How companies can beat the counterfeitersAugust 27, 2013: 10:42 AM ET
Fake versions of luxury goods can cost pennies to manufacture and millions to track down.
By Iris Mansour
FORTUNE -- "We want to know what you think is the real or the replica Beats," says the voice off camera, belonging to Jack Gilbert, a British teen hosting a segment on his YouTube channel, TechFusions. He's talking about Beats by Dr. Dre luxury headphones. Gilbert and his co-host conclude that they look almost identical.
The black pair on screen goes for $430 and is worn by the likes of LeBron James and Justin Bieber. The other is white, costs $90 and is part of a $48 billion problem.
Counterfeiting is a global issue and has been for years. Technology has just made it worse, much worse. And here's a clue as to why. Gilbert and his co-host sign off with a warning to viewers that want to buy a real pair -- avoid buying on eBay (EBAY). "That's a massive mistake lots of people make. Because a lot of the time they think it's real, but actually, they're not," says Gilbert.
Technology has given counterfeiters the ability to make convincing electronic rip-offs -- fast -- while the Internet has made it easier to buy counterfeit products. Websites can be made to look reputable in a way that a sleazy middleman selling Air Phones and Apple-a-likes on Canal Street never could. And doppelganger websites frequently dupe customers into thinking they're getting the real deal, even at a fraction of the price.
"It's a very profitable business," says Alan Zimmerman, a professor at The City University of New York who's written extensively about the impact of counterfeit goods on companies and the economy. "You can get into business at very low cost, and the penalties if you get caught are very small compared to other illegal activities." He adds that it's almost impossible for Customs and Border Protection to stop the problem. Zimmerman has calculated that customs agencies worldwide seize approximately one-tenth of one percent of total imports.
Eighty-four percent of counterfeit goods seized by the U.S. Customs and Border Protection in 2012 came from China or Hong Kong. Louis Feuchtbaum, a lawyer who helps brands fight fakes, refers to China as the "wild west for manufacturing counterfeit products." He describes a government that fails to consistently deter counterfeits and enforce intellectual property rights.
With new innovations rendering previous models obsolete, should brands spend their time fighting outdated counterfeits? "The problem doesn't go away merely because there's a new product," says Feuchtbaum. For one thing, counterfeiters act fast. One of his clients recently had a product counterfeited before it even went onto the market. Older products also often remain in the supply chain as companies continue to sell different versions, with the older model at a discount. "Then there's the everlasting damage done to brands by counterfeits," he says, adding that fakes also put consumers in physical danger. He cites exploding batteries and other fire hazards as common risks.
Despite the scale of the problem, there still seem to be fewer fake electronics than fake clothes and accessories reaching the U.S. Apparel and handbags represented 29% of all items seized in 2012 while 15% were electronics. Susan Scafidi, a professor in fashion law and intellectual property at Fordham University, says that the quantity of seized fashion goods still outstrips electronics for a simple reason: "It still takes more skill to craft a cellphone than to craft a handbag," says Scafidi.
Knock-offs tend to be made in either a registered factory that makes them on the "third shift" after the legitimate product is made, shipping the counterfeits out the back door when no one is looking. Or then there's the purely clandestine factory that has no relation to the original product. Customers these days are also more easily duped, partly because the Internet gives items legitimacy more easily than a sale on a street corner would, and partly because they're harder to detect.
"The measures that an apparel company has to take and an electronics company has to take are very similar," says Scafidi. She mentions the importance of trademarks, being careful when drawing up agreements with factories, and educating customs officials to spot fakes.
Despite the best efforts of brands and officials, catching counterfeits is like slaying a hydra. Adrian Punderson, Vice President of Oakley Brand Protection says the apparel and accessories company's first line of defense is to attack production facilities. He estimates that once fakes get into the "stream of commerce" it costs approximately 100 times more to stop being sold. Yet Punderson says that during 2012, Oakley and Chinese officials raided a clandestine factory almost every other day. Despite that, the company is still making large seizures of counterfeit sunglasses from China, in locations on every continent.
"They operate pretty much like you would see in a narcotics network," says Punderson. He says that manufacturers spread production between several factories, so if one gets raided the rest of the stash will still be intact. Once the goods are ready, they're immediately moved out. According to him, wholesalers are now the ones willing to take the risk of storing goods and moving them around, so they also have a larger share of the reward and the power.
The network itself stretches across the world. Punderson describes how an Oakley investigator saw 10-15 pairs of counterfeit sunglasses in Acapulco, Mexico. They traced them back to a Venezuelan and a Columbian front company in Panama, which were shipping goods as far as Mexico and Venezuela.
As always, there's a human cost to getting fake Beats headphones and Oakley Sunglasses at rock bottom prices. Says Punderson, "There's no way that any government in the world would allow a legitimate factory to operate that way -- in the conditions these people work in -- it's pretty frightening."