JOURNAL OF PRODUCT & BRAND MANAGEMENT, VOL. 7 NO. 5 1998, pp.

433-440 MCB UNIVERSITY PRESS, 1061-0421 433

It is widely recognized that a major advantage from international operations
is the leverage of charging country-specific prices reflecting differences in
willingness to pay. One intriguing fact is that parallel importation seriously
undermines a manufacturers ability of doing so. Parallel importation refers
to purchasing a product in a low-priced country and shipping it to a high-
priced country to profit from the price difference. As a business practice
dating back to 1886 (Duhan and Sheffet, 1988), it is usually carried out by
enterprises that are not part of a manufacturer's distribution plan, such as
catalogue retailers and discount stores. Consider the following typical
vignettes:
Many Europeans know that cars are cheaper in Belgium than in nearby
countries, the difference largely due to substantial tax differences.
European car dealers have been unable to stop the entry of unauthorized
imports from Belgium that parallel and compete with their own
authorized transactions. This situation helps explain why Belgium is a
substantial exporter of automobiles more than 25,000 some years
even though it does not have an auto manufacturing facility.
A pharmaceutical company shipped some of its American-made drugs
to its distributor in a Central American country, intending to sell at a
substantial discount because the local market could not afford to pay
American-level prices. However, the pharmaceuticals did not stay in the
Central American country. Instead, they were shipped back to the US to
be sold through drug channels that were not part of the American
companys plans and at prices lower than the previously set American
prices.
In a major shopping area in Tokyo, a large discount retailer sells Fuji
film at a discount. However, the package carries the Korean language,
not Japanese. It was meant to be sold in Korea, but made its way back
into the Japanese market. Other Fuji film, also discounted but still more
expensive, is packaged with the Japanese language on the box.
The range of parallel imports spans from daily-used low-end products to
highly sophisticated ones, especially in the case of premium brands of
automobiles, cameras, watches, computers, perfumes, wine, drugs, and
construction equipment. The practice has been widely reported also as gray
market, product diversion, re-imports, and arbitrage. We use the
name parallel imports to specify that a parallel channel is created, and
goods are moved across borders to differentiate with the more general gray
market that could sometimes be domestic. The problem was severe in the
Pricing in separable channels:
the case of parallel imports
B. Rachel Yang
Assistant Professor of Operations Management, Department of Business
Administration, University of Illinois at Urbana-Champaign, Illinois, USA
Reza H. Ahmadi
Associate Professor of Operations and Technology Management,
Anderson School of Management, University of California, Los Angeles,
California, USA
Kent B. Monroe
J.M. Jones Distinguished Professor of Marketing, Department of
Business Administration, University of Illinois at Urbana-Champaign,
Illinois, USA
Parallel importation
A large discount retailer
sells Fuji film at a
discount
US in the late 1980s due to a strong dollar, with an estimated annual inflow
of $7 billion and a 22 percent growth rate (New York Times, 1986), and the
flow was reversed and spread to the rest of the world with the rise of other
currencies in the early 1990s.
Recently, the problem re-surfaced at an alarming scale as the recession-
stricken Asia became a huge source for parallel imports. For example, many
halted projects there sent a tidal wave of ordered but unused heavy
equipment back into the US at prices sometimes 50 percent off list, causing
a sudden jump in its share of the world excavator sales from 4.7 percent in
1997 to 19.5 percent in 1998 and taking over half of the 1998 US excavator
market (Business Week, 1998). Forty percent of the nations heavy
equipment dealers reported that they are competing head-to-head with
parallel importers. Their strategies to fight back include launching
advertising campaigns appealing for customer loyalty and appealing to
manufacturers for lower prices. Should manufacturers such as Caterpillar,
Deere, and Komatsu answer their call?
Assmus and Wiese (1995) studied price coordination as a way to address the
gray market threat, and suggested an approach to select various coordination
mechanisms (centralization, formalization, economic measures, and informal
coordination) based on local subsidiary resources and product market
complexity. They are certainly effective mechanisms to implement or
asymptotically approach a coherent pricing strategy, but what is this
coherent strategy that governs the manufacturers global plan and that these
coordination mechanisms will help to realize? This paper is an attempt to
address this important research issue. Through theoretical modeling, we
demonstrate how a companys pricing in one country can help create
separable channels in another country and affect their pricing. Therefore,
pricing decisions in different countries can not be made isolated or without
considering the consequences of resulting prices in separable channels, and
we need to link all these prices to form a coherent pricing policy that is
aligned with the overall corporate strategy.
The rest of the paper is organized as follows. We will first examine the
