For the past few weeks Tech Data Canada has been gathering figures generated from orders, receipts and invoices involving Hewlett-Packard products.

It’s for one of the manufacturer’s periodic audits of all of its distributors across North America to make sure everything’s accounted

for. But this year’s audits are different: HP wants two years worth of information.

“The scope of this audit is the largest I’ve seen,” says Ray Gonsalves, Tech Data Canada’s director of product management.

HP is one of a number of IT manufacturers using tougher audits as a weapon against grey market products. Intel, for example, drops into distributors for an audit every time it changes prices on processors. The industry feels the problem is getting worse – or it doesn’t want it to get worse than it already is.

“It’s something we need to address,” says Derek Smith, HP Canada’s vice-president of sales and marketing. “We want to make sure that we address it on behalf of our authorized partners.”

The grey market can broadly be defined as discounted product obtained deceitfully from manufacturers by resellers, as well as product obtained legitimately and sold across borders to take advantage of currency swings.

It vexes some VARs. “We see a fair amount of it,” says Patrick Power, a partner at the OAM Computer Group of Toronto, a reseller of HP, Cisco, IBM and 3Com gear.

“We’re competing on a deal and a price from a competitor is too good to be true. Either the guy’s stuck with inventory and wants to get rid of it, or he’s bought from an unauthorized channel.”

To fight it, he has to appeal to customers’ “sense of good faith and morality.” Most of the time, it works, but “sometimes we’ve lost deals.”

The grey market here is “pervasive,” insists 3Com Canada managing director Nick Tidd. “It’s amazing how many manufacturers don’t deal with it or don’t even know it’s happening to them.”

Three years ago the problem here with 3Com equipment was significant he said, until the company cracked down and started suing resellers. Since then grey market in its products has dropped.

How big the grey market is in this country isn’t clear because no one has precise figures. Smith said HP thinks it totals less than five per cent of its Canadian sales. Gary Isaacs, director of partners for IBM Canada, said resellers talk about it less now than they did three years ago.

Perhaps that’s because two years ago a group of majors – including HP, Compaq Computer Corp., 3Com, Cisco Systems and Xerox Corp. – were alarmed enough to found the Anti-Gray Market Alliance to stop the flow of product to the market. Earlier this year a KMPG LLP study it commissioned estimated the grey market costs IT manufacturers US$5 billion in profits a year, a figure it came up with by interviewing 11 vendors and 43 distributors and resellers around the world.

More significant than that unaudited number, however, was the finding that the grey market offers tempting incentives to distributors: better prices and fast product delivery. Seventy-one per cent of the distributors interviewed by KPMG (23 in the Americas, 15 in Europe and five in the Pacific) believed it was necessary to buy from the grey market. Forty-one per cent purchase there regularly in defiance of OEM contracts.

Understandably, for manufacturers this means war. HP, Compaq and 3Com have been the most visible warriors, laying criminal or civil charges. In October an Ohio man is scheduled to be sentenced in a Boston court after pleading guilty to a scheme to defraud Compaq (now part of HP) in 2002. The prosecution alleged he was one of several people who submitted a false purchase order to Compaq for hardware for a university, getting a discount by saying there was a competing bid. However, the equipment was shipped to Canada and England.

That person was also sued in civil court: HP recovered US$1.8 million in August.

The criminal trial of his co-defendants, who pleaded not guilty, ended in a hung jury and has been rescheduled for January.

Next year will also see scheduled trials in two civil lawsuits filed by 3Com Canada against several Ontario resellers. In one case, 3Com is demanding $12 million in damages, alleging it was given forged government purchase orders to get deep discounts from its “Meet Comp” program, which gives resellers special pricing to meet competitive bids.

The defendants have issued a $15 million counterclaim, denying any documents were forged and alleging that 3Com Canada officials told a reseller what end users should be specified on certain purchase orders. The officials have denied that allegation.

In another suit, 3Com Canada is demanding $10 million in damages, alleging the Meet Comp program was abused when a company claimed it had an order for switches from a U.S. firm destined for China and Australia. 3Com alleges it found the equipment was actually sold in Europe and the U.S.

In a statement of defence the defendants say 3Com Canada was told no firm deals had been made by the company before product was ordered, and that it was only a reseller to other distributors. In addition, they are suing Tech Data Canada, which sold them the equipment, for any monies they may have to pay to 3Com.

To meet the grey market problem KPMG urges manufacturers to devote more staff to police their incentive and warranty programs and audit their distribution channels. Isaacs said IBM has a handle on it by tracking product serial numbers. 3Com’s Tidd advises vendors to keep product prices relatively stable around the world. Cisco has a different strategy: let partners sell service and support on its grey market products.

Will it go away? Not likely, suggests Patrick Power: “IT is probably the best grey market industry you can have.””

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