "They might take the inventory and fine the owner $100, and that's the end of it," he says. "From a brand-owner perspective it's still effective though, because you become known as someone who is enforcing your brand, and the counterfeiters know you're going to harass them."
In larger cases, says Haddad, companies can pursue a legal remedy instead. But that can be slow and cumbersome. "You have to be prepared for a fight that goes on for years," he warns.
Despite long odds, companies have won many counterfeiting battles, both at home and abroad. Adams says that every week his firm raids Chinese factories that produce counterfeit goods. Vogl's firm helped stop a company that was collecting used golf balls, repainting them, applying the names of popular brands, and selling them as new. On the day attorneys showed up at the illicit operation with a team of federal marshals, they seized almost half a million balls.
Wins like those won't stop the knockoff trade, but they can have an effect. "As we've made life difficult for counterfeiters, we've seen them migrate to other targets," says Japlon of Schneider Electric, which has an aggressive brand-protection program in place. "Our customers feel confident they're getting the real thing when they buy from us and our authorized distributors."
Such confidence, unfortunately, is now something that many companies will have to work harder to guarantee.
Randy Myers is a contributing editor of CFO.
Counting the Counterfeits
7%: Amount of all goods sold globally suspected of being knockoffs
$600 billion: Value of those goods
750,000: Number of American jobs lost due to counterfeiting
$200 million: Value of counterfeit goods seized by U.S. Customs in '07
Sources: World Customs Organization, U.S. Customs and Border Protection
Top intellectual-property rights seizures, FY 2007
(in $ mill.)
|Media (motion pictures, software, music)|
|All other commodities|
|*Sums rounded; Source: U.S. Customs and Border Protection|