pricing issue in different countries to explain how parallel imports emerge.
We then investigate the interactions between separable authorized and
unauthorized channels to show the impact of parallel imports on the global
marketplace. Finally we offer suggestions for multinational companies to
move towards a sound pricing strategy that explicitly considers the problems
of differential prices in geographical markets and the existence of separable
distribution channels.
Pricing in different countries
Consider a multinational manufacturers pricing problem in two countries.
The manufacturers global profit is defined as the sum of sales revenues in
all countries less total production, transportation, and distribution costs. For
simplicity, suppose that consumers will face a price determined by the
manufacturer, which is the case in many industries where the manufacturer
has strong influence over the distribution network, such as the auto industry.
As we assume that the manufacturer can centrally set prices for consumers
in different countries, this is a model of centralization according to the
framework of Assmus and Wiese (1995), but can also be used as a
benchmark to other coordination mechanisms like formalization, economic
measure, and informal coordination. We now examine several common
pricing practices in this context.
434 JOURNAL OF PRODUCT & BRAND MANAGEMENT, VOL. 7 NO. 5 1998
Tidal wave of ordered
but unused heavy
equipment
Manufacturers pricing
problem in two countries
Because most parallel imports are premium global brands, the manufacturer,
having a sole trademark agent in each country, possesses the market power
to set prices. It is hence natural for the manufacturer to differentiate prices
based on buyers willingness and ability to pay, in order to extract
consumers surplus and maximize profit potentials in different countries.
Therefore, the most frequently observed pricing policy in different countries
is country-specific price segmentation (denoted by local), i.e. charging the
highest feasible price in each country according to the local markets
willingness to pay.
A consequence of this pricing policy often leads to a price difference
between the two countries for the same product. In many cases the price
difference is large enough for a business enterprise to purchase the products
in country A (the lower-priced country), ship and distribute them into
country B (the higher-priced country), and still make a profit. That is, when
the price difference between two countries exceeds a threshold, parallel
imports emerge and create a channel of unauthorized product flows. Figure 1
illustrates the emergence of parallel imports.
Parallel imports are often costly to the manufacturer since they cannibalize
the sales of the manufacturers authorized channel in country B and
deteriorate the relationship with its distributors. To overcome this problem,
the manufacturers response might be to completely eliminate the price
difference and charge a uniform price (denoted by uniform). A third
pricing strategy we observe in this situation is denoted by friction. This
strategy suggests that a company set price differences equal to the costs of
transshipping and redistributing products across countries, as in the price
corridor suggested by Simon and Kucher (1992) for the European Union.
The friction strategy is clearly a compromise between the local policy with a
large price difference and the uniform policy with no price difference. By
employing the natural friction cost between two countries to eliminate
profit potential for parallel imports, this policy would be appropriate for
achieving the goal of eliminating parallel imports. However, is this goal in
the best interest of the company? To answer this question, we need to
examine how the authorized channel and unauthorized channel each serves
the company and how they interact with each other.
The separable authorized and unauthorized channels
The important distinction of parallel imports from counterfeits is that, unlike
counterfeits, parallel imports are genuine goods, but re-channeled into
markets that they are not originally destined for. Usually consumers can tell
parallel imports apart from authorized products as the former are sold at
discount outlets, bearing labels in foreign languages, and are not covered by
JOURNAL OF PRODUCT & BRAND MANAGEMENT, VOL. 7 NO. 5 1998 435
Plant
Country A Country B
parallel
P
P
1
P
2
authorized authorized
Figure 1. The emergence of parallel imports
Price difference between
the two countries for the
same product
Parallel imports are
genuine goods
manufacturers warranty and after-sales service. Some parallel imported
goods, such as the automobiles from Europe and the heavy equipment from
Asia, have to go through costly conversion to meet different gauging, safety,
and emission standards to be used in the US. Therefore they are valued less
by consumers and are sold at a lower price than the authorized products.
Unlike being deceived by counterfeits, consumers in country B are making
conscious choices between the higher-priced but warranty-backed authorized
products and the lower-priced parallel imports. Depending on which product
can give the customer a higher value-in-use, defined as the difference
between the consumers valuation and the price paid, the consumers in
country B are partitioned into three segments:
(1) Buyers in segment 1 have the ability to purchase either the higher-priced
authorized products or the lower-priced parallel imports. However, they
value authorized products more and will purchase them.
