When Gray is Good: Gray Markets and Market-Creating Investments

27 Pages Posted: 3 Dec 2012 Last revised: 5 Jun 2014

See all articles by Romana L. Autrey

Romana L. Autrey

Willamette University - Atkinson Graduate School of Management

Francesco Bova

University of Toronto - Rotman School of Management

David Soberman

University of Toronto - Rotman School of Management; INSEAD

Multiple version iconThere are 2 versions of this paper

Date Written: May 6, 2014

Abstract

Gray markets arise when an intermediary buys a product in a lower-priced, often emerging market and resells it to compete with the product’s original manufacturer in a higher-priced, more developed market. Evidence suggests that gray markets make the original manufacturer worse off globally by eroding profit margins in developed markets. Thus, it is interesting that many firms do not implement control systems to curb gray market activity. Our analysis suggests that one possible explanation lies at the intersection of two economic phenomena: firms investing to build emerging market demand, and investments conferring positive externalities (spillovers) on a rival’s demand. We find that gray markets amplify the incentives to invest in emerging markets, because investments increase both emerging market consumption and the gray market’s cost base. Moreover, when market-creating investments confer positive spillovers, each firm builds its own market more efficiently. We find that firms can be better off with gray markets when investments confer spillovers, provided the spillover effect is sufficiently large. These results provide a perspective on why firms might not implement control systems to prevent gray market distribution in sectors where investment spillovers are common (e.g., the technology sector) and, more broadly, why gray markets persist in the economy.

Keywords: gray markets, unauthorized distribution, emerging markets, investment spillovers, management control systems

JEL Classification: M40, M49, M31, D43, D49, C72

Suggested Citation

Autrey, Romana L. and Bova, Francesco and Soberman, David, When Gray is Good: Gray Markets and Market-Creating Investments (May 6, 2014). Rotman School of Management Working Paper No. 2184523. Available at SSRN: https://ssrn.com/abstract=2184523 or http://dx.doi.org/10.2139/ssrn.2184523

Romana L. Autrey

Willamette University - Atkinson Graduate School of Management ( email )

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Francesco Bova (Contact Author)

University of Toronto - Rotman School of Management ( email )

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David Soberman

University of Toronto - Rotman School of Management

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Toronto, Ontario M5S 3E6 M5S1S4
Canada
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416 978 5433 (Fax)

INSEAD ( email )

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