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Grey marketing of watches gets colourful support

With the imminent release of the Apple Watch, COLEBY NICHOLSON reviews the ramifications of Swatch Group’s loss to Costco over copyright infringement in the US courts.

The recent court case, Omega v. Costco, is a victory for common sense. Indeed, not only did Costco land one hell of a punch on Swatch Group’s chin but it could also be the long overdue ‘knock-out blow’ needed to force some common sense into many industries.

Firstly, a little background. The fight began when the giant US supermarket chain started selling Omega Seamaster watches for US$1,299 even though the RRP was US$1,995. Omega was naturally unhappy about the large discount being offered to US consumers but even more so because Costco was not an authorised retailer of its watches.

This was simply a ‘grey market’ play by Costco, where a product is bought and sold outside of the manufacturer’s authorised wholesale and retail distribution channels.

In 2004, in an unusual move, Swatch decided to take legal action by suing Costco for copyright infringement. While the watches themselves could not be copyrighted, Swatch argued that the small, copyrighted ‘globe’ emblem engraved on each watch had been imported by Costco without its permission.

In 2007, a court initially ruled in favour of Costco stating that the first sale doctrine applied. That doctrine stipulates that a copyright owner cannot claim infringement for distribution of copies of copyrighted work after consenting to the initial sale; however, a subsequent judgement in 2008 reversed that decision on the basis that the doctrine did not apply to products imported into the US.

The latest decision by the US Court of Appeals to reaffirm the original 2007 ruling essentially means that Costco has won approval to sell heavily discounted watches, much to the chagrin of the Swiss.

The pain continues for Swatch – the court ruling was strident in its criticism of the Swiss behemoth, saying Swatch had attempted to suppress retail competition: “Omega does not own a copyright in its watches. Omega merely owns the copyright in its Globe Design, which it engraved onto its non-copyrightable watches to limit retail competition.”

The condemnation was also colourful: “Even when drawing all reasonable inferences in Omega’s favor, there is no genuine dispute concerning whether restricting retail competition was one of the reasons Omega sued Costco for copyright infringement.

“Omega had other available remedies. It could have terminated its distribution agreements... Or, if Omega believed that Costco, or intermediaries ... were inducing distributors to breach their contracts, Omega may have been able to sue them for tortious interference. Instead, Omega improvidently decided to sue Costco for copyright infringement. By doing so, Omega misused the Congressionally limited power of copyright protection to address a problem better left for other  avenues of relief.”

The Court’s denunciation went further; “The watchmaker’s anticompetitive acts promoted neither the broad public availability of the arts nor the public welfare. Instead, they eliminated price competition in the retail market for Omega watches and deprived consumers of the opportunity to purchase discounted gray market Omega watches from Costco.”

Costco and Australian market

This grey marketing issue is not confined to the US – Costco Australia is currently selling Omega, Tag Heuer, Raymond Weil and other Swiss brands. Presumably it has obtained the product from outside authorised Australian watch suppliers and international distribution agreements.

I’ve always sympathised with brand owners wanting to control their distribution channels, preserve brand integrity and maintain some form of pricing structure that doesn’t devalue the brand’s status and reputation. Afterall, the manufacturers invest millions of dollars in consumer marketing.

As such, I can fully understand why luxury brands have issues with their products being obtained by discount retailers and internet sellers and sold at heavily marked-down prices.

While the US court pointed to other legal remedies available to Swatch, the issue is more complex than that. All too often it’s the watch brands themselves that are to blame; they force their international wholesalers to accept minimum order guarantees, which hurts wholesalers when the product doesn’t sell as well as anticipated.

If international brand owners won’t accept return of unsold product, local wholesalers must dump the excess product to get much-needed cash, which is used (rather ironically) to buy the next range.

If watch companies better managed their production, sales and distribution channels, Costco and other internet dump sites would have little chance of securing product on the grey market.

But is there good cause for better management?

Maybe not; one former Swiss watch distributor told me the matter is made much worse because the Swiss attempt to force product downstream in order to meet accounting forecasts, which in turn affects the financial market analysis of publicly listed companies.

The better the sales forecasts the better the stock will perform on share markets so there is reason to “force” stock into the sales channels, even if the channel can’t adequately handle the volume.

Fear of losing distribution rights

My colleague said that most Swiss watch companies are not concerned because they know the local distributors will accept their demands for fear of losing their distribution rights. In fact, he argues that in many cases Swiss staff receive incentives and annual bonuses to reach sales targets – something that is not unusual in any industry – so the true sales results would be exposed if unsold product was returned which could then affect staff bonuses.

In other words, head office staff can have a financial incentive to artificially increase sales results and over burden local distributors.

Another local distributor with extensive experience dealing with Swiss brands (not Swatch) confirmed that many international watch companies pressure local distributors, and therefore stores, to increase orders under rebate systems in the full knowledge that much more stock is being delivered into the market than is supportable.

The practice is not restricted to watches, by the way. Over the years I have heard many complaints about similar practices with jewellery where international companies place unrealistic “minimums” on a local distributor based on US or European sales formulas.

“If they knocked off two zeros from their sales budget, it was doable,” is how an Australian supplier once described his negotiation with a large overseas jewellery company.

All of these issues are commercial decisions between two parties, however the brand owners should not be shocked to discover that their unsold product finds its way to discount retailers like Costco or worse, internet dump sites that specialise in using heavily discounted prices to compete against the brand’s own stockists.

That’s why I say that Costco’s victory is a one for common sense even though I sympathise with brand owners wanting to control and preserve brand integrity and reputation.

For now, at least, Swatch and others might be better served by reviewing their whole business model rather than trying to control markets and consumer behaviour via a misuse of copyright lawsuits. That might be especially so if the international watch market is about to enter an era of disruption courtesy of the Apple Watch.

Regardless of Apple’s impact, or lack thereof, I have long believed that any attempt to circumvent the free market will eventually result in the exact opposite outcome than the one hoped. Omega's anti-competitive actions to stop Costco selling watches is one such example.

Download PDF: Omega V Costco Court Ruling

More reading
The real Apple Watch 'game'
Google watch a game changer?
Costco wins approval to sell discounted Swiss watches

Coleby Nicholson

Former Publisher • Jeweller Magazine

Coleby Nicholson launched Jeweller in 1996 and was also publisher and managing editor from 2006 to 2019. He has covered the jewellery industry for more than 20 years and specialises in business-to-business aspects of the industry.


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