Why does parallel trading occur?

37. Parallel and grey traders take advantage of cheaper prices in one country to make a profit by selling these goods in another country where they are generally sold at higher prices. CIPA told us that in their view, grey and parallel trading derives from decisions taken by brand owners as to where and how they sell. "Where differential pricing of standard stock is encouraged by brand owners, grey and parallel trading will occur."[89] There are a number of other possible reasons for the same goods being priced differently in different markets such as: exchange rates; brand owners wishing to offload surplus stock; brand owners producing additional goods in order to boost sales figures; differences in handling and promotion costs. Differences in product quality or composition may lead to price differences. The extent to which factors other than price facilitate grey and parallel trade, inevitably varies from case to case.

38. It was also pointed out that "much parallel trading stems from bad husbandry on the part of the brand owners":[90] for example, careless dumping of old or outdated stock or inefficient distribution channels. Apparently legitimate branded stock may be available cheaply from factory over-runs in the country of manufacture, facilitated by an absence of control by brand holders over licensees and contracted manufacturers. Philippa Clare of Rishworth Chase told us that "the brand owners in my opinion give far too much information to one particular manufacturer and have a level of trust in that manufacturer which is at one level endearing but at another level extremely irritating".[91] A finished garment can be produced from start to finish in just one factory. She quoted one case where a brand holder even gave a factory owner "the plates to make the swing tags and the specification for the string".[92]

Motor cars and Motorbikes

EFFECTS OF GREY IMPORTS

39. We have received both written and oral evidence from the car and motorbike official distributors, from grey traders importing vehicles, and from the manufacturers. Our inquiry has focussed on the new car and motorbike market and on those cars that are grey imports, that is, those that are sourced from outside the European Economic Area. The Society of Motor Manufacturers and Traders (SMMT) support the principle of trade mark protection and only EU-wide exhaustion of rights as upheld in the Silhouette case. They maintain it gives a balance between "the protection and recognition of manufacturers' brands developed over a number of years through inward investment and innovation: the brand also ensures that there is a significant residual value" and the "availability of consumer choice whereby consumers can purchase vehicles from manufacturers official dealers in any EU member state".[93] The SMMT also state that if international exhaustion is permitted then "manufacturers would select the cheapest site for manufacturing, along with the standards required by the selected country, in many instances falling below the standards currently required by EU law".[94]

40. There are a substantial number of companies importing both grey cars and motorbikes into the UK, largely because of the high price differentials.[95] As a consequence, prices have been reduced for both cars and motorbikes (particularly the latter). In their evidence, the British Independent Motor Trade Association (BIMTA) state that their members "typically offer new and used cars at prices up to 34% cheaper than franchised dealers".[96] The Association of Parallel Importers (API) show figures that indicate that grey importers have offered "dramatic discounts" on motorbikes resulting in the official importers dropping their list prices.[97] Consumers' Association noted that "the growth in parallel trade in motorbikes has squarely knocked on the head the claims of trade mark owners that their restrictive practices are in the interests of the consumer".[98] The increasing grey trade has even led to the establishment of a magazine, GreyBike, for those who own or want to buy grey bikes.

SOURCE OF IMPORTS

41. Mr Tay of the API told us that some of the Japanese motorbike manufacturers deliberately oversupply products into the UK that are designed for the UK market and badged as such.[99] Mr Neesan of the API went on to tell us that some manufacturers supply thousands of UK-specification motorbikes to countries where there is no real market for them indicating, in the API's view, the manufacturers 'implied' consent to grey trading.[100] The API state that despite the fact that Honda have initiated legal action against grey traders they still have no problems getting supplies. "Each bike is individually identifiable, they [the manufacturers] know exactly what course or trade of supply it has gone through. If there was a real will on their part, without any legal litigation, they could stop this trade within a few weeks".[101] Mr Dane of BIMTA agreed that manufacturers could stop the supply of new cars and motorbikes straight away if there was a will to do it. "The fact is that all the time you see cars coming in from outside the EU there is a will from a manufacturer somewhere to make those available."[102] He quoted the example of Mercedes Benz: "if you saw the number of Mercedes Benz that we have bought that should be in Barbados, every person in Barbados would be running a sports Mercedes, they are patently not but Mercedes Benz want to keep up a service, presumably, a service presence in Barbados and other countries like that for use by diplomats, UN people, a small local market, buses, trucks etc, so they turn a blind eye to some product which was destined for that market going to places like the UK".[103]

42. Both the car and motorbike grey traders state that official dealers are also selling grey imports. Indeed we were told: "For years they [official dealers] have sold these bikes at full list price being parallel imported".[104] Mr Dane of BIMTA told us "there are plenty of franchised car dealers in the UK now who are selling cars that they have bought on the parallel or grey market".[105] From the evidence we have received, car and motorbike manufacturers are both supplying the grey market and decrying grey trading, presumably at the prompting of their official dealer network.

INSURANCE

43. The SMMT stated in their evidence that insurance costs for grey cars were higher due to reduced security and higher repair costs. They also noted that these vehicles might not be correctly insured either because the insurer did not know that the vehicle was non-EU specification or because the vehicle had been re-branded. [106] The RAC stated that "many insurers are charging higher premiums for such [grey] vehicles".[107] Mr Dane of BIMTA told the Committee that last year there were some cases of customers finding it difficult to get insurance for grey cars. In his opinion, "there were moves with some of the big insurance companies who may well have been influenced by other people to make it difficult to get insurance on parallel imports".[108] However, BIMTA believe that this is less of a problem now than 12 months ago.

