Business Management

Whose Product Is It Anyway? Understanding Counterfeits and Knockoffs

Fraud, deceit, confusion—call it what you want, but counterfeit and diverted products hurt the entire industry.

It was like a scene out of "The Untouchables." Federal marshals stormed a beauty dis­tributorship in Florida on De­cember 19, 1997, with guns drawn. They rounded up everyone in the building, se­cured the premises, then opened door for Seche's Charles Martens and his attorneys who wielded their own powerful weapon —a search and seizure order is­sued by South Florida's Third District Federal Court.

The order authorized Martens and his search team to search the building for counterfeit products. They didn't have to look far.

"We entered the warehouse and found box upon box or counterfeit Seche Vite," says Martens, CFO and chair­man of the Laguna Beach, Calif., top coat maker Seche Vite. "Ob­viously they were getting ready to make deliveries."

Eventually, these counter­feiters were stopped; but the practice continues in the nail industry, and those affected see no end in sight. Manu­facturers not only are con­cerned about counterfeiters, they also note an increase in product "knockoffs" — a product so similarly named and packaged to another that a consumer thinks they're buying one product when they're actually buying an­other. They are taking a hard-line stance to stop counterfeiting and knock-offs that damage their busi­ness through lost sales and wasted energies policing and defending their brands. Nail technicians and their cus­tomers don't escape the ef­fects either. In addition to higher product costs (some­one has to pay the investiga­tors and lawyers), you cer­tainly aren't getting what you pay for when the product is fake or just not the brand you really meant to buy.

That's not to say that generic, "compare to," or even knockoff products are bad. Sometimes these alter­natives are valid, cost-effec­tive choices that perform just as well (or maybe even better, in the user's opin­ion) than the product being copied. It's only when the copycat crosses the line with a name and packaging so similar — or an outright counterfeit of the original — that both the company and its customers lose.

Not the Real Thing

According to nail manu­facturers, product counter­feiting is on the rise. For ex­ample, in early 1997, Pro Finish (Scottsdale, Arizona) president Kurt Kittleson received reports from several authorized distributors that a few competitors were sell­ing his product at vastly dis­counted prices. At the same time, Kittleson noted that his customer service repre­sentatives were receiving a high number of complaints about product performance. Kittleson investigated and found the products looked like Pro Finish's, but had forged labels and an entirely different product formula­tion. He traced the products back to the distributors who sold them (who weren't au­thorized Pro Finish dis­tributors), seized their in­ventory, and sued.

"When someone counter­feits a product," says Kittleson, "the nail technician is getting ripped off, and so is her client." Not to mention the manufac­turer. Martens conservatively estimates that as much as $200,000 of counterfeit Seche Vite had already been sold be­fore he was able to stop the counterfeiters, and he admits the actual dollar amount could very well be higher.

"We think they had been counterfeiting our product for three to four years," Martens says. "Over that amount of time, how many hundreds of thousands of dollars in business have they done? We may never know."

Kittleson's estimate is even higher: He thinks $300,000-$400,000 of Pro Finish was sold to unknowing nail tech­nicians. Both Kittleson and Martens sued the parties in­volved (see "The Sting," at the end of this article for the details on Seche's investigation and law­suit), and both were satis­fied with the results: "We won a $20,000 judgment against one distributor, which 1 think acts as a deterrent for anyone tempted to carry counterfeits," Kittleson says. As for the other two distributors named in the lawsuit, one went bank­rupt and the other, which had only a small amount of the phony product on its premis­es, lost the money it had in­vested in the inventory.

An Ongoing Battle

Although he tasted victo­ry, Kittleson is embittered by reports of more counter­feiting. He's currently fo­cused on an increase in product complaints in the Houston area. "That one we're still investigating," he says. "We want to find the manufacturer and all the sellers. It takes lots of foot­work, but our distributors and educators, as well as the product users, are happy to help us. We'll get them," he says confidently. Once he has them, he says, he'll de­liver them to state and fed­eral authorities, too, as fraud carries criminal as well as civil liability.

Martens, on the other hand, has a different ap­proach: "I've learned from past litigation that if we can work it out with the principal defendant then everyone can walk away happy," he explains. "I don't want to ruin anyone's life, I just want what he owes me. [The counterfeiter] is dri­ving a Mercedes that I paid for, and I want my money back."

Payback is sec­ondary, however, to the message com­panies like Pro Fin­ish and Seche are sending to poten­tial counterfeiters. "We've gotten our message out very strongly in the manufacturing busi­ness," says Martens. "They know that Charles Martens has no fear of litigation. We've won, and we will con­tinue to do so."