(2) Buyers in segment 2 are price-sensitive. Although they have the ability
to purchase either product, they will buy the parallel imported product.
(3) Buyers in segment 3 have the ability to purchase only the parallel
imported product.
Clearly, the manufacturer is losing segment 2 to the parallel importer in
country B. However, remember that the parallel imports are not produced by
the importer but are purchased from country A. Because of parallel imports,
the manufacturer is selling more in country A, with the added sales potential
equal to the size of segment 2 plus segment 3. Therefore, the net change is a
volume increase equal to the size of segment 3. In terms of profit, the impact
is less clear. Buyers in segment 2 in country B used to buy from the
manufacturer at country Bs higher authorized price, but now they buy from
parallel importers who purchase this volume from the manufacturer in
country A at country As lower authorized price. Yet, some of the additional
sales in country A are re-channeled into country B to supply the new
segment III, and the manufacturer is making profit on these sales. The net
change may be positive or negative. In summary the overall effects of
parallel imports on the manufacturers global supply chain are to:
shift the middle market segments sales volume from the higher-priced
country to the lower-priced country,
create a new market segment at the lower end in the higher-priced
country,
increase the total sales volume in the global marketplace, and
may increase or decrease total profit depending on the profitability of
various market segments.
The changes in sales volume and profit in countries A and B before and after
parallel imports emerge are summarized in Table I.
This understanding of interactions between authorized and unauthorized
channels is valuable for devising optimal strategies towards parallel imports
in the companys global interest. In light of this, we can identify the
weakness of the pricing policies we have discussed so far. They are either
based on ignoring the possibility of parallel imports (local) or being over-
reactive to parallel imports (uniform and friction) without recognizing
its effects on overall sales volume and profit, as well as the re-distribution of
sales volume and profit across distribution channels in different countries.
436 JOURNAL OF PRODUCT & BRAND MANAGEMENT, VOL. 7 NO. 5 1998
Three segments
The changes in sales
volume and profit in
countries A and B
A global strategy and managerial prescriptions
One lesson we can learn from examining the interactions among different
countries and among separable channels as we did in the last section is as
follows. If it is in the companys best interest to prevent parallel imports, the
price difference should be set at the threshold where profitability to the
parallel importers just vanishes. If it is in the companys best interest to use
parallel imports to boost global sales or even profit, the company should
allow parallel imports by setting prices in different countries such that the
resulting parallel imports flow will contribute to the firms goal in an
optimal way. In either case, when companies set prices in different countries,
they are effectively preventing or creating alternative channels of
unauthorized flows, and setting prices for these separable channels. A global
strategy should realize this linkage and align such pricing decisions with the
corporate global strategy to guide the multinational company to
simultaneously manage its channels in different regions and alternative
channels in one region. The remaining questions are: when should the
multinational company allow or prevent parallel imports and what are the
appropriately set prices in each case?
When the parallel importer sets a price to sell parallel imports to consumers
in segments 2 and 3 in country B, it has to purchase the same quantity from
the authorized dealer in country A and compete with the authorized dealer in
country B (who still retains consumers in segment 1). Therefore the price of
parallel imports is based on the authorized prices in both countries A and B,
and in this sense the parallel importers pricing decision follows the
manufacturers. As parallel imports will re-distribute sales volume and profit
among the authorized channels in countries A and B, the manufacturer
should anticipate the move of the parallel importer and incorporate that
response into its pricing decisions. This kind of leading-following-
anticipating interaction is best captured in a leader-follower game known as
the Stackelberg game. One such game theoretic model in which the
manufacturer is the leader to set authorized prices and the parallel importer
JOURNAL OF PRODUCT & BRAND MANAGEMENT, VOL. 7 NO. 5 1998 437
Table I. Impact of parallel imports on authorized channels
Before parallel imports After parallel imports Change
Sales volume
Country A Authorized channel sells Q
1
Authorized channel sells Q
1
A
to local consumers to local consumers, and A
to the parallel importer
Country B Authorized channel sells Authorized channel sells wA
Q
2
to local consumers. (Q
2
wA) to segment I of
local consumers
Parallel channel sells A to
segments II and III
consumers
Total Q
1
+ Q
2
Q
1
+ Q
2
+ (1 w)A (1w)A
Profit
Country A Authorized dealer makes Authorized dealer makes Gain
profit more profit
Country B Authorized dealer makes Authorized dealer makes Loss
profit less profit
Parallel importer makes profit
Total 1 + 2
1
+ (p
1
c s
1
) A +
2
+/
(p
2
c s
2
)(1 w) A
A global strategy