WARRANTIES

44. The SMMT noted in their evidence that warranty and service records for grey imports were "either limited or non-existent".[109] The RAC stated that "the difficulty in sourcing spare parts may also require policy limitations on warranties for certain vehicles".[110] In oral evidence the API and BIMTA told us that they both offer at least one year's warranty. BIMTA told us that "we ask our members as part of their code of conduct not to offer anything less on an imported vehicle in the terms of warranty than they would on a vehicle they have sourced in the UK. For most of them that means in practice that they are offering one year's warranty. With some of them it is up to three years."[111] The API also told us they would honour any outstanding warranty if an API member went out of business.[112] Mr Pulham of the National Franchised Dealers Association remarked that the UK tended to have longer warranties than other European countries and that "if you are going and buying a car in France and taking advantage of the opportunity that will give you on price you may have to take the disadvantage that that market gives you on warranty". He went on to state "generally the better brands in this country have now said that they will honour the warranty to a UK standard, so if you buy a one year BMW in France and bring it to the UK the BMW organisation in the UK will now support it for three years as they will for a UK sourced vehicle."[113] With grey imports, Mr Macgowan of the Retail Motor Industry Federation (RMIF) said "I would not suggest anyone is bringing cars in and not giving a warranty" but "the problem arises perhaps with the used vehicle that comes through on some occasions through what I would suggest are more spurious channels and are sold as seen and there is no warranty".[114] He went on to confirm that RMIF members would respect the warranties associated with grey imports.

SERVICING

45. We were supplied with largely anecdotal evidence of time delays and some evidence of extra costs for servicing of grey cars.[115] The RAC told us that their patrols did not have access to technical repair information for grey imports and "they may not be able to read the vehicle's onboard diagnostics or be able to source replacement parts".[116] The Association of Parallel Importers deny that the problems pointed out by the Motorcycle Industry Association of lack of availability of spare parts and problems with recalls and manuals only available in Japanese,[117] exist to any significant degree. They stated that there were no problems with servicing grey bikes although there are "some instances" when manuals and handbooks come in foreign languages, "it is not a major problem at all. We can just get English replacements if necessary".[118] The Motorcycle Industry Association expressed concerns over the assembly of grey motorbikes that arrive in crates and need to be assembled.[119] The RMIF initially concurred with the grey importers that the issue had been exaggerated but subsequently added that they strongly supported the "provision of such assembly manuals for the proper assembly of high performance motorcycles by factory-trained dealer technicians".[120] The API told us "the biggest problem we have is if we ask for people to go on training courses and that sort of thing they [the manufacturers] will not respond. We have sent to every manufacturer a request to send people on training courses and not one has even given us the courtesy of a reply to say no".[121] Although we accept that there are bound to be areas of conflict between manufacturers and grey importers, we would be most concerned if these lead to problems in servicing which could ultimately endanger not only owners and grey importers but others as well.

SPECIFICATIONS

46. In the case of motorbikes, the Association of Parallel Importers told us that "the bikes in many cases are absolutely identical. There is not a single difference whatsoever".[122] The Retail Motor Industry Federation told us that in the case of some cars, there can be "as many as twenty different variants between the grey import and that which is routinely sold in the UK".[123] They concede that "we do not think any of these differences singly are particularly important. We certainly do not think that any of them are likely to be safety issues".[124] Cars that are produced for the EU market have to meet the European Whole Vehicle Type Approval (ECWVTA), introduced in 1993. Cars made outside of the EU do not have to meet this standard but are tested via the Single Vehicle Approval (SVA) scheme. The SVA currently limits the number of cars allowed in under the scheme to 50 models per year and no more than 100 per model over five years. The RMIF make the point that "if there is a standard in Europe we find it disappointing that that standard seems to be swept to one side and vehicles that do not comply are welcomed in despite the fact that there is a standard".[125] Differences submitted in evidence include seatbelt anchorage points not complying or the absence of a cold start system.[126] There is also the question of speedometers that register in kilometres per hour and odometers that register kilometres. The RMIF note that "removing the speedometer and odometer and replacing it with a new unit clearly introduces the problem of accurate mileage".[127] The SMMT state in evidence that "there are significant technical differences between vehicles with ECWVTA and those purchased on the grey market".[128] We welcome the Government's announcement that it is lifting the limit on the number of cars that can be brought in to the UK via the Single Vehicle Approval (SVA) scheme.[129] The Government also announced the "introduction of stronger technical standards for key environmental, safety and security items". We trust that this will go some way to dealing with the issue of the differences in specification. So long as the grey imports can meet common safety, environmental and security standards there seems to be no overwhelming reason why any differences in specification, in themselves, should be a reason for preventing consumers from choosing to purchase these cars. The Minister told us in oral evidence "It would be very interesting to see the Department of Transport's results in terms of the examination of vehicles which it has allowed in up to now to see if there are big differentials in terms of vehicle safety".[130] We recommend that an assessment of this information is made publicly available in order to clarify where the main safety problems arise and to address the manufacturers' legitimate concerns over grey importers carrying out all the necessary safety work.

CONSUMERS

47. The Motorcycle Industry Association noted that there was a "significant risk of disillusion with brands" if the customer's expectations are not met by the grey import.[131] Whilst we agree with this statement, we have seen no evidence of consumers being disillusioned after a purchase of a grey motorbike. Indeed, we have received a number of letters from motorbike owning members of the public, all of which were in favour of grey imports. The British Motorcyclists Federation, representing the interests of the UK's motorcyclists, stated that they were in favour of international exhaustion and that the effect of new and used machines coming in through unofficial channels had been "both to provide purchasers of motorcycles with better choice and to force down the prices of officially imported motorcycles".[132]

AWARENESS

48. We do have some concerns over grey imports coming into the UK and consumers being unaware of the differences. The RAC noted that "evidence suggests that many consumers are unaware they are buying vehicles of non-EU specification".[133] They go on to state that "our own experience, via our members, reveals that many grey imports are often sold as vehicles meeting EU specification. Many grey imports are actually badged as EU specification."[134] BIMTA told us in oral evidence that they are "adamant with our members and stamped on it hard that if it is a Pajero when it comes to them, it stays a Pajero, it does not become a Shogun".[135] There may however be some less scrupulous operators around who conceal the origins of the products they sell. The RMIF suggest that any grey import car should be labelled as such and a grey import tag should be clearly added to registration documents and held on files at the DVLA.[136] This would enable all future purchasers of the car or motorbike to be made aware that they are buying a grey import. We would agree that such information would help consumers and recommend that the Government consider the feasibility of implementing a labelling scheme for vehicles other than personal imports. Any label should indicate that as a result of buying a grey import vehicle, there is the possibility of some problems in servicing. We also recommend that the Government considers running a consumer awareness campaign in order to ensure that consumers are fully informed of the existence of grey imports and are aware of the consequences of buying a grey imported vehicle. We are of the opinion that if consumers are aware of the fact that they are purchasing a grey import car or motorbike and that there may be some unforeseen consequences, then it is up to individual consumers to weigh up the pros and cons of purchasing these vehicles.