While this message is an important one, Kittleson says an even more effective pre­ventive measure is for a brand-name product manu­facturer to commission cus­tomized bottles and caps in­stead of choosing from a container supplier's stock col­lection. It's a seemingly simple solution, but also an expensive one, involving the creation of custom molds that cost a pret­ty penny. Still, Pro Finish has chosen this route, and Seche, too, is developing custom bot­tles and caps that will give its product a distinctive look that, Martens hopes, will be too expensive for a counter­feiter to duplicate.

The investment should be well worth it OPI's COO, Eric Schwartz, says counterfeiting has not been an issue for OPI (N. Hollywood, Calif.), he partly attributes to its unique polish bottles.

How can you tell if you're buying "the real thing"?

"A low price is a good tip-off," says Kittleson. "Also, it's the nail technician's respon­sibility to make sure she's buying from an authorized distributor, just as it's the dis­tributor's responsibility to make sure he's buying from the true manufacturer." If you have any doubt as to whether a distributor is authorized to sell a particular company's product, you can call or write the manufacturer.

 “You Look Just Like...”

Have you ever mistaken a stranger for someone you know because their features are so similar? While with humans it's truly a genetic quirk, when it comes to products the popular term is "knockoff," and it's a deliber­ate attempt of one company to leverage another's image and create enough confusion between the two products that the purchaser may think they're buying one brand of product when they're actual ly buying another. Knockoffs are becoming increasingly common in the nail industry, say brand-name manufacturers, and they're annoyed and frustrated by the confu­sion it creates.

"We had a company that came out with an adhesive that was very similar to our 5-Second Nail Glue" explains Lee Tomlinson, president of IBD Professional Nail Systems (Gardena, Calif.). "Their label said, 'Dries in' in very small letters, and then in big letters said, '5 Seconds.' The label used similar colors to our label, and it looked like IBD's 5-Second Nail Glue." [IBD ultimately sued the company and won.]

Matt Walker, advertising/purchasing director for European Touch Co. (Butler, Wis.), says knockoffs are a constant drain of time and money for his company.

"You have to defend yourself, but most companies would hope they could spend their profits in areas that directly benefit the nail professional, such as research and devel­opment," he explains. For ex­ample, knockoffs of European Touch Co.'s Revivanail have included "Revitanail" and "Rejuvanail," to name a few, he says.

Most of the time, Walker and other company princi­pals say knockoffs are easily dealt with through a simple phone call to the offender or a cease-and-desist letter from a lawyer warning the offend­ing company to stop infring­ing on the company's trade­mark (too similar of a name or logo) or trade dress (simi­lar containers or packaging). At other times, manufactur­ers are forced to file a lawsuit charging the other company with trademark, copyright, or trade dress infringement.

Yet knockoffs can look very much like a competi­tor's brand and still be with­in legal boundaries. Nailco recently introduced a gel line in its catalog called Lightbox Gels made by For Profes­sional Use Only that looks very similar to IBD's Salon Essentials line, and even compares itself to Salon Es­sentials in its advertising. "We wanted to have some­thing to offer our mail-order customers, and decided to stock one that was as similar as possible to the IBD line, which we used to carry," says Larry Gaynor, president and CEO of Nailco Salon Mar­ketplace (Farmington Hills, Mich.). "In any market, comparable products look, perform, and are priced sim­ilarly because they meet a certain criteria customers are looking for." In an agree­ment made recently between the two companies, For Pro­fessional Use Only will change the colors on the Lightbox packaging to lessen the confusion.

"This will help lessen the confusion," says IBD's Tomlinson, but it won't make it dis­appear."You want new prod­ucts to help build the industry, not create confusion among buyers. I believe if you see a product and can figure out a way to make an alternative product that is high quality yet costs less, then you've got a worthy competitive product. If it just looks like someone else's then it hasn't done any­thing to improve or contribute to the marketplace."

In 1993 Essie Weingarten of Essie Cosmetics (Elmhurst, N.Y.) filed a lawsuit against a competitor to prevent that company from introducing a line of nail polishes packaged in bottles very similar to her own clear, square glass bottle with a simple, cylindrical cap and no identifying label. Fortunately for Essie Cosmetics, Judge/jack B. Weinstein of the U.S. District Court in Brook­lyn, N.Y., said, "Her Essie Cosmetics] trade dress is, in effect, the absence of trade dress... The important factor is that her customers associate the trade dress in her bottle design with her alone." She won, but at no small cost: Her lawyer did extensive surveys around the country to prove the point that the bottle was strongly identified with Essie Cosmetics. His time, plus court costs and other expens­es, were a significant expense for the polish manufacturer.

And while you can't trademark a polish color, Weingarten does trademark her polish names, but she says even that doesn't stop companies from riding on her coattails. "It's never-ending," she complains. She makes phone calls and she writes letters, but at a certain point she says she has to weigh the benefits she'll gain versus the time and money she'll spend stopping it. Sometimes, manufacturers agree, it's just not worth it.

