Estimating losses from parallel imports

Quantifying the size of the parallel import market to support a business case for action

Our client, a producer of engine components, enjoys a monopolistic position (i.e. they have pricing power, setting prices differently in each market) in its aftermarket components business due to compatibility issues. However, its business had been facing significant revenue losses from parallel imports of its most popular original components, which are priced more cheaply in China. Synovate has therefore been commissioned to establish the market size for parallel imports in terms of potential revenue losses.

We first established a baseline by interviewing distributors and customers about "cheaper" products that "are not covered by warranty". These results are however only indicative of the minimum parallel import market size despite collating results from a representative sample, because interviewees naturally have an incentive to under-report their sales or consumption of such products.

To provide a reliable range of this market, we then proceeded to model the maximum volume of parallel imports that market forces will permit. We obtained the client's internal cost estimates to plot the supply curve: What volume of output is the client currently selling? For each change in pricing, what would be the corresponding volume that the client is ready to produce? We then similarly used the client's historical pricing and sales data to plot the demand curve, using only ("price maker") changes in pricing that were made to assess commensurate changes in volume demanded, rather than any price changes made as a result of customer or competitive pressure.

Based on marketplace interviews, we ascertained the lowest average price (P¹) of the product's parallel imports, that stimulate excess demand away from products priced at our client's higher current market price P^*. As long as the total price (including shipping, tax, and sales costs associated with bringing the product to market) for each unit of parallel import remains priced lower than P^*, an economic incentive exists to bring in parallel imports even for those priced higher than P¹, up to P^* where customers will prefer to switch back to purchasing original products.

The distance between Q_S¹ and Q_D¹ represents that maximum volume of parallel imports in volume terms that the market would permit, while shaded area below the supply and demand curves, in multiplying this quantity with price, produces the revenues lost to our client due to parallel imports.

Armed with this intelligence on the magnitude of cannibalization posed by parallel imports, our client could now build a business case to evaluate the costs and benefits of potential strategies to best to address this issue, such as import and pricing controls, trade lobbying, warranty programmes, or channel incentives.