Clothing and footwear

49. Trade marks are the primary vehicle for the advertising and branding of broadly similar clothes and footwear from competing manufacturers. Supermarkets, primarily Tesco and Asda, have advertised unauthorised sales of 'designer' clothes for some time; Tesco is currently facing legal action initiated by Levi for selling such imports. We received evidence from Tesco and Asda, from a clothing warehouse, from traders involved in importing clothing, and from a company that traces consignments of grey goods, mainly clothing and footwear. We also received evidence from the British Brands Group who, although they mainly represent other sectors than clothing, do count Levi Strauss amongst their members. The DTI told us "across the sector prices are moderately higher in the European Community as compared with the USA, although prices in Japan are slightly higher than Europe".[137] Other commentators would describe the price differentials between the EU and USA as substantial.[138] As a consequence, prior to the Silhouette judgment, the majority of branded clothes sold in the UK outside official channels were sourced from America.

SELECTIVE AGREEMENTS

  50. The question of selective agreements arose during this inquiry in the context of retailers attempting to sell certain brands of clothing, footwear and other branded goods as an authorised retailer and, on failing to do so, turning to grey and parallel importing.[139] In this sense, the operation of selective distribution networks is another reason for the existence of parallel trading. Selective distribution arrangements are those where the brand owner chooses distributors for their goods on the basis of "objective criteria necessary for the efficient distribution of the goods in question. Selected distributors normally provide some pre or after-sales services and may only sell to final consumers or other selected dealers".[140] Levi Strauss noted that "LSUK applies its criteria for potential new retail accounts consistently and objectively and if these are met will supply any retail applicant".[141] The British Brands Group told us that selective distribution agreements are "all fundamentally part of the brand" and that these agreements mean that certain requirements have to be met in order for that brand to be stocked through those distributors. "Typically they could be to do with the range of stocks that are sold in store, the environment, the refund policy to consumers."[142] Mr Noble told us that "these agreements allow these brands to compete in a ferociously competitive market place." He went on to say: "If you did not have the opportunity to influence the service that is provided to the consumer at the retail level there is an opportunity to actually reduce the number of brands in the market place which would actually reduce competition and reduce consumer choice at the end of the day".[143] A paper supplied to the Committee set out Levi's distribution policy stating that their network of 1,900 authorised dealers: "enables people to choose from a good range of current styles, sizes, fits, fabrics and colours; ensures consumers are served by trained staff with effective after-sales service; guards against counterfeits; provides continuity of supply".[144]

  51. Tesco told us that they had approached branded clothing and footwear manufacturers such as Calvin Klein, Levi, Lacoste, Nike and Polo Ralph Lauren for 'approved status', that is to become official retailers. Largely they were refused "often without being made aware of what the criteria are and how we have scored against them".[145] Levi told the Committee that they had written to Tesco setting out the reasons for their refusal to supply them and supplied Tesco with guidance on how to satisfy the requirements for entry into the selective distribution system operated by Levi Strauss.[146] Asda told us that products they had wished to sell include "perfumes, cosmetics, sunglasses, watches, ties",[147] and that "without exception brand owners or their authorised intermediaries have refused Asda's requests for supplies of such products" mainly on the grounds that "Asda is not a suitable outlet".[148] Tesco told us that "despite our efforts, brand owners, including sportswear brands such as Nike, base their refusal to supply on concerns about the ability of Tesco to offer technical support. However, they are prepared to supply to retailers that sell through mail order and are unable to offer the consumer any technical support whatsoever".[149] It was as a result of these refusals - which in effect excludes them from the standard channels of distribution - that Tesco and Asda began grey importing of certain 'designer' goods. Indeed, it is not just supermarkets who are in this situation. Costco, the membership warehouse club, have also been refused supplies by UK manufacturers of premium branded goods and are, as a consequence, heavily dependent on parallel or grey imports for a range of products including apparel and shoes.[150]

52. Tesco also quoted as a reason given to them for non-supply the "necessity for customers to pass by other goods such as food".[151] Consumers' Association noted that: "If this condition were applied across the board, then Selfridges and Harrods should be refused supply because they have food halls".[152] Another reason given by some brands for refusing to supply retailers such as Tesco and Asda was based on the premise that their sales area is inconsistent with the brands' image. The Parallel Traders Association describe the current situation as one in which "manufacturers' selective and anti-competitive distribution networks and the artificially high prices set, are protected by the [Trade Marks] Directive".[153] Tesco concur, stating that "the effect of selective distribution and trade mark law as interpreted by the European court are detrimental to consumers. Prices are kept artificially high, suppliers controlled and competition stifled".[154]

  53. Tesco told us that in the electrical market they started off parallel trading and now deal direct with the manufacturers.[155] Quoting the example of Fujitsu, Tesco now have staff trained in store by Fujitsu, they provide a helpline and replacement and home repair warranties. In a high technological sector such as electrical goods where selective distribution networks would be more important in terms of back-up, training and consumer guarantees, parallel trading has actually led to a supermarket becoming a direct supplier. It is not, therefore, the case that selective distribution networks are always an obstacle to multiple retailers.