Leader-follower game
is the follower to set parallel import prices is described in the Appendix and
more details can be found in Ahmadi and Yang (1997). The result is a wider,
more tolerable differential in authorized prices than the uniform and friction
pricing strategies prescribe when parallel imports should be prevented, and a
narrower differential in authorized prices to maximize the manufacturers
global profit when a certain quantity of parallel imports should be allowed.
This strategy is global and proactive compared with the three previously
discussed strategies (local, uniform, and friction). Their comparisons are
summarized in the Table II with regard to price gap, quantity of parallel
imports, global volume change caused by parallel imports, global profit
change caused by parallel imports, and attitude towards parallel imports.
When should a company choose to prevent and when to allow parallel
imports in the global pricing strategy? A manufacturer may choose to
prevent parallel imports due to one or any of the following reasons:
The parallel imports hurt the manufacturers overall global profit.
The manufacturer is primarily concerned with its brand image that may
be tarnished by the parallel imports.
The manufacturer is primarily concerned with its channel relationship
with the distributors in country B, especially when country B is a major
market.
In contrast, a manufacturer may choose not to fight parallel imports, but to
adjust its global prices so that the parallel imports will contribute to the
companys goal in the global marketplace, if:
Preventive pricing is too costly and will hurt the companys global profit.
The manufacturer is primarily concerned with expanding its global sales
volume or market share.
Next we revisit the heavy equipment example at the beginning to show how
the theoretical model can help to draw several managerial implications.
Impact on global market expansion
As reported, the share of parallel imports in the excavator world market is
estimated to be 19.5 percent in 1998. Since parallel imports create a new
market segment (segment 3 in country B) for those who could not afford the
authorized products otherwise, the overall worldwide sales volume has
increased. How much have manufacturers like Caterpillar, Deere, and
Komatsu benefited from the parallel imports-driven expansion of aggregate
sales volume? The world market expansion due to parallel imports can be
estimated as:
438 JOURNAL OF PRODUCT & BRAND MANAGEMENT, VOL. 7 NO. 5 1998
Table II. Comparison of pricing strategies towards parallel imports
Pricing Price Parallel Volume Profit Attitude
strategy gap imports change change to P.I.
Local Large Large Expand Large loss Ignore
(price discrimination)
Uniform 0 0 0 Large loss Reactive
Friction Smaller 0 0 Medium loss Reactive
(transshipment cost)
Global
Prevent Small 0 0 Small loss Proactive
Allow Medium Medium Expand Gain Proactive
Choose to prevent or
allow parallel imports
Parallel imports create a
new market segment
If w, the discount in product valuation, is estimated to be 0.5 in this case, the
total sales volume has grown by 10.8 percent.
Impact on global revenue
As reported, parallel imports will take over more than half of the US
excavator market in 1998. This will lead to a revenue loss for the
manufacturers as part of the sales in the low-priced countries will substitute
for authorized sales in high-priced countries. The extent of global revenue
loss can be roughly estimated as:
Where we have assumed region Bs price is three times as high as in region
A, and the two regions have roughly equal market sizes.
Preventive pricing
If Caterpillar, Deere, and Komatsu decide to answer the 40 percent US
heavy equipment dealers call to lower prices to prevent parallel imports,
they do not have to lower their prices down to the level in the recession-
stricken Asia (uniform pricing). They do not have to restrict the price
corridor between the USA and Asia to the transshipment cost (friction
pricing), either. The most efficient preventive pricing according to our global
strategy is to maintain a price difference equal to the transshipment cost plus
50 percent of the US list price:
p
2
p
1
= s + (1 w) p
2
> s > 0
This price difference will still be effective in preventing parallel imports, but
will allow more room for the manufacturers to charge different prices in
different regions according to willingness to pay.
Conclusion
The parallel import problem is an important and rapidly becoming
perplexing issue for international trade and management. The problem of
managing separable channels of distribution for exports is difficult, but is
compounded when one of these channels is unauthorized. The pricing
problem is very real and has important effects on profitability and long-term
relationships with distributors. There is clearly great need for formal
research efforts to offer a sound theoretical solution to the problem and
establish an empirical investigation of the theoretical propositions.
This paper demonstrates that the issues of regional pricing and separable
channels are related. The different pricing practices in two countries
authorized channels may cause an unauthorized channel to emerge, and this
unauthorized channel, in return, will alter sales and profits in the authorized
channels. Eliminating regional pricing will also eliminate separable
channels, but coordinating regional pricing with the appropriate management
of separable channels can better serve multinational companies based on
their various needs.

