How to Understand the Impact of Illicit Trade on Business Around the World. Philip Buchanan and Lourdes Chavarria

Transcription

1 How to Understand the Impact of Illicit Trade on Business Around the World Philip Buchanan and Lourdes Chavarria

2 Not to be distributed without permission.

3 HOW TO UNDERSTAND THE IMPACT OF ILLICIT TRADE ON BUSINESS AROUND THE WORLD Philip Buchanan Head of Consulting Latin America, USA Lourdes Chavarria Consulting Manager, USA CONNECT WITH US EUROMONITOR INTERNATIONAL 2015

4 CONTENTS 1 INTRODUCTION Key definitions The shape of illicit trade 7 OVERVIEW OF MAIN DRIVERS Consumer preferences Business conditions Regulatory framework 12 WINNERS AND LOSERS OF ILLICIT TRADE The winners The losers 21 ILLICIT ALCOHOL IN LATIN AMERICA: A CASE STUDY 25 WHY ILLICIT TRADE MATTERS 27 ABOUT EUROMONITOR INTERNATIONAL 28 THE AUTHORS 30 REFERENCES iv EUROMONITOR INTERNATIONAL 2015

5 INTRODUCTION Despite the efforts of global organisations, governments and companies in controlling illicit trade, the phenomenon continues to be a latent threat for the global economy. According to the World Economic Forum, the global value of illicit trade and transnational activities is estimated at between 8% and 15% of global GDP, potentially reaching as high as US$12 trillion in To put this into context, this is approximately the size of China s total economic output in that same year. Each year, an increasing number of goods and brands are affected by illicit trade, from consumer goods like electronics, apparel and alcoholic beverages to other industries such as vehicle lubricants and auto parts; impacting virtually every product and industry. According to the World Customs Organization (WCO), in 2013 approximately 3 billion pieces of counterfeit and piracy products were seized; more than half of the reported intercepts were illicit pharmaceutical products (2.3 billion pieces), followed by 470 million pieces of electronic appliances, 95 million of other taxable products, 50 million of foodstuff, amongst other commodities. Additionally, the complexity of illicit trade activities is increasing as illicit players become more sophisticated, organised and well-resourced. Improved global logistic networks, real time data sharing systems and online platforms enable a more efficient supply of illicit products and increase the number of parties participating in this market, creating significant challenges for licit manufacturers, government and other stakeholders within affected industries. These facts help to underscore the growing problem of illicit trade in today s global economy. EUROMONITOR INTERNATIONAL

6 Introduction To help our clients understand and define strategies to deal with the growing threat posed by the illicit trade, Euromonitor International has conducted extensive research on this topic across numerous industries and countries, collaborating with international organisations and stakeholders to help increase awareness. Through these experiences, Euromonitor International has accumulated a significant amount of knowledge and expertise on the structure and dynamics of illicit markets, which form the basis of this paper. With this paper, we aim to: Draw attention to a global issue that might be affecting your industry Define key components of the illicit trade that are fundamental to understanding its complexities Describe the main winners and losers of the illicit trade Describe the main drivers and enablers of the illicit trade Key definitions While illicit trade is a global issue that affects many industries, sectors and economies, its definition is not consistent or standardised. Public organisations, academia, press media, NGOs, companies and governments globally refer to illicit trade using different terms such as informal trade, unrecorded trade, non-commercial and illegal trade. The terminology, scope and Developing an analytical framework with clear definitions is critical to understanding illicit markets. metrics of the studies and reports available are extremely varied, limiting their comparability and usage to analyse the overall market behavior, its size, trends and drivers and supply chain dynamics across regions and industries. In other words, an apples to apples comparison is almost impossible, adding another layer of complexity to the goal of understanding this topic. Despite the lack of an internationally accepted set of definitions to quantify the size of the illicit trade or to measure its social and health consequences, Euromonitor International utilised its expertise in supply-side research in more than 80 countries, to successfully develop a framework with consistent definitions and scope, allowing for a reliable cross comparison of market sizes, category segmentations and qualitative insights across most consumer products industries. 2 EUROMONITOR INTERNATIONAL 2015

