Over the past twenty-five years, American consumers have increasingly turned to online marketplaces to fill their shopping needs. In fact, according to a 2019 report from CNBC, 75% of Americans shop on Amazon.com “most of the time.” While this shift away from brick-and-mortar stores and toward e-Commerce has undoubtedly created conveniences, it also comes with risks. Dangers include the unchecked sale of counterfeit goods and goods known to pose safety risks to the public. Sadly, many Americans remain largely unaware of those risks.
That may be about to change. On Friday, January 24, the U.S. Department of Homeland Security (DHS) issued a report to the President titled “Combating Trafficking and Pirated Goods.” In it, DHS officially acknowledged the vast problem of counterfeiting within online venues and vowed to enact measures that should at least slow the influx of phony products into American sales channels.
Q4 2019 hedge fund letters, conferences and more
Baupost's investment process involves "never-ending" gleaning of facts to help support investment ideas Seth Klarman writes in his end-of-year letter to investors. In the letter, a copy of which ValueWalk has been able to review, the value investor describes the Baupost Group's process to identify ideas and answer the most critical questions about its potential Read More
e-Commerce platforms are known targets for counterfeiters
While it is certainly good that the federal government is now paying attention to the online counterfeiting dilemma, industry groups have been aware of the problem for years. In fact, the International Anti-Counterfeiting Coalition (IACC) has long recognized that e-Commerce platforms like Amazon, eBay, and Walmart.com are flooded with counterfeit products.
Indeed, according to IACC reports, counterfeiting plagues companies in every sector of its membership -- which includes leading brands in over 200 product categories. Frighteningly, industry sectors like automotive parts, pharmaceuticals, and personal care items are among the most heavily impacted. Phony products in those categories can cause real and immediate harm to the public.
Even Amazon acknowledges that it has a problem with counterfeiters. It’s hard not to when, in 2019, the company landed on the “Notorious Markets List,” which is published by the American Apparel & Footwear Association to warn consumers of significant counterfeiting risks.
Despite the company’s awareness of this problem, it continues to take measures that actually increase the chances that counterfeit products will be sold in its marketplace. For example, Amazon has heavily recruited third party sellers from China. This is significant because when the U.S. Customs and Border Patrol (CBP) recently launched “Operation Mega Flex” to provide increased oversight and inspections of shipments from Hong Kong and China, the operation revealed that over 5% of shipments from those ports were counterfeit. Thus, by actively seeking out third party retailers from this region, Amazon only increases the chances that American consumers will be duped.
In case you’re tempted to believe Chinese counterfeits make up a small portion of Amazon’s overall inventory, consider this: Every 1/50th of a second, a new product listing is uploaded to Amazon from China and Chinese sellers currently make up 38% of Amazon’s overall third-party retailer program.
The problem is so bad, in fact, that industry watchers have taken to calling Amazon an “online flea market.” Amazon is not the only online marketplace to foster this problem, however. A 2017 study by MarkMonitor revealed that nearly 39% of counterfeit goods were purchased from online platforms.
Counterfeiters and sellers of other pirated goods have plenty of reason to flock to online venues like Amazon. After all, they can set up shop within the world’s largest online shopping venue with incredibly low start-up costs. Once they do so, millions of customers become available to them on a daily basis and the Amazon brand name provides them with an instant air of legitimacy.
Moreover, Amazon and other online marketplaces allow these third party retailers to operate under fictitious business names and the companies vigorously protect sellers’ true identities even from consumers who are scammed by them. This cloak of anonymity is highly attractive to all third party retailers, to be certain. Those who operate from overseas, however, enjoy an even greater protection from enforcement as their foreign residence makes it nearly impossible for them to become subject to criminal prosecution or civil liability in the United States.
In addition to the potential harm counterfeiters and other rogue sellers create with respect to consumers, they also have devastating impacts on business. Counterfeiters, of course, produce knock-offs at a fraction of the cost to produce legitimate items. Unauthorized sellers, for their part, often obtain products to sell online through wholly illegitimate means -- such as cargo theft or purchase of expired products at rock bottom prices. Both groups can then sell their items in online marketplaces at prices far below the legitimate manufacturer’s minimum advertised price (“MAP”). Over time, brands and their legitimate retailers find it impossible to compete.
As a consequence, legitimate companies suffer from price erosion, declining sales, lost profits, and employee layoffs. Over time, those companies lose all incentive to create new products, knowing that any time they create a popular item, it will quickly be knocked off and sold for a fraction of the price they need to charge in order to stay in business.
This is not an isolated problem. In 2018, Frontier Economics reported that in the year 2013, counterfeit products displaced sales of products from legitimate companies to the tune of nearly a half a trillion dollars. That number is expected to rise to over $1.2 trillion by 2022. Frontier also reported that counterfeiting resulted in roughly 2.5 million lost jobs in 2013, with an expectation that that staggering number will double by 2022.
Bruce Anderson, Co-Founder of eEnforce, a global brand protection firm, sees these problems every day. According to Anderson both counterfeits and the sub-MAP sale of legitimate products by unauthorized sellers “creates an environment of unfair competition, rampant trademark violations, lost profits, and reputational damage to brands.”
