Product Diversion: What Is It and How Is It Identified and Managed?

Pro QC has noted a significant increase in interest related to product diversion assessments and programs. For this quarterly newsletter, we wanted to take a moment and discuss what product diversion is, how it works, the related impacts, and a few suggestions for avoiding and managing.

What Is Product Diversion?

"Product diversion" (which is also sometimes referred to as "gray market" or "parallel distribution") severely disrupts the channels of distribution established and supported by manufacturers and authorized distributors. Because the products usually cannot be obtained outside of the authorized distribution channels through any legitimate means, diverted products are often acquired by deception and fraud."

Source: Conkle, Kremer & Engel Law Corporation

How Does Product Diversion Happen?

Historically connected to the salon industry, product diversion occurs across a variety of products and industries. Three common scenarios are noted below:

* A supplier is approached by a customer who is looking to place a volume order, often for export but perhaps domestically in a nontraditional channel. The customer is usually willing to prepay but at a lower price from you as they are purchasing truckload quantities and often will handle pickup and logistics. Typically, diverted products are then sold in unauthorized sales channels at prices that are not in line with those of your authorized channels. Such a scenario presents clear risks to your relationship with loyal customers, notes one supplier.

* A distributor, wholesaler, or retailer over-purchases an item to get a better volume discount. When they fail to sell everything, they sell off the extra inventory to a third party without the manufacturer's consent.

* A buyer orders merchandise purportedly for sale in a foreign country, and loads it on to a ship that sets sail for an intended destination. When either some or all the product comes back to U.S., it is resold at a lower price. Packages and shipping documents are often marked "returned goods, manufactured in the U.S." (a statement that is technically true) to help the diverter evade customs or related fees, says another producer.

Source: Nicole Potenza Denis (Specialty Food News 3/13/2014)

What Is the Impact of Product Diversion?

Lost margins are the initial thought and usually on the forefront of concern.

Brand value is impacted.

Relationships with customers and suppliers are affected negatively.

Diversion creates issues with traceability, such as in the event of a recall.

Retailers and stores are noted as being affected, in relation to the impact on sales and likely quality issues.

The inability to control what is being sold in the marketplace is another consideration with possible detrimental impact to consumers. The possibility exists for products sold in this way can be expired, tampered with or otherwise contaminated.

How Is Product Diversion Managed?

Product diversion is managed in a number of ways.

A common solution is to employ tracing and tracking to identify the distribution of products and have the ability to identify when diversion occurs. Legal costs are often incurred once the diversion is identified.

Many companies invest in the development of a product diversion policy that assists in legal protection when signed agreements are in place across the supply chain. Agreements can be used as a stand-alone protective effort, or in combination with an on-site program.

An additional measure to control product diversion includes an on-site evaluation program. With this, a one day on-site surveillance is recommended annually at each supplier site. This includes an evaluation of a prevention system including one or more of the major points below:

* Anti-diversion policy
* Selection of buyer / seller / distributor
* Non-diversion agreement
* Control of authorized buyer / seller / distributor
* Control of unauthorized seller

Product diversion components can be added to custom evaluations that incorporate other issues such as social responsibility, security, etc.

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