While these companies lament the time and money in­volved in protecting their trademarks and copyrights, they acknowledge they have no other choice. "It's expensive, but with any brand, you spend money building it, so you have to protect it. If you don't pro­tect the brand, you won't have anything left, "Tomlinson adds." Companies that spend a lot of money protecting their image end up making the brand stronger because it makes it more unique."

And image is, after all, what the beauty industry is about.

Diversion Rears Its Ugly Head

While OPI Products says it has been spared of coun­terfeiting problems, the company has been a victim — and activist — in the war against diversion. Di­version (when professional-only products are re-routed illegally to discount centers and other public outlets) is particularly troublesome in the hair industry but is starting to trickle into the nail industry as well. When OPI polishes began showing up in Price Club/Costco. CVS, Albertsons, Drug Emporium, and other retail stores, the com­pany acted swiftly. It began a strong anti-diversion campaign by announcing lawsuits against the aforementioned companies, as well as the middle men who helped put OPI on their shelves.

"Our product started being diverted in 1993, about the time that we began advertising in consumer magazines," says CEO/president George Schaeffer has to have a cer­tain level of popularity to be de­sirable for diversion."

Diversion takes many forms and Schaeffer says that OPI products have been diverted primarily by both "collectors" and overseas clients. A collector works with a group of salons by asking each of them to buy a bit more of the products they are already authorized to purchase. For example, XYZ Salon will order extra OPI polishes at $3 a bottle in addition to their regular order. The salon turns around and sells the extra prod­uct to the collector at a. small mark-up. Then the accumulation of products is sold to an unau­thorized vendor, such as a drug­store at an additional low-per­centage mark-up. Finally, the vendor sells the diverted prod­ucts to consumers, who pur­chase them at a lower price than that offered by profession­al-only salons and outlets. "These vendors don't always care about making money on our products and usually work on a small margin of about 2%-3% says Eric Schwartz OPI's COO/general counsel who heads up the company's anti-diversion efforts.

"They use OPI polishes as a loss leader In other words, the vendor will place the polishes at the front of the store, hoping that the ex­citement of professional-only products will entice consumers to come In and buy others, Then, they make a profit off any additional purchases."

While diversion is not illegal in the same way that, say, theft is specifically outlawed, the action can violate some state statutes, the contracts that a company has with its suppliers, and the company's reputation.

Though OPI is paid for the original product sale, damage is done. If a client is told that the product is professional-only and purchases it at the salon's retail price, then finds OPI in her local drugstore for less, all parties In­volved (including the salon) lose credibility, as well as future sales, And though OPI safeguards it­self from diversion of products shipped out of the country and even requires that they not re­enter the U.S., diversion still sometimes occurs with the same results.

OPI fights diversion by marking products before it ships to distributors so that if the products show up on unauthorized shelves, OPI can trace them back to the original distributor OPI also investi­gates confirmed tips, maintain­ing a strong partnership with its dealers, and allocates funds to lawsuits and buying back products. However; both Schaeffer and Schwartz ask for nail technicians' help. Nail techni­cians who know of instances of diversion should report it to the company with as many de­tails as possible about the store and which products they saw there. While no major lawsuit had been settled as of press time, OPI vows to continue to protect its relationship with distributors and nail techni­cians. "Anti-diversion tactics re­quire a tremendous amount of time and resources," says Schaeffer. "We would much rather invest in education and re­search and development."

The Sting

Seche's December 1997 seizure of counterfeit products and the equipment used to make them v/as borne of 18 months of intensive investigation and re­search It was early summer in 1996 when Charles Martens got the first hint of a problem from an au­thorized distributor who called to com­plain about a company underselling him on the company's flag­ship product, Seche Vite.

"He wanted to know if we were cut­ting deals," Martens says/'but I knew that at the prices he gave me, they couldn't be selling our product,"

Experience told Martens he couldn't just confront the dis­tributor he suspect­ed of selling counter­feit Seche Vite — not if he wanted to catch everyone involved, from the distributor, to the bottle screener and filler, to the liquid manufacturer. Instead, he called Seche's general counsel band product to get a sense of how big the counterfeiting operation actually was. "We wanted to make sure it wasn't a one-time deal," ex­plains Rodriguez Work­ing through one of his East Coast dis­tributors, Martens bought 1,000 bot­tles of the fake Seche Vite, which was quickly delivered.