+


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JOURNAL OF PRODUCT & BRAND MANAGEMENT, VOL. 7 NO. 5 1998 439
Revenue loss for the
manufacturers
The price difference
The different pricing
practices
References
Ahmadi, R.H. and Yang, B.R. (1997), Challenge from unauthorized distribution channels,
working paper, Department of Business Administration, University of Illinois at Urbana-
Champaign, IL.
Assmus, G. and Wiese, C. (1995), How to address the gray market threat using pricing
coordination, Sloan Management Review, Spring, pp. 31-41.
Business Week, (1998), The earth is shifting under heavy equipment, April 6, p. 44.
Duhan, D.F. and Sheffet, M.J. (1988), Gray markets and the legal status of parallel
importation, Journal of Marketing, Vol. 52, July, pp. 75-83.
New York Times, (1986), Gray market grew with rise of dollar, December 9, D-4.
Simon, H. and Kucher, E. (1992) The European pricing time bomb and how to cope with
it, European Management Journal, Vol. 10, June, pp. 136-44.
Appendix: A game theoretic model of parallel imports
A price-setting game with the manufacturer as the leader and the parallel importer as the
follower consists of the following two stages:
(1) Stage 1: The manufacturer sets prices p
1
and p
2
for authorized channels in the two
countries to maximize its profit, defined as revenues in two countries less quantities times
constant marginal production cost c and shipping costs s
1
and s
2
.
Max = (p
1
s
1
) (Q
1
+ A) + (p
2
s
2
)(Q
2
wA) c[Q
1
+ W
2
+ (1 w)A]
where A = quantity of parallel imports = max
(2) Stage 2: The parallel importer chooses a price p for parallel imports to maximize its
profit, defined as revenue less quantity A times constant marginal transshipment cost s
and purchasing cost p
1
.
where the local demands Q
1
and Q
2
for the authorized products in the two countries and
the demand Q for parallel imports in country B are:
p
i
= a
i
(N
i
Q
i
), i = 1,2; p = wa
2
(N
2
Q), 0 < w < 1
Where a
i
and N
i
are the price elasticities and market sizes in the two countries,
respectively.
Solving the second stage problem and substituting the solution into the first stage problem to
arrive at the equilibrium, we can obtain the optimal prices for the global strategies:
(1) The optimal authorized prices to prevent parallel imports are:
Where the authorized price difference satisfies p
2
p
1
= s + (1 w) p
2
> s > 0.
(2) The optimal authorized prices when parallel imports are allowed are:
Where the quantity of parallel imports is allowed to be:
Where
1
= 2w (1 w)(wa
2
a
1
),
2
= a
1
+ w(2 w)a2, 3 = a1 + w(4 3w)a
2
.
A
a N w c s ws s
w w a a w w a

+
+

1 2 2 1 2 3
2 1 2
1
4 1 2
[( ) ]
( ) [ ( ) ]
. r
p
w w a a N a s
a w w a
c s
p
w a w w a a N wa s
a w w a
c s
1
2
1 2 1
1 2
1
2
1 2 2 2
1 2
2
3
2 2 2
1 2 1
2 2 2

+
+
+

+ + +
+
+
+
( )
[ ( ) ]
[( ) ( ) ]
[ ( ) ]
.
p
w w a a N wa w a c w a s wa s a s
a w a
p
w a a N a wa c wa s a s wa s
a w a
1
1 2 1
2
2
2
2 1 1 2 1
1
2
2
2
1 2 1 2 2 1 1 2 2
1
2
2
1 2
2
1 2
2

+ + + + +
+

+ + + + + +
+
( ) ( )
( )
( ) ( )
( )
Max

1
]
1

'

p
p p s
wp p
w w a
max ( )

( )
, .
1
2
1
1
0
wp p
w w a
2
2
1
0

( )
,

'

;
)
440 JOURNAL OF PRODUCT & BRAND MANAGEMENT, VOL. 7 NO. 5 1998