PRICING

54. Price differentials in branded clothing can be substantial. The Committee received various examples of clothing or footwear that appears to have been priced at a higher level in the UK for no justifiable reason. For example, Ms Cross of Tesco told us that "yesterday we were offered UK produced Levi jeans from the States which had been originally put on sale in the States at a lower price than I can buy American Levi Jeans in the States".[156] Costco noted in their submission that, "it is well recognised that many brand owners pressurise their authorised dealers to resell products at artificially high prices".[157] We have seen little or no evidence that the selective distribution networks, in a relatively low service and technological sector such as clothing, work in the favour of consumers. Such networks serve as much to maintain high prices as they do to carry out the legitimate function of preserving the brands image. Under EU law such agreements must be objectively justifiable; we would be surprised if some of those agreements described to us would pass this test. We recommend that the Government actively encourage the Commission to instigate studies into the realities of the operation of selective distribution agreements.

BRAND OWNERS' CONSENT

55. Set against the cases where brand owners have refused to supply their products to supermarkets, are cases where brand owners have allowed their goods to be imported through 'grey' channels. Asda notes in their submission that they understand that "as much as 30-40% of Calvin Klein's turnover is generated through sales to companies outside the authorised reseller network".[158] Rishworth Chase, a trading company that specialises in tracing consignments of grey goods (particularly clothes) to ensure their authenticity, gave some examples of occasions where brand owners have given implicit if not explicit consent for their goods to be imported unofficially into the UK from outside of the EEA. Phillipa Clare told us that: "I know of instances where large consignments of well-know brands are sold in the United States with a representative of the brand holder.. present at the meeting who simply says nothing but knows perfectly well that those goods are coming into the European Union."[159] Rishworth Chase also stated that "many brands have been built in Europe through the 'parallel' market: Tommy Hilfiger is one example; FUBU is presently another label which is strategically releasing goods into the parallel market whilst holding off investment in an effective European distribution network". There are also brands, such as Chaps Ralph Lauren, that never set up European networks but "bring their product into Europe entirely under the wing of parallel traders".[160] In Rishworth Chase's opinion, the Silhouette case has resulted in European brands shipping their excess stock out to America. Traders stock houses are "getting container loads of Armani jeans, container loads of Prada bags and sunglasses galore and are calling us [Rishworth Chase] on a regular basis saying 'Why can we not bring this back into the European Union? It is European stock surely'" and the answer is no, because these stock houses are the first recipients of the stock and their contracts are likely to have a prohibition on reselling to the EU.[161] It is also worth noting, as Consumers' Association pointed out, that "the existence of product discounters like TK Maxx in the USA and UK, attests to the fact that manufacturers often wish to off-load stock, at a discount, that has not sold very well through official distributors".[162] This benefits the brand owner who is able to dispose of older or poorly performing stock and benefits consumers who are able to purchase certain branded goods at lower prices. It may not, of course, be welcome to the formally appointed distributors. We can only conclude that a number of clothing and footwear manufacturers at the very least connive in the supply of goods to the grey sector while naturally preferring to retain the option of using trade mark rights to halt it.

Perfumes and toiletries

56. The situation with perfume and toiletries is very similar to that in clothing and footwear. There is a relatively high level of parallel and grey importation. Mr Frenkel of the Parallel Traders Association told us that parallel trading of cosmetics is responsible for about 13% of the global market share.[163] Many brand owners operate selective distribution systems; Tesco told us that some brand owners (such as Clarins, Christian Dior, Givenchy, and Van Cleef & Arpels) had refused to supply them. However, A&G Ltd, a wholesaler involved in parallel trading, told us "some brand owners will supply large volumes of current product to traders dealing in the grey market on the basis that the parallel dealers will not disclose this to the authorised dealers".[164] Some brand owners also supply large volumes of current product to authorised distributors despite the small size of that outlet— for example, a small dealer may be supplied with 1,000 bottles of perfume, even though his/her turnover clearly indicates that they cannot possibly sell more than 100.[165] This implies either the unlikely scenario that manufacturers' are unaware of their distributors' sales levels, or that they are happy to supply the grey market. Mr Keep told us that grey importers also source from brand agents or representatives for various countries and that, whilst he had no evidence "generally in the industry it has been recognised that anything between 20 and 25 per cent of global sales in fragrances end up in the grey market".[166] Some brand owners also "directly supply known traders in the grey market in order to achieve sales quotas" with the obvious benefit that they dispose of far greater volumes than they would sell through only the authorised channels.[167]

57. As Mr Keep put it "hypocrisy always comes to mind because we know that they do not play the same rules on both sides..We currently have an issue with a brand and yet we know that this product is still available to us in out-and-out quantities".[168] This is one of the examples the parallel and grey traders gave us of the difficulties they face working within the constraints of the Silhouette judgment. Mr Mehta of Shaneel Enterprises told us "it is a nightmare to trade nowadays".[169] In their general experience, post-Silhouette, there is no consistency: "some consignments can be sold without interference, others may be the subject of an action".[170] Shaneel Enterprises are currently involved in four actions taken by French perfume houses. It is interesting to note that the goods in question were seized as they crossed French territory whilst in transit, apparently destined for customers outside the EEA.[171]

PRICING

58. Mr Doody of Direct Cosmetics Ltd and a member of the Parallel Traders Association (many of whose members deal with cosmetics, perfumes and toiletries) told us that in the area of perfumes and toiletries, many parallel imported goods are produced in the EEA before being distributed both inside and outside of the EEA. He gave the examples of Yves St. Laurent Jazz aftershave costing £11 in the UK wholesale and $8 wholesale in the US, and Parfums Balmain costing £9 UK wholesale and $4 US wholesale, yet both the Jazz and Balmain were "manufactured in France and sold, at a profit, before coming on sale in the UK and USA at vastly different prices".[172] The reason behind the price differentials was given as "exploitation of our market to charge the highest prices possible".[173] The DTI noted in evidence that "consumers should benefit from lower retail prices for such products with little direct effect on manufacturers since ex-works prices in countries of export are similar".[174] The DTI also note that these price reductions arise by avoiding the cost of retailing in traditional 'luxury' outlets and selling through more 'down-market' and non-specialist retailers and "it can be argued that this will damage the competitive edge of the sector, that of its luxury image".[175] The Parallel Traders Association (PTA) deny that the grey imports are sold in a more perfunctory manner in outlets with lower costs and point to the existence of the large retailers selling grey imports.[176]