Dismayed at the ease and speed with which the company filled the order Martens hired an in­vestigator who spe­cializes in counterfeit­ing cases to start gathering evidence. "From that point we investigated for a year to find out who was screening and filling, who was providing the liquid, and who was supplying the caps and bottles," Martens explains. "We also needed to get a sense of whether; if we ded­icated $100,000-$200,000 to the case, we would get that money back1'

The investigation continued for more than a year, but the biggest break was a lucky one, Martens admits." was work­ing on developing a product, and we were considering

 Anthony Rodriguez & Associates in Bev­erly Hills, Calif., who recommended Mar­tens arrange to buy some of the contra buying from a cap manufacturer -that we had used before until he could no longer meet our vol­umes," he says, "We called to find out what, volume he could do for us now, and he told us he had only sold the cap to one other company since us. They told us who it was — and this was after a year of trying to find out through our own in­vestigation,"

At this time, Martens arranged a second purchase through his distributor to make sure the com­pany was still counter­feiting his product. "At one point we thought they maybe had made 5,000 or 10,000 bot­tles and then went away, but when the issue came back up we placed another order to make sure it was still a substantial operation. They immediately delivered another thousand bottles," Martens says.

While they still didn't know who was providing the liquid, Martens and Ro­driguez had the names of the bottle screener and filler as well as the distribu­tor, and they started planning the bust.

"Once you find the credible evidence you prepare a law­suit, which is filed under seal so no one finds out about it be­fore the seizure," Ro­driguez explains,'' With-in a certain period, generally 10 days, the seizure has to be arranged, and the court requires you to get a bond to com­pensate people for any damages that may occur if it's a wrongful seizure. Once the court is notified the seizure has occurred, the law­suit becomes public record."

Once they secured authorization and a search warrant. Mar­tens and his lawyers were allowed into the first building by feder­al marshals. Martens seized the counterfeit product while his lawyers gathered sales receipts and other records from the beauty distributor's files. "We also took their computers and downloaded the hard drives so that we could get any sales in­formation kept there," he says,

The distributor's records showed the company had pur­chased the phony product from a local cosmetics manufactur­er, Already tipped to the manufacturer's name, Martens' lawyers had included it in the search and seizure order and Martens and his attorneys went direly there, with the federal marshals again leading the way.

"The marshals en­tered and cleared out the building, and we went in after the whole place was empty" Martens re­members, "Under the direction of the mar­shals, I'm free to do whatever I need to find any kinds of fin­ished product or bot­tles or silk-screens showing my product is being counterfeited."

This time, Martens didn't find cases of product sitting out waiting to be discov­ered, so he started searching for empty bottles, bottle caps, cardboard boxes with Seche's name — any­thing that would show they had been produc­ing phony Seche Vite — but there was nothing.

"I thought, 'Oh, great We were so sure about this and now we'll have a wrongful seizure suit on our hands' I couldn't find a sample of screened product anywhere," he says. Then a pile of silk-screens caught his eye and, on a hunch, he flipped through the stack. Pay dirt! "I found five silk-screens for Seche, and then I knew we were in the right place," he says.

While Martens searched the manufac­turing plant, Rodriguez was following the paper trail in the man­ufacturer's files. "The owner of the compa­ny showed up, and Tony worked with him to find the paperwork. We were trying to find out how many units had been made," Martens explains.

While Martens says he may never know exactly how much counterfeit SecheVite was sold to unsuspecting nail technicians and their customers, he's confi­dent the December raid means no more will be sold — espe­cially by this manufac­turer. "When we found the screens, that was enough evi­dence to show they were screening and filling counterfeit bot­tles of Seche Vite, so we brought an 18-wheeler in and seized all their means of mak­ing, screening, and fill­ing the bottles. The ob­jective is to stop them from doing this."

Seche settled out of court with the liq­uid manufacturer in February. In March, it settled with the print­er of the distributor's catalogs (who was being sued for violat­ing Seche Inc.'s copy­right on its ad materials because it printed altered ads). Finally, in April, the remaining suits were settled with the screener and filler; the box maker, the film positive maker and the distributor.

What It All Means

Counterfeit: A product that is fraudulently presented as a particular company's product but was actually made by an­other.

Diversion: A product that is diverted from an authorized retail outlet, such as a professional-only distributor, to an unau­thorized outlet, such as a drug store or mass merchandiser:

Exclusive line: A product line that is distributed exclusively by one distributor in a defined area or region.

Knockoff: A product so similarly named and packaged to another that a consumer could become confused and buy one when she meant to buy the other

Open line: A product line that is open for distribution by any and all distributors in an area or region.

Private label product: One company or individual contracts with another to provide a product such as polish under the first company's own brand name. The product formulation may or may not be exclusive to the company buying the product. This is a common practice in the nail industry

Repackaging: Re-filling one company's product container with another company's product. This is considered fraud when the repackaged product is presented as the original.

 

Keywords:   diversion     patents  

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