Immediate actions & recommendations that will impact Amazon and other online marketplaces
Fortunately, the DHS report to the President offers a host of initiatives that should help stem the tide of counterfeits flooding the online marketplaces. Here are some of the highlights from those recommendations:
- Ensure that entities with financial interests in imports bear responsibility
The first strategy for combating counterfeiting involves imported goods that have not been sold to a specific consumer at the time they are imported into the U.S. In those cases, the goods are released to domestic warehouses and fulfillment centers. The CBP recommends that those centers be treated as the ultimate consignee for undesignated goods.
The reason for this is simple. Often, imported goods languish in these warehouses as they evade detection from CPB agents. Once the warehouse is treated as a consignee, however, CBP and other interested agencies will have the power to identify importation abuses in the goods that are stored there.
- Apply civil fines, penalties, and injunctive actions for violative imported products directly to online marketplaces
One of the keys to solving the rampant sale of counterfeits in online marketplaces is for the marketplaces themselves to bear responsibility for the phony goods. Consequently, CBP and related agencies will use existing statutory/regulatory schemes to impose penalties on the online marketplaces if evidence reveals those marketplaces have illegally aided in the importation of counterfeit items and other pirated goods. This creates a built-in incentive for marketplaces like Amazon to more dutifully police the products sold through their websites.
- Create a modernized e-Commerce enforcement framework
Under this strategy, CBP can treat products that infringe on the intellectual property rights of others much in the same way that illegally-imported Schedule I and II drugs are treated. Specifically, once the infringing products are discovered by federal agencies, they will be summarily forfeited. This will not only streamline CBP’s enforcement methods, but it will also lend an air of seriousness to the crime of selling and distributing infringing goods.
As part of this initiative, CBP is also seeking changes to relevant laws that will allow the agency to share information about these forfeitures with the private sector. This will arm legitimate industry actors with the information they need to put a stop to intellectual property theft.
- Private sector best practices
Finally, the DHS report makes several recommendations for change within the private sector. The hope is that by collaborating with federal agencies in this manner, the tsunami of counterfeit imports will be greatly eradicated. The private sector recommendations include:
Terms of Service Agreements. Legitimate brands should have the contractual ability to suspend and/or terminate online seller accounts under certain circumstances, including the use of a trademark that is confusingly similar to a registered mark. Under this recommendation, legitimate brands would also be allowed to permanently remove offending sellers from online venues and to call for destruction of all infringing goods stored in marketplace warehouses.
Vetting of third-party sellers. Under this recommendation, online sellers would have to provide valid identification, disclose all accounts and listings, and provide location/contact information. Sellers would also have to acknowledge that, as retailers, they sell products for which they do not own the trademark. Under this strategy, brands would be able to use technology and historical data to identify those sellers who pose the greatest risk for engaging in infringing activities. This technology would continually track repeat offenders so that appropriate risk levels could be assessed.
Notice & Takedown Procedures. Intellectual property owners will assume greater responsibility for monitoring various online platforms to identify counterfeiters and other illicit sellers. Although this can require significant investment in e-Commerce enforcement techniques, DHS recommends that existing impediments to enforcement (such as delays between notice of infringement and takedown procedures from the online venue) be streamlined. The reduction in takedown delays will only serve to protect consumers who, at present, continue to purchase offending products between the time notice of infringement is sent and actual takedown occurs.
Enhanced post-discovery actions. Under this recommendation, the onus will be put on the online marketplace to notify consumers who have purchased counterfeit goods. They will also be responsible for removing and destroying offending goods that exist within their fulfillment centers and will provide notice to appropriate law enforcement agencies once a counterfeit is identified.
Transactions through U.S. banks. Each online marketplace will require its sellers to process financial transactions solely through banks and other payment platforms that comply with federal laws regarding requests for information, as well as laws pertaining to the financing of counterfeit products.
Establish marketplace seller ID’s. This recommendation is intended to remove the cloak of anonymity currently enjoyed by third party retailers in online forums. Marketplaces will require all sellers to provide sufficient identifying information, including: names of related businesses, other seller profiles controlled by each retailer, and other merchant accounts that share transaction-processing services. Importantly, this information will be available not only to brands, but also to consumers who have a direct interest in knowing who is selling products to them. Additionally, it will allow brands to identify the full spectrum of related sellers that are peddling their products online. Finally, this information will help the online marketplaces police its sellers and to efficiently identify repeat offenders.
Fortunately, the current administration is invested in taking strong action against foreign intellectual property violators. By enacting the recommendations set forth in the DHS report, federal agencies will immediately have greater teeth for enforcing against the onslaught of counterfeit goods entering our ports and being sold in legitimate online marketplaces.
Moreover, a concerted effort by and between brand owners, online marketplaces, federal law enforcement, and private e-Commerce enforcement providers will quickly ensure that American consumers can shop with confidence. It will also return fair competition among U.S. retailers and will potentially save the jobs of millions of Americans.
Bruce Anderson is the co-founder of eEnforce, a brand protection firm, as well as a freelance journalist that covers the rapid explosion of harmful activities in eCommerce that adversely impacts brands, organizations and consumers. Bruce is currently a member of the FBI Infraguard, and the Secret Service Financial Crimes Task Force, is former police detective and is registered as a Private Investigator, specializing in investigating illegal eCommerce and brand protection activities. You can reach him at [email protected].