A Diversion POV

Diversion is the process of moving a genuinely branded product from its intended distribution channel to one unauthorized by the manufacturer (Figure 1). This activity, which is often referred to as the "Grey Market" results in billions of lost profits for consumer goods (CG) manufacturers. What initially began as an issue in the international trade of high-value goods, the grey markets are now also firmly rooted at the domestic retail shelf.

Products at risk include those that retain high brand recognition, strong consumer appeal, high intrinsic product value and long shelf life/relatively low perishability. Recently, diversion has become an issue with more common branded grocery products and "near-commodity" items.

The primary motivator for a retailer to engage in grey market activity is the vast price discrepancy that can exist across the marketplace creating arbitrage opportunities for retailers that can "buy low" from the manufacturer and "sell high" to other retailers that may not qualify for a low price. These price differences between retail customers can invite two possible responses -- either small retailers pool their orders through a single member and trans-ship to one another or a single retailer purchases an excessive over-supply from the manufacturer and supplies retailers that did not qualify for the volume discount or applicable promotional deals.

The presence of these grey markets and the diversion of consumer goods through unauthorized channels of distribution drive the very real destruction of economic value and brand equity for the CG industry. Negative consequences include:
Economic - The oversupply of products into the market at disproportionately low prices creates lost revenue opportunities at higher prices for the CG company.
Strategic - The presence of brands in unauthorized outlets, channels with little control over merchandising and retail pricing guidelines creates immeasurable brand equity erosion.
Regulatory - In addition to enabling diversion, ineffective administration of pricing can also lead to serious violations of anti-trust laws such as Robinson Patman. The same lack of clarity in dead net-pricing that drives diversion potential is a ticking time-bomb of regulatory exposure.
Relational - the retailers who do not engage in grey market trade face the troubling fact that they are buying at high prices and that lower prices indeed have existed across other retailers or distributors. This revelation damages the relationship between retailer and supplier.

While all the aforementioned consequences have tangible economic costs, the largest benefit to the CG company is addressing the lost revenue opportunity due to price differentials. While it is difficult to estimate the magnitude of the diversion problem, Deloitte Consulting LLP's experience suggests that lost sales revenue due to diversion increases exponentially as the spread of price differential expands beyond the cost involved with transporting diverted goods across markets.

Root Causes

While many companies view themselves as victims of channel partners engaging in rogue grey market activity, the irony of the situation is that many of the root causes of diversion lie within. The vast majority of the drivers enabling grey market activity are the company's own controllable internal business practices, including:
Price and Promotion
Distribution Control and Special Markets
Supply Chain Performance and Policies
Organization Incentives

Tackling the Issue

The diversion issue is a complex one. When addressing the problem, CG companies must learn to walk before they can run. Deloitte Consulting recommends a three-phased approach for tackling the issue.

[1] The "Diagnose and Analyze" phase of the program focuses on getting at the heart of the diversion issue through detailed analysis of trade programs, pricing discrepancies, trade flows and sales force incentives.

[2] The "Short Term Fixes" phase of the program begins to address the specific diversion issues identified during the analysis stage, as well as pilot new operations and control systems that will be used to track diversion activity and minimize its occurrence.

[3] The third phase focuses on creating sustainable "Long-Term Solutions" that can be run in conjunction with developing short term fixes to gain synergies between the two efforts.

Diversion is a symptom of a much broader and strategic failure in the CG industry. The rampant disregard for pricing and promotional disciplines has given way to retailers exploiting the inefficiencies and arbitrage opportunities created therein. The consequences of not controlling and addressing the problem of diversion are simply too great to ignore. While the industry continues to struggle to find profitable growth opportunities, diversion and the lost sales opportunities it drives can simply not be left unchecked.

For more information and a copy of the full report, please visit the Consumer Business section of Deloitte Consulting's Web site at www.deloitte.com/us/cb.