How Companies Prevent the Creation of Profit Damaging Grey Markets

Published: 16th March 2011
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The upturn in the internationalisation of many companies has resulted in the evolvement of 'grey markets'. Restricted by the differing price structures in each individual European countries, it is often an attractive possibliity to re-import a commodity into its country of origin and sell it there for considerably less than the usual price. This management training article looks at four strategies companies might use to avoid the production of such profit-damaging grey markets.

1. Optimising the transfer prices and sales volume.

Most grey markets arise through unwanted price policy decisions in third countries. If a company finds out that a subsidiary in another European country has ordered a large amount of a certain product at a comparatively low price, then it might respond by increasing the transfer price for this country. This way the calculations the local management use to determine price will be changed and increases, so to speak, 'through the back door' prices in this country.

The imposition of sales volume quotas is also an effective measure: if a particular subsidiary is receiving an obviously inflated number of goods in comparison to the country's market volume, there is a suspicion that grey markets are being fed. By artificially cutting back offers businesses can dry out these unwanted sales channels and encourage local management to raise its prices.

The precondition for both strategies is that the company is comprehensively in the know about the markets in the third countries.

2. Centralising price policy decisions.

In many multinational companies price policy is heavily decentralised. In general, local management knows its markets and its competitors better than head office and therefore has a lot of freedom when it comes to price policy. This is reasonable and correct as long as price policy decisions in these third countries have no international effects. As soon as large quantities of low price products start flooding into a high-price country, the head office has to intervene in a regulatory capacity.

It is, however, dangerous to withdraw responsibility for price from local management: by doing so companies eliminate any chance of local management responding in the short term to market changes. They also demotivate the local manager by restricting his /her room to steer.

The regionalisation of price policy has proved to be a practicable compromise in this situation by creating country groups, such as, for example, southern Europe, central Europe, northern Europe, North America, eastern Europe, South America and Asia. Price policy decisions are then centralised at these levels.

As a rule, the head office limits itself to an observer role and only intervenes on a case-by-case basis in a co-ordinating capacity.

The strategic aims of the whole company have priority over local interests.

3. Formalising price policy decisions.

By this we mean the fixing of price-setting and calculation procedures for the whole company to follow.

A widespread formalisation strategy is the allocation of cost bands, within which a product's cost must move. Here the company stipulates, for example, that the product has to always move within the top third of the market price (high price strategy), at the average price level or in the lower third of the market price (low price strategy) of respective countries. Management training will be required to ensure the procedures and policies are fully understood by all managers.

4. Creating a system of informal co-ordination.

Empirical studies show that this strategy is becoming increasingly important. It is not based on instructions and orders, but on data, communication and persuasion. Companies organise frequent meetings of those responsible for global price policy and use these to present desired and undesired developments and to discuss these.

81.3% of all multinational companies in Germany, France, Italy and the UK currently hold such meetings. The aim is for participants of these meetings to be committed to the strategic aims of the whole company. It is made clear in the meeting that management will have to subordinate local interests to a certain extent.

This approach gives local managers co-responsibility for global success. Whilst management training is important to ensure local managers have the skills necessary to implement the strategic goals, the use of performance incentives and bonuses are also often used to give them a stake in ensuring success.


Richard Stone is a Director for Spearhead Training Limited that specialises in running management training courses to improve business performance. Richard provides consultancy advice for numerous world leading companies. View more details by clicking on the link.

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