7 Introduction For the purpose of our research, we define illicit trade as the production, import, export, sale and purchase of goods that fail to comply with current legislation in a particular jurisdiction. The most common categories of illicit trade are: Category Concept Common in Contraband: smuggling Counterfeit: falsification, tampering, refill Products with original branding that have been illegally imported into a country and sold evading taxes and tariffs Fraudulent imitations of: legitimate products (piracy), illicit industrial manufacturing, empty packages of legitimate products refilled with other materials Mostly premium brands of: alcoholic drinks, tobacco, beauty and personal care products, apparel, consumer electronics Alcoholic beverages, pharmaceuticals, apparel, beauty and personal care products, oils and lubricants Tax leakage Legally produced goods on which the required taxes were not paid in country of production Alcoholic drinks, tobacco and other highly taxed goods Artisanal: homemade products Products made outside the regulatory framework following artisanal practices. In most cases these products are illicit if made for commercial purposes Alcoholic drinks. Resell of expired goods Trade of expired goods, usually stolen Pharmaceuticals, packaged food, home care products Source: Euromonitor International While these are the most common categories within illicit trade, there exist other forms of trade that, while technically not illicit, are commonly included in discussions on tackling illicit markets because they typically infringe on the distribution and management rights of a brand owner. This is the case of parallel imports, which are authentic, branded products licitly imported into and sold in a market without the consent of the brand owner. For example, Company A has established exclusive distribution contracts with Distributor B in order to control the supply of its brand in country Y. However, other companies are legally selling their brand to non-authorised distributors in the same country. EUROMONITOR INTERNATIONAL

8 Introduction Some industries are highly affected by parallel imports such as software, alcoholic drinks, tobacco, beauty and personal care products, apparel, consumer electronics, amongst others. Another important aspect to understand about the illicit trade is the fact that in many cases, an illicit product can fall into more than one category, hence there is a risk of over estimating the size of the problem. To control this risk, avoid double counting and to better understand each of these illicit categories, Euromonitor International s approach classifies a given product to the category in which it first encounters illicit activity. For example, if an illicit artisanal alcoholic beverage is created from smuggled ethanol, the product is considered contraband because the alcohol became illicit the instant it entered the country without paying taxes, prior to the artisanal production and distribution process. The following example illustrates the category assignments for the purpose of market sizing an illicit market: Illicit Trade Category Assignment Although the contraband raw material was used in an artisanal beverage, it is counted as contraband where the first illicit activity occurred. Ethanol production Contraband of ethanol Distributed to illicit producer Illicit artisanal beverage produced Finished product distributed Product sold and consumed Beverage classified as contraband because it became illicit at that specific stage of the value chain = CONTRABAND Source: Euromonitor International 4 EUROMONITOR INTERNATIONAL 2015

9 Introduction The shape of illicit trade Understanding how the illicit trade looks in a particular industry is as important as understanding its size, due to the negative implications it has on consumers, governments and industries. Hence, even though the global awareness is mostly focused on contraband and counterfeit, our experience has Local conditions significantly impact the dynamics and structure of illicit trade within a country. taught us that each illicit market has a different landscape, not only based on which category is most predominant (e.g., Contraband vs. Tax leakage), but on how that category manifests itself in the market. For example: Who are the main buyers or end users? Who are the illicit manufacturers and suppliers? How is the supply chain conformed, and what is the common route to market? This means that, if the main global issue for a particular industry is contraband, how it looks across countries might be different. Along these same lines, different industries within the same country might experience different issues as it pertains to illicit trade. For example, although the alcoholic beverages industry is globally affected by counterfeit, the situation across countries is different in terms of how the beverages are being counterfeited, where and how those illicit beverages are being sold and what kinds of ingredients are being used. If we analyse the counterfeit spirits in three countries Colombia, South Africa and Brazil we know that the main ingredient used is ethanol. However, the end products and distribution channels are not the same. EUROMONITOR INTERNATIONAL

