Counterfeiting: Good or Bad?

Yi Qian, Assistant Professor of Marketing and Kraft Research Professor at Northwestern University’s Kellogg School of Management

China is undoubtedly the world’s biggest market for counterfeit products. From fake Louis Vuitton bags, to Prada purses, Adidas sweatpants, Nike sneakers and Rolex watches—you can buy them all for a song in huge multistoried markets across China’s cities. How does the prevalence of counterfeits impact brand owners? Should the likes of Gucci and Prada crack down on counterfeits?

Yi Qian, Assistant Professor of Marketing and Kraft Research Professor at Northwestern University’s Kellogg School of Management, has been studying the interplay of intellectual property rights (IPRs), brand value and counterfeiting for a while now. She feels that counterfeiting can have both a positive as well as a negative rub-off effect on actual brands. Her forthcoming research paper titled 'Counterfeiters: Foes or Friends' (Management Science) examines exactly that.
Excerpts from an interview held on the sidelines of the 2013 China-India Consumer Insights Conference co-organized by the CKGSB and Yale School of Management (Yale SOM):

Q. China is full of fake brands. What are some of the broad implications of a market like that?
A. There are many general implications. I look at the 4-P implications of counterfeiting on the market. ‘4-P’ refers to the four pillars in traditional marketing–product, price, promotion and place. What I found was when counterfeits enter the market, authentic brands have incentives to upgrade their quality and innovate. As a result their marginal costs and some other costs increase. They have to charge a higher price to recoup those costs as well as to signal a higher quality, so that consumers can differentiate counterfeits from the authentic products.

In terms of the third P, ‘promotion’, authentic products will engage in a lot of self-enforcement activities, including informed advertisement, vertical integration of their company stores, which partly links to the last P, ‘place’. So traditionally they have the products sold in a lot of the retail stores. (But) after they were infringed by counterfeits, they found it to be very effective to rent their company stores and display authentic certificates on the wall. (They) also collect different quality levels of products in this one store of their own so they could garner more control of their distribution channels. And in these leased company stores, they would have the employees to do more informed advertisement to consumers, to teach consumers how to differentiate the counterfeits from the authentic products.

In terms of the advertisement, there is also a de-promotion effect, for the counterfeiters. Companies like Nike, Adidas and a lot of these branded companies would have their own employees walk around the market and track down counterfeits and report to the government. Then they would collaborate with the government to outlaw these counterfeit localities. So this self-enforcement sort of de-advertises or de-promotes the counterfeiters. And of course the vertically integrated, licensed stores also de-promote counterfeits because counterfeiters have little incentive to imitate that strategy—otherwise they get identified very easily by the government.

Q. Right. You have been talking about the government enforcing intellectual property rights (IPR). But still you have places like the Silk Street Market in Beijing, where on the ground floor the big banners proclaim, ‘Don’t buy fakes, buy only branded products’, yet the whole market is full of fakes. Isn’t it contradictory that markets like that exist all over China? Is the government doing enough?
A. It’s a political question as well as a legal question. In fact, I found in my data that there was a sudden surge in counterfeiting from 1995 to 1996 and some following years. I looked into why that was the case, as well as interviewed the companies. I found out that it was largely due to an actual policy shift around that time because of a series of accidents that unexpectedly took place in seven safety sectors, such as food, drugs, gas, etc. These accidents were unexpected and caused a lot of safety hazards, so the government had to emergently reallocate resources away from the fashion industry to these industries to ensure that sub-quality products and counterfeits in these safety prone sectors were ruled out. As a result, the enforcement on trademark monitoring by the government in the fashion industry, shoes included, loosened significantly. And that leaves loopholes for counterfeits to enter.

And that creates a very nice, natural experiment for me. What I found was exactly that after this sudden surge of counterfeiting in the market, there were these 4-P reactions in the market. And I have several theory papers looking at welfare calibrations and it’s interesting because with the innovations authentic companies did with these different pricing strategies, some of the consequences were actually positive for the consumers. Of course, it really depends on the parameter values. There were also large areas of the parameter range where the welfare was detrimental. So it is a mixed bag, but one thing is clear—the collaboration between private sector and public enforcement could be most effective in the sense that we leverage both the companies’ expertise of product quality and authenticity and the government’s authority of tracking the counterfeits.