Soft drinks

59. The British Soft Drinks Association (BSDA) noted that the issue of parallel importing affecting various food and drinks products has been around for some time. However, in 1998 the BSDA began to receive a substantial number of enquiries concerning foreign labelled products. The 1996 Food Labelling Regulations stipulate that the label must be 'in a language easily understood by the consumer'. Products were, and continue to be, drawn to the BSDA's attention that do not contain English labelling alongside another language.[177] The BSDA noted in their evidence that drinks produced outside the EU may not meet the compositional standards set out under EU Directives and UK regulations as they were not originally intended for sale in these markets. There may also be safety and health concerns if the ingredients list is not in English.

60. The issue of materially different goods was also drawn to our attention in relation to the drinks sector where products made for different markets may have a different composition or taste. For example, the Chartered Institute of Patent Agents told the Committee that the formulation of Coca-Cola varies in sweetness content from country to country and that the Coke that can be bought in Prêt-à-Manger is French and tastes slightly different.[178] The recent warnings given to consumers to check labels on Coca-Cola cans in order to avoid cans from Belgium and Luxembourg following contaminated supplies in certain factories, highlights the importance of clear and easily understood labelling and origin marking.[179] In the case of food and drink it is particularly important that consumers are fully aware of any differences in the contents of similarly branded food and drink products where these have not been produced for the UK market, and that they are clearly marked in English as such.

Music

61. In the music industry, by far the most important intellectual property right is copyright. Nonetheless, the well-known existence of substantial price differentials across the global markets, notably in CDs,[180] means that a fair amount of parallel trade occurs. The issue of international exhaustion of trade mark rights is therefore of some importance for the music industry where the brand and the design are key selling points as well as the musical content. The British Phonographic Industry (BPI) noted that the recording industry is a particularly high-risk industry. "The level of investment required is extremely high and there is a good deal of uncertainty in the expected return. On average, only 1 in 10 recordings are successful".[181] The structure of the music industry is such that, particularly for UK independent companies (as opposed to the five major global companies with operations in markets throughout the world) recordings are either licensed to unrelated companies in each export market or the finished product is exported through unrelated distributors.[182] If the exports are licensed, the company only receives the royalty income and does not have any control over the selling price. Mr Mills of Beggars' Banquet told us "my Russian licensee is telling me that if it is going to be able to sell my CDs at all it has to price them at $6. I can think: is that a discount I can live with? Would I rather develop my Russian market and would I be happy to have those sales rather than not have them?"[183] Beggars Banquet state that "overseas sales allow independents to survive- no copyright creator can break even out of the UK market" and that "sub-licensed overseas products being imported at the expense of normal margin UK sales would put them out of business".[184]

THE INTERNET

62. It is widely expected that the distribution of musical recordings on-line via the Internet will become increasingly common over the next few years. The BPI noted in their evidence that when dealing with this sort of distribution, it is much easier to use the trade mark law than copyright law. To proceed successfully in relation to copyright infringement on parallel importation over the Internet, it is necessary to show that the importer is not the consumer, who has a defence because s/he is not importing in the course of a business. The same is not true in relation to trade marks.[185] Mr Mills told us that "the Internet is going to have the effect of levelling global prices".[186] He went on to say that it is likely that within five years, all prices will be "within 10% either way of American prices". There is also the issue of digital sales and sales by non-physical means which are likely to have a different price structure. Mr Deacon agreed and noted "in the longer term with digital diffusion and music being fed, as it were, down the Net, we are going to find probably that many things will even out in the longer term".[187]

PRICES

63. Regarding prices for pre-recorded music, the BPI told us that "in America there is a much lower range of mid-price and budget range goods" than there is in the UK. The US market is structured differently to the UK and retail mark-ups are less in America. The NERA report concluded that prices are somewhat higher in many EU countries than in the USA, although the difference, after taking account of sales taxes is moderate and not necessarily due to the absence of parallel imports.[188] In 1994 the Monopolies and Mergers Commission (MMC) reported on the supply of recorded music and found that the real price differentials "were considerably lower than is often supposed". The MMC also found that removing the right of copyright owners to control parallel imports was unlikely to lead to a reduction in the price of recorded music generally.[189] However, as parallel and grey importers exist primarily because price differentials exist, the fear that international exhaustion would have a substantial impact on the UK music industry indicates that there may indeed be quite substantial price differences outside the EU.

PARALLEL IMPORTS

64. In terms of parallel imports, one distinction that was made by the BPI was that whilst the term parallel import implies that a product is being imported "in parallel", this is not always the case in the record industry. If a recording has been licensed to and manufactured by different companies in different countries, then the parallel import "may be an identical product to the domestically produced product but there is no original export transaction".[190] The record industry are unhappy about parallel trade and very clear on their opposition to grey trade. EMI's evidence states that in its opinion, any form of international exhaustion "would be disastrous for its business. Legitimate and pirate product would flow into the EEA (including the UK) unchecked from countries with poor intellectual property protection and relatively weak currencies".[191] "To withdraw protection through the application of international exhaustion will have devastating economic consequences" and would lead to damaged profits and reduced investment by record companies in their European business.[192] Further consequences would be: job losses in the music industry in the UK; reduction of tax revenues in the UK; reduction of investment in and export of UK musical culture.[193] British Music Rights stated that: "if wholesale parallel imports were permitted and those parallel imports were sourced from countries which do not observe international conventions on copyright, returns to publishers and creators would fall as more music was sourced/licensed through non-royalty paying countries".[194] The International Federation of the Phonographic Industry noted that parallel importers focus their business on the top selling hits and if local record companies are denied access to the profits from their top selling acts, their ability to invest in new local talent will be undermined.[195]

65. The BPI told us that they were not aware of companies ever "encouraging parallel imports when it suits us and discouraging parallel imports when it does not suit us".[196] The Committee did, however, receive some evidence that parallel trade is relied upon by the record companies to sell large quantities of their stock, and that product is sold to parallel traders by companies in the full knowledge of where that product will be sold on to.[197] We were told that, as with other sectors, there is an inconsistency between the record industry's public protestations against parallel trade and their real willingness to use the parallel market when it suits them.