10 Introduction Counterfeit Alcoholic Drinks in Colombia, South Africa and Brazil Colombia South Africa Brazil Main product type Aguardiente White spirits (cane and vodka) Whisky, vodka, beer and cachaça Main ingredients Cheap ethanol Cane ethanol Ethanol, water, cheaper alcoholic beverages Main distribution channels Source: Euromonitor International Formal retailers, i.e., supermarkets and small independent stores Independent wholesalers and retailers Mostly on premise (restaurants and bars) Another good example of this is the illicit market in Mexico for two different industries: premium perfumes and alcoholic beverages. The illicit alcohol market is comprised mostly by tax leakage compared to premium perfumes, which is mainly contraband. Given this complex scenario, it is critically important for any stakeholder trying to tackle illicit trade to understand the landscape and structure of the specific illicit market and to consider that many different manifestations can be presented depending on local conditions. Failure to consider the nuanced interplay of these variables within the market risks a significant misunderstanding of how illicit markets operate, which would undermine any strategy towards combatting them. Furthermore, as one can imagine, this complexity makes understanding the landscape and structure of the illicit market a challenging endeavor, especially for global companies trying to combat this problem in many different parts of the world. It requires cross-country comparable information, a holistic view of the issue (e.g., from the demand vs. supply perspective) and consistent definitions. 6 EUROMONITOR INTERNATIONAL 2015

11 OVERVIEW OF MAIN DRIVERS Despite the differences across industries and countries, the illicit trade is driven by a common set of factors across the globe divided into three main categories: consumer preferences, business conditions and regulatory frameworks. All of these factors play a key role in understanding the dynamics of the illicit trade and are strongly interrelated, which makes it difficult to single out the effect of any one factor on the illicit market. Main Drivers of the Illicit Trade Consumer Preferences Lower priced products Access to premium brands (aspirational) Social acceptance of illicit trade Limited knowledge about illicit products and how to identify them Source: Euromonitor International Business Conditions Price gap between licit and illicit products High levels of excise taxes Availability of ingredients and packaging materials Regulatory Framework Ineffective enforcement Weak rule of law Corruption Inadequate sanctions Consumer preferences In normal conditions, consumer behavior often determines most purchase decisions, such as brand selection, frequency and occasion Consumers drive sales of illicit of consumption and price tolerance. products in search of lower prices In the illicit trade, these decisions and greater product variety. remain the same and largely influence what products are made available and how they reach end consumers. EUROMONITOR INTERNATIONAL

12 Overview of Main Drivers Most studies related to illicit trade show that consumers are attracted to smuggled or counterfeited products because they offer the possibility of paying lower prices for comparable or, sometimes even the original branded products, which have been illegally imported or stolen and made available at lower prices. For example, this is quite common in the tobacco market where consumers purchase illicit products because of a desire or need to save money. Another driver behind consumer preferences is access to premium brands or aspirational products that are often outside the reach of consumers due to budget limitations. This is the particular case of pirated designer brands and luxury goods; consumers are willing to spend money in counterfeit products in order to gain social status and keep up with market trends. At times, consumers are not even aware that they are participating in the illicit market because they are deceived by sellers and assume that they are paying lower prices for authentic products, when in reality they are buying knock-offs. Social acceptance is another driver of the illicit trade around the globe. In many countries, consumers do not perceive buying illicit products as a criminal activity. In fact, on the contrary, many consumers around the world perceive these purchases as good deals, a sentiment preventing social pressure from discouraging participation in the illicit trade. According to Euromonitor International s research in Latin America, it is socially acceptable to buy smuggled or counterfeited products mostly because they are easy to obtain, sometimes being sold through formal retail channels, causing this commercial activity to be perceived as normal, thus acceptable to consumers. Limited knowledge about the consequences of buying illicit products is another factor to consider, as consumers often minimise the effects of tax evasion and do not consider other implications, such as the health risks, increased instability and criminality and support of criminal groups. Consequently, less informed consumers are more inclined to buy illicit products. The exceptions to this rule are cases when consumers are unaware they are paying for fraudulent products and thus encouraging an illicit activity. In this scenario, the lack of consciousness about the issue and its consequences is not the main driver, but most likely paying lower prices. In order to change consumers perspective, many industries launch campaigns to increase awareness on the negative effects of the illicit trade. For example, in the USA, the Council of Fashion Designers of America has launched a You Can t Fake Fashion campaign to educate consumers about the perils of buying counterfeit items, while luxury fashion magazine Harper s Bazaar has been holding annual anti-counterfeiting summits with the same goal 8. 8 EUROMONITOR INTERNATIONAL 2015

