Decisions, Operations, and Technology Management

The legal diversion of large quantities of goods from authorized distribution channels to unauthorized or “gray market” channels has important consequences to both firms and consumers through issues such as revenue generation, price erosion, service and warranty availability and cost, and product availability. Unlike previous research, which has focused on pricing issues (e.g., the potential for gray markets to create arbitrage and customer differentiation opportunities), we consider how gray market activity is driven by the uncertainty that surrounds inventory ordering decisions. We analyze a stochastic supply chain model of a manufacturer, distributor, and retailers in which the distributer and the authorized retailer have the option of diverting inventory to a gray market and address the following: (i) How does this diversion impact the various supply chain participants? (ii) What strategies might producers use to combat or exploit gray markets? (iii) How do the retailers set their optimal order quantity in the presence of a gray market? This analysis yields new insights into gray market behavior and results that can inform management strategies and policies for confronting gray markets.