66. We acknowledge that the music sector is in many ways different from those examined above. Whilst copyright is the most important intellectual property right, international exhaustion of trade mark rights may have a damaging effect on UK copyright industries.

Pharmaceuticals

67. In this inquiry, we have looked solely at prescription-only drugs since the majority of the parallel trade activity is in this area. Levels of parallel trade have increased in recent years; the number of UK prescriptions filled with a parallel imported product has risen from one in ten in 1997 to one in eight in 1998.[198] The evidence we received focussed on parallel rather than grey importing. The Association of Pharmaceutical Importers (API) represent companies that account for almost 95% of the value of imported licensed pharmaceuticals sourced from within the EU: their members do not source from outside of the EU. The Association of the British Pharmaceutical Industry (ABPI) raised a number of concerns over both the existing parallel trade and the potential consequences of grey importing in pharmaceuticals. Trade marks are an important form of IPR for the pharmaceutical industry, particularly when a patent has expired. International exhaustion of trade marks would, in principle, enable parallel traders to import patent-expired products into the EU from other countries.

PRICING

68. A fundamental difference marks the pharmaceutical industry from other sectors we have considered; namely, that within the EU the pricing of pharmaceuticals is controlled or substantially influenced by governments. It is also worth noting that the intellectual property right of the most importance in the pharmaceutical industry is the protection offered by patents. Under the European Patent Convention, a 33patent is granted for up to twenty years,[199] but in practice (due to testing and the need for authorisation) the real term of patent protection, that is, the period between first marketing and expiry of a patent is much shorter, around eight to ten years.[200] In that time companies seek to recover their research and development costs as well as making a trading profit. In the UK the profits of pharmaceutical companies from prescription drugs are regulated through a system known as the Pharmaceutical Price Regulation Scheme (PPRS). The Government does not directly set the price of medicines in the UK - manufacturers are free to set the price of branded products but the profits are controlled under the PPRS. This is intended to allow companies to receive reasonable returns but not to abuse their position by exacting excessive profits.[201]

69. Inevitably, different EU governments set prices at different levels, taking into account to a greater or lesser degree the amount of innovation and research involved in the development of drugs. The UK system includes greater rewards for research and development than other countries. In Germany, for example, the system for reimbursement for medicines is controlled in such a way as to enforce the use of less expensive generic products or to substitute alternative products. In practice, this means that drugs are priced by reference to their lowest-priced equivalent. Prices in Spain are also particularly low.

70. Parallel imports from Spain and Portugal were banned, as a transitional measure when they joined the EU, until 1997. The transitional arrangements were seen as necessary because of a perceived absence of fully effective intellectual property protection. Glaxo Wellcome told us that "price levels in Spain and Portugal were based upon generic production costs and took no account of the R&D costs incurred by originator companies.... unfortunately the ban was lifted well before the advent of fully effective intellectual property protection in Spain and Portugal ... prices are depressed by the absence of full patent protection as well as the low-price regulatory regime operated by the Spanish Government."[202]

71. It is the scale of these discrepancies in the pricing of pharmaceuticals across the EU that has facilitated parallel importing. However, unlike other sectors where parallel trade occurs, the EU pharmaceutical market is still some way from a Single Market. In 1996 Commissioner Bangemann set up a tripartite dialogue (the European Commission, Member States and industry) to discuss the Single Market in pharmaceuticals. In November 1998 the Commission agreed a Communication which was to form the basis of a third Round Table discussion. The Communication noted that "the Single market for this sector is far from being complete".[203] The ABPI stated that parallel trade of price-controlled pharmaceuticals within the EU "distorts competition and moves Europe farther away from the Commission's stated goal of deregulation of pharmaceutical prices".[204] A European issue of this sort can only be solved at a European level. We recommend that Ministers encourage the new European Commission to continue the work of its predecessors in addressing the conflict between the need to complete the Single Market in pharmaceuticals and the desire for Member States to retain control of healthcare expenditure and pharmaceutical prices.

PARALLEL TRADE AND PATIENT INFORMATION

72. Applications to the Medicines Control Agency (MCA) for parallel licence imports increased by 18% in 1997 over the previous year. By August 1998 there were 2,726 valid parallel import licences in the UK,[205] held by 32 licence holders.[206] The MCA grants a Product Licence to import a drug after checks to ensure that the imported drug is therapeutically the same as the domestic version.[207] Only approved importers that meet certain standards will be licensed to import and distribute prescription medicines. The MCA undertake "regular visits" to ensure compliance with the terms of a licence and to ensure that all the labelling and patient information regulations are met.[208] We would hope that the additional costs to the MCA attributable to parallel importing are fully reflected in the charges to the importers for licences. The API told us that they had "no evidence to suggest that any product which is not packaged in the English language comes onto the British market".[209] The Committee, however, received evidence from the Parkinson's Disease Society of the United Kingdom that: "it was not unusual for people with Parkinson's Disease to receive medicines which were intended for non-UK markets and therefore have patient information leaflets written in another language".[210] The specific example they quoted was that of Celance (Pergolide) with the information leaflet written in Spanish.[211] The ABPI also supplied us with some examples: Zoladex, an injectable medicine for prostate cancers whereby "in translating it back from Spanish the parallel importer has got the indication and the site of injection wrong"; a lipid lowering agent called Zocor that had no leaflet at all; another with no batch number.[212] Eli Lilley noted in their evidence that "there was a recent case of a schizophrenic patient becoming non-compliant because he received a Greek product".[213] SmithKline Beecham provided evidence of non-compliant parallel imported pharmaceutical products with, for example, incorrect instructions.[214] Within the last twelve months the licensing division of the MCA received a total of 11 letters from the general public and 8 from manufacturers. "None of these deficiencies were considered to present significant safety risks".[215] Reports of defects in labelling of dispensed medicines are, however, usually dealt with by the Royal Pharmaceutical Society of Great Britain. We are concerned that there is evidence that pharmaceutical products are being prescribed to patients with incorrect or missing instructions, instructions in foreign languages or in broken sets lacking batch numbers. We urge the Government to consider how the procedures for parallel importing of pharmaceuticals can be tightened up to eliminate such problems.