13 Overview of Main Drivers Business conditions Other important factors driving the illicit trade are related to the business environment in a particular industry and country. As mentioned before, illicit players take advantage of the business conditions on which licit counterparts have to operate, especially when those conditions help widen the gap between licit and illicit prices Conditions within local markets influence the attractiveness of illicit activity. due to high levels of excise taxes and operational costs, which increase the competitiveness of illicit competitors. As an illustrative example, recent tax increases in Ecuador, particularly the ICE, contributed to the growth of illicit alcohol while reducing the sale of licit alcoholic beverages. As retail prices were forced to increase, licit brands became less affordable and therefore less attractive in the eyes of consumers when compared to illicit ones 2. In general, when the price gap between licit and illicit products is wide, demand from most segments of the population skew towards products with lower prices regardless of their legitimacy, thus favoring illegal trade. Some industries, such as tobacco and alcoholic beverages, face strong taxation policies, as these are considered an effective way to discourage consumption and therefore minimise the negative effects excessive consumption of these products have on society. However, when taxes are extremely high, the outcome is the opposite given the fact that illicit products that evade all types of taxes are available and become more attractive as they are more affordable. Due to the transnational nature of illicit trade, this situation is even more attractive to illicit players when disparity in excise tax rates exists across neighboring countries or regions because it allows them to implement a more diversified marketing strategy, maintaining production in one market while shifting sales to another offering greater opportunity. Availability of raw materials and packaging can also help support the illicit trade by giving counterfeit manufacturers access to important inputs for their business operations, such as ethanol and empty bottles in the case of alcoholic drinks. For example, in some countries, the oil industry follows responsible business practices related to the collection and recycling of used lubricants, but in others countries, used lubricants, especially engine oil, can be acquired by illicit players with the intention of re-selling them as new products in original containers. This is also the situation faced by the pharmaceutical and alcohol industry, as some common ingredients and raw materials can be sold without any control, enabling the production of counterfeit and artisanal products. EUROMONITOR INTERNATIONAL

14 Overview of Main Drivers Regulatory framework The implications of the regulatory framework on illicit trade can be analysed from two perspectives: the lack of effective regulations and the lack of compliance with them. Based on Euromonitor International s experience, a country can face either case, depending on a given industry. Ineffective regulation and weak enforcement allow for increased illicit trade. Usually, the regulatory framework tends to be good as industries are high tax collectors (e.g., alcohol, tobacco, luxury brands, oil, etc.) and controlled due to health risks associated with harmful consumption (e.g., pharmaceutical products, alcohol, tobacco, etc.). In these instances, the main drivers are related to ineffective enforcement, corruption and weak rule of law, which allow illicit players to operate without major obstacles. There are other instances where the main issue comes from the lack of regulation or inadequate sanctions, focused either on the production and commercialisation of finalised products or on the supply chain of raw materials. For example, out of 17 Latin American countries where Euromonitor International has conducted illicit trade research for the alcohol industry, we have found that only in two did the regulatory framework applicable for ethanol prove effective, reducing the illicit flow intended for the production of artisanal alcoholic beverages, counterfeit, tax leakage or consumption as surrogate. According to the OECD, the biggest challenge comes in those markets with weak laws, or where laws may be strong but punishments weak, or where the police / judiciary do not effectively enforce available laws. This can make the illicit trade attractive versus other forms of criminal activity, as any punishments such as fines are often factored into their business plans, and operations can be readily resumed if no custodial sentence is involved 7. Although there is an obvious correlation between these drivers and the illicit market, over time, the cause - effect relationship is highly dynamic, interrelated and therefore difficult to define. For the licit industry players, understanding this relationship is relevant because some actions can be implemented on a company or industry level, but most of the time a regional strategy, including multiple stakeholders is required. 10 EUROMONITOR INTERNATIONAL 2015

