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Discounters Beware: Costco's Gray-Market Lawsuit Could Affect You

In a case that could transform the discount retailing industry, the U.S. Supreme Court will consider whether Swiss luxury watchmaker Omega should be able to stop Costco Wholesale (COST) from selling its watches at deep discount. If the court rules for Omega, discounters could lose a major channel for buying up desirable merchandise on the cheap.

It's long been an open secret where a lot of discount merchandise comes from, particularly name-brand goods. The items are often purchased on the "gray" or secondary market -- bought from intermediaries abroad rather than directly from the manufacturer, then imported to the U.S. for sale. Avoiding a direct purchase from the manufacturer leaves the retailer free of any manufacturer price agreement and the chain is free to set a lower price than the maker would have required.

Companies frequently complain when their goods turn up on shelves at Target (TGT) or pop up at bargain-basement prices on eBay (EBAY), but the practice has been widespread since discount apparel chains such as Ross Stores (ROST) first appeared in the early 1980s. Gray-market buying has continued in part because in the past, the Supreme Court ruled that goods made here in the U.S. lose their copyright protection if they're sold to customers abroad, who then import them back into the U.S. for resale. So U.S. manufacturers don't have any recourse against gray-marketeering.

In the Omega case, the watches were made overseas, then sold by that company to a foreign buyer that Omega presumed would retail the goods or resell them abroad. Costco then purchased the watches from that buyer and imported them to sell in Costco warehouse stores.

The impact of the case could be massive: A KPMG study showed some $58 billion in technology products alone move annually on the gray market, robbing manufacturers of some $10 billion in profits. In other words, it's a technically legal but certainly unethical way to rip off manufacturers. For its part, Costco has said it doesn't buy a substantial amount of gray-market goods, though in 2008 it got into a similar scrap with rubber-shoe maker Crocs (CROX).

Costco lost this case in the 9th U.S. Circuit Court of Appeals in San Francisco, which ruled copyright protection holds for foreign-made goods brought back to the U.S. against a manufacturer's wishes. The Retail Industry Leaders Association noted that if the Supreme Court upholds that opinion, it could hasten the export of American manufacturing jobs, as goods made overseas would be better protected from discounters. The RILA and other major retailers have voiced their support for Costco in the case.

The fact that the Supreme Court took the case indicates it's troubled by some aspect of the circuit court's ruling. Discounters better hope the Supreme Court tosses the case out when it's heard in the fall, or many chain stores could soon be sporting some empty shelves.

Costco photo via Flickr user scaredy_kat; Omega watch photo by Flickr user Howard O. Young