RECALLS OF PARALLEL IMPORTED PHARMACEUTICALS

73. The ABPI told us of their concerns over mechanisms for batch recalls of parallel traded pharmaceuticals. "It is unclear whether adequate mechanisms are in place to adequately recall parallel trade medicines. Batch number recording is not consistently applied throughout the supply chain and in practice may make comprehensive product recall difficult, creating a risk to patient safety".[216] The MCA's figures show 76 batch recalls of medicines in the UK in a 12 month period resulting from confirmed quality defects; 8 of these concerned parallel imports.[217] No evidence has been presented to suggest that batch recalls are either more difficult or more frequent for parallel imported products.

CONSEQUENCES OF PARALLEL TRADE

74. SmithKline Beecham noted in evidence that eight of their products in the UK were subject to significant levels of parallel trade and "for three of these between 40% and 55% of prescriptions written by GPs are filled with medicines imported mainly from France and Spain." The consequence has been that "SB announced 123 UK posts redundant due to restructuring required as a result of competition from parallel trade in our products".[218] Glaxo Wellcome told us that parallel imports of their products into the UK amounted to £106 million in 1998. For four of their leading products parallel imports last year accounted for between 25% and 43% of UK sales with resulting losses of £42.3m.[219] From the view of the exporting country, the ABPI told the Committee that "there are shortages of some of our products in Spain at the moment because more of it is being exported by the wholesalers than they should do".[220] Unfortunately, despite the Committee requesting figures indicating such shortages, the ABPI were unable to supply them. It is interesting to note that it is reported that Alliance UniChem, the drug retailer and wholesaler, has hit back against parallel importers by starting its own parallel import arm.[221]

75. The API claim that "the research based industry overestimates the volume and value of the trade using unreliable data from sources which admit that the figures used are, at best, extrapolated estimates".[222] The API also listed a number of 'tactics' used by the innovative pharmaceutical industry to limit parallel imports including: making products available only in small batch sizes; supplying direct to pharmacy outlets at reduced prices; applying for licences in different strengths of drug dosage (for example, 10mg strength in Spain but 20mg in Germany); and different pack sizes.[223] Mr Barker told us that making tablets of different colours, shapes or with different packaging, was "a conscious attempt to impede the trade which they will privately admit".[224]

76. We have received conflicting accounts over the extent to which parallel trade brings financial benefits to the Government through lower wholesale prices. The ABPI referred to the 'clawback' mechanism which attempts to direct some of the profits accruing to pharmacists back to the Government, but claimed "the main beneficiaries of parallel trade in pharmaceuticals are arbitragers".[225] The clawback system is a complicated one that is designed primarily to reimburse the pharmacist at their net acquisition cost.[226] Pharmacists and dispensing doctors are reimbursed according to a UK tariff price.[227] The NHS pays them a 'headline' price (based on the list published price of the medicine) less a percentage reduction representing the average discount obtained against headline prices (calculated on the basis of discount inquiries). The headline price for proprietary products is set by the manufacturer.[228] Wholesalers compete for business on discounts offered to community pharmacies and dispensing doctors. The MCA told us that the annual pharmacists' discount inquiry seeks to determine the average discount attained for proprietary, generic and parallel imported medicines and to establish a fixed claw-back that is applied to pharmacists to capture the discount benefits for the NHS. The discount inquiry indicates that parallel imported products are, on average, supplied to community pharmacists at a higher discount rate than the equivalent UK-sourced proprietary products.[229] Consequently there is some incentive for pharmacists to dispense parallel imported drugs because their profit levels will then be higher. The ABPI also told us that "certainly the patients do not benefit because they pay their flat prescription charge",[230] and that "for every £6 of reduction due to parallel trading the Government only sees £1".[231] The API, on the other hand, told us that the clawback mechanism "yields a saving of some 2% of the total drug bill to the Treasury each year".[232] They also told us that "there are many examples of both where the original manufacturer has been unable to seek a price increase and where prices have been reduced as a direct consequence of the share of the total market being obtained by the imported version."[233] The evidence suggests while only a small proportion of the profit of parallel trade in pharmaceuticals accrues to the taxpayer in the form of lower levels of reimbursement to pharmacists, there are no overwhelming arguments in public policy to restrain such trade.

77. The innovative pharmaceutical industry maintain that international exhaustion of intellectual property rights, particularly patents, would have far reaching effects. SmithKline Beecham noted that they, and other companies, agree to lower prices in those countries least able to afford modern medicines and vaccines.[234] "In essence a virtuous circle exists, which allows the industry to recoup its investment, 'poorer' countries to benefit from prices they can afford, and patients across the world to have access to new medicines".[235] Glaxo Wellcome stated that their "policy of providing Retrovir for the treatment of HIV/Aids in developing countries at one quarter of the price in the developed world would have to be reconsidered, since it is only the Western price that reflects the R&D investment in Retrovir".[236] We are not convinced that the pharmaceutical companies would be unable to supply such drugs to third world countries. We accept, however, that the nature of the pharmaceutical market means that any move towards international exhaustion of intellectual property rights could have severe consequences.