15 Overview of Main Drivers Euromonitor International s research has shown that segregated strategies to tackle illicit trade are not very successful, given that illicit players can find a better way to overcome the challenges created such as making new pack types difficult to copy, improved tax stamps and tougher border controls. In other words, a holistic approach is required to fight against the illicit market, which sometimes means a strategy beyond the jurisdiction of a country. According to Interpol, for example, any response to the illicit trade in tobacco products requires the active and coordinated involvement of a number of different stakeholders. Given the global nature and complexity of the phenomenon, solutions to treat the issue must be global in nature and fundamentally aimed at international cooperation and the harmonisation of laws and regulations in the area of illicit trade beyond borders 5. An explicit attempt to develop a coordinated global framework to tackle illicit trade is, for example, the World Health Organization (WHO) Protocol to Eliminate Illicit Trade in Tobacco Products 11. EUROMONITOR INTERNATIONAL

16 WINNERS AND LOSERS OF ILLICIT TRADE As this paper has emphasised, the illegal trade is very complex, both in its composition and how its various components interact with one another. This reality makes determining winners and losers of the illicit trade a challenge, but important nonetheless to try to understand which actors are benefiting, which are being harmed and, most importantly, how. Ethical arguments aside, it is evident that some actors benefit from illicit trade. For illicit manufacturers, ingredients providers, distributors and resellers, it can be a very profitable activity. For consumers, illicit trade can increase the variety of products to which they have access and allow them to buy certain goods at lower prices. However, by nature of being illicit and as most observers suspect, there are several significant consequences of the illegal trade, which tend to negatively affect licit companies, consumers and governments the most. The specifics of these impacts are explored in greater detail below. The winners It is obvious that the main winners are and will always be the illicit players, from the input suppliers to the distributors and resellers. Just as in the licit market, whenever the demand of certain product increases, the commercial opportunity for the suppliers also increases. In other words, there is a supply because there is a demand. For illustrative purposes, we will describe how the four main winners benefit from the illicit trade. 12 EUROMONITOR INTERNATIONAL 2015

17 Winners and Losers of Illicit Trade Benefits of Illicit Trade Input Suppliers Growing demand of: Main ingredients or materials Packaging and labels Other services Source: Euromonitor International Illicit Manufacturers Gain higher margins due to illicit activities Consumers Access to lower priced products Free access to controlled products Access to aspirational brands Government Illicit economy creates jobs, reducing poverty levels Input suppliers In general, input suppliers are vital to any commercial activity, whether licit or illicit, and they can be involved, knowingly and unknowingly, at different points in the supply chain. Suppliers of ingredients, raw materials, packaging and labels are required for any counterfeit activity, while other service Illicit manufacturing represents a revenue source for some input suppliers. providers, such as transportation, are required for other illicit trade activities (e.g., contraband, tax leakage and resell of expired products). In regards to the raw materials or ingredients, even though these are regulated for some industries (i.e., pharmaceuticals, alcoholic beverages, tobacco) in some countries, weak regulatory frameworks and poor enforcement allows these products to be easily accessible for illicit manufacturers. As previously mentioned, one clear example is the control of the ethanol production and trade, a main ingredient for many alcoholic beverages. While in some countries the denaturation process, from which potable ethanol is combined with other substances to change its flavor and odor and consequently avoid its use as ingredient for alcoholic beverages, is compulsory, in others illicit manufacturers can buy potable ethanol freely. In recent projects, Euromonitor International found that in countries like Mexico and Colombia, the illicit market of empty bottles of alcoholic beverages and perfumes is growing at a fast pace, due to the increasing demand from counterfeiters. It is easy to buy original packaging at lower prices with a simple click in a website. In response to this phenomenon, global brand owners, local manufacturers and local associations are increasingly implementing programs to collect empty bottles in order to limit their availability for illicit purposes. However, in some cases, informal groups of recyclers and pickers often receive higher prices per bottle if they sell it to illicit counterparts instead of to the licit ones. EUROMONITOR INTERNATIONAL

18 Winners and Losers of Illicit Trade Another key link in the supply chain is the service providers, mainly transportation of the raw materials or end products. According to industry sources, a counterfeit drug, for example, is usually shipped to more than five countries before arriving at its final destination and point of distribution. Drugs travel for approximately three months, using legal shipping companies. From the market