Q. Can you share an example of how this 4-P effect played out with a given brand?
A. I’m not allowed to reveal the brand names, so anything I say is just generic about a brand, it may or may not be in my sample. In my sample there are a collection of multinational corporation brands as well as domestic brands, and I have brands from the renowned brand category all the way to the small brand level. What was interesting was that at the time I started collecting my samples, some of the brands started with similar price and quality level in their products. And after the natural experiment, which associated with the sudden surge of counterfeiting, the brands that were infringed by counterfeiting witnessed a sudden jump in quality and price, as compared to the brands that were not infringed by counterfeiting. So we clearly see these 4-P effects for the treatment group as compared to the control group.

Q. In terms of brands and, particularly luxury brands, what are some of the typical reactions that you see? Louis Vuitton faced this problem in China and in reaction, they opened more stores. The logic was that people are buying fakes because probably they can’t get the real thing. Is that a good thing, or should they really be going after these small guys?
A. It’s analogous to the government’s question of what is the optimal level of public enforcement? Which sectors to protect more? Which sectors to protect less? The companies also face the question of how to optimize the internal enforcement against counterfeits of their own. And the question lies in whether the benefit of tracking all counterfeits outweighs the costs of tracking down all of them, which could be insurmountable in some cases. My research actually helped address some of these questions. In my new research that is forthcoming in Management Science, I look at the double-edged sword effect of counterfeiting and I titled it ‘Counterfeiters: Foes or Friends?’ because I found in the end that counterfeiters can be both foes and friends. I analyze the product line level data of a panel of brands operating in China and I again look at what happens to the sales of different product line levels after the counterfeits enter. I also probed deeper into the heterogeneous effect across product lines within each brand. And then pulled this across the whole sample of brands.

The end result points to the fact that counterfeits could have a positive effect on sales of the high-end products and a negative effect for the low-end products in the same brand. And this is analyzing the different product line sales for the same brand, and finally getting the average effect, pulling across all the brands in the sample. And I have a theory model that tries to generalize the findings and the rationale is that when counterfeits enter it could actually increase brand awareness.

This is especially true for emerging markets where brands are starting to gain popularity or where consumers still don’t have very much knowledge about brands, especially multinational brands. A metric they often look at is how many people wear the brand. So the more brands they see on the street being worn, the more popularity they infer. The opposite effect is the common-sense business stealing effect. You have a close substitute, which tries to imitate your appearance and quality, so it steals business from you. The net effect really depends on the interplay of these two countervailing effects. The fact that (at) the high-end (counterfeits) are less of a substitute helps in the end because the advertisement effect outweighs the substitution effect. For the lower-end products, the business stealing effect outweighs the advertisement effect, resulting in a net negative effect.

I further conducted lab experiments to probe into how consumers think about this issue, how they react to exposure to counterfeiting. In the lab I randomly assigned the exposure to counterfeit to two groups. I found an analogous, heterogeneous effect—the purchasing intent for the authentic shoe stimuli increased when they were exposed to counterfeit. The purchasing intent for the lower-end authentic shoe declined when these subjects were exposed to counterfeits as compared to the control group who didn’t get exposed to counterfeits.

I also asked these subjects to state their motivation behind their purchasing intent ratings. And a very common quote was that ‘the fact that the brand was counterfeited implies that it must be popular, so it has followers.’ This research provides solid, empirical evidence based on field data and lab experiments. It shed light on how brands could prioritize the enforcement. So it seems to me that brands could prioritize enforcement against counterfeits that are close substitutes to their products, so as to ameliorate the business stealing effect. But they may not need to worry too much about the other types of counterfeits that are just generally out there helping build word of mouth and brand awareness and advertising for the brand.

This is an economics approach to things, and there is also a sociology approach. Sociology research done by my colleague at MIT, Renee Gosline, found that consumers who purchased counterfeit in the first year actually followed up with purchases in more authentic products of the same brand. Her theory, based on a series of sociology theories, is called ‘omnivorism’, which means high-taste consumers want to traverse a wide quality ladder of products, so they want to possess the counterfeit of the brand as well as the high-end range of the product.

Q. Is there anything else you want to add?
A. I think the different research also speaks to policymakers in various dimensions in terms of enforcement. And one other surprising policy prescription might be to reduce income inequality. Your maid is also buying Louis Vuitton, which is likely to be a knock-off. In our lab experiments in a separate study with another colleague we found that when people are exposed to more income inequality in the region,… So for poor who live in a more unequal neighborhood, they actually have more desire to acquire a counterfeit in order to compensate for the lack of economic resources and the feeling of powerlessness than people in the more equal neighborhood. So reducing income inequality could also help to eliminate some of the demand for counterfeits.

[This article has been reproduced with permission from CKGSB Knowledge, the online research journal of the Cheung Kong Graduate School of Business (CKGSB), China's leading independent business school. For more articles on China business strategy, please visit CKGSB Knowledge.]