90   Ev, p175 Back

91  Q563 Back

92  Q563 Back

93  Ev, p185 Back

94  Ev, p185 Back

95  See Trade and Industry Committee, First Report, 1998-99, Vehicle Pricing, HC64 Back

96  Ev, p37 Back

97  Ev, p35 Back

98  Ev, p196, paragraph 5 Back

99  Q124 Back

100  Q167 Back

101  Q172 Back

102  Q172 Back

103  Q172 Back

104  Q134 Back

105  Q137 Back

106  Ev, p186-7 Back

107  Ev, p193, paragraph 2.2 Back

108  Q159 Back

109  Ev, p186 Back

110  Ev, p193, paragraph 2.3 Back

111  Q157  Back

112  Q163 Back

113  Q196 Back

114  Q210-211 Back

115  Ev, p53-55 Back

116  Ev, p194, paragraph 4.1 Back

117  Ev, p189 Back

118  Q149-150 Back

119  Ev, p192, paragraph 2.4 Back

120  Q 218: Ev, p52 Back

121  Q154 Back

122  Q126 Back

123  Q191 Back

124  Q191 Back

125  Q191 Back

126  Ev, p53 Back

127  Ev, p47 Back

128  Ev, p186 Back

129  Press notice 13/05/99 Back

130  Q577 Back

131   Ev, p189, paragraph 1.5 Back

132  Ev, p245 Back

133  Ev, p192, paragraph 1.4 Back

134  Ev, p193, paragraph 2.1 Back

135  Q134 Back

136  Ev, p47, paragraph 5 Back

137  Ev, p150 Back

138  Eg, Ev, p224: Ev, p240-1: Ev, p33 Back

139  The Committee looked at the selective and exclusive distribution agreements in the new car market in its First Report, 1998-99, Vehicle Pricing, HC64 Back

140  Green paper on vertical restraints in EC competition policy, Executive Summary, pv Back

141  Ev, p168 Back

142  Q2 Back

143  Q14 Back

144  Ev, p168 Back

145  Ev, p21, paragraph 4 Back

146  Ev, p266-267 Back

147  Ev, p224, paragraph 1.4 Back

148  Ev, p224, paragraph 1.5 Back

149  Ev, p22 Back

150  Ev, p240 Back

151  Ev, p21, paragraph 4 Back

152  Ev, p200, paragraph 26 Back

153  Ev, p56 Back

154  Ev, p20 Back

155  Q75 Back

156  Q96 Back

157  Ev, p241 Back

158  Ev, p225, paragraph 2.1 Back

159  Q547 Back

160  Ev, p139, paragraph 7 Back

161  Q549 Back

162  Ev, p198, paragraph 18 Back

163  Q236 Back

164  Ev, p78, paragraph 2.3 Back

165  Ev, p78, paragraph 2.4 Back

166  Q327 Back

167  Ev, p78, paragraph 4.1 Back

168  Q329 Back

169  Q332 Back

170  Ev, p79, paragraph 5.3 Back

171  Ev, p80 Back

172  Ev, p62 Back

173   Ev, p63 Back

174  Ev, p150 Back

175  Ev, p150 Back

176  Q224 Back

177  Ev, p214, paragraph 3 Back

178  Q433 Back

179  Press reports, eg, 17/06/99 Back

180  See Fifth Report, 1992-93, National Heritage Committee, The Price of Compact Discs Back

181  Ev, p85, paragraph 3.3 Back

182  Ev, p86, paragraph 3.5 Back

183  Q369 Back

184  Ev, p96 Back

185  Ev, p90 Back

186  Q379 Back

187  Q379 Back

188  NERA, Assessment of impact of changes in trademark exhaustion regime at sector level, p83 Back

189  The Supply of Recorded Music: A report on the supply in the UK of pre-recorded compact discs, vinyl discs and tapes containing music. Summary, p4, paragraph 1.6, paragraph 1.10 Back

190  Ev, p87, paragraph 4.1 Back

191  Ev, p182 Back

192  Ev, p181 Back

193   Ev, p182 Back

194  Ev, p256 Back

195  Ev, p232 Back

196  Q350 Back

197  Evidence submitted in confidence Back

198  Q265 Back

199  This can be increased for up to a further five years by the granting of a Supplementary Protection Certificate Back

200  Ev, p221 Back

201  Supplementary Protection Certificates, A report by the Common Law Institute of Intellectual Property, p3 Back

202  Ev, p222 Back

203  Press notice ip/98/1038 Back

204  Ev, p66, paragraph 3.1 Back

205  Ev, p66, paragraph 3.2 Back

206  Ev, p260, para 14 Back

207  Ev, p117 Back

208  Ev, p118, paragraph 2.2 Back

209  Q474 Back

210  Ev, p238 Back

211  Ev, p238 Back

212  Q306-307 Back

213  Ev, p172, paragraph 4.4 Back

214  Ev, p211 Back

215  Ev, p260, paragraph 13 Back

216  Ev, p68, paragraph 4(ii) Back

217  Ev, p260, paragraph 8 Back

218  Ev, p208-209 Back

219  Ev, p222 Back

220  Q257 Back

221  FT 28/05/99 Back

222  Ev, p123, paragraph 4.2 Back

223  Ev, p120-121 Back

224  Q474 Back

225  Ev, p65, paragraph 2.2 Back

226  Q246 Back

227  Q260 Back

228  Ev, p261, paragraph 17 Back

229  Ev, p261, paragraphs 18-19 Back

230  Q259 Back

231  Q261 Back

232  Ev, p123, paragraph 4.1 Back

233  Ev, p123 Back

234  Ev, p206 Back

235  Ev, p207 Back

236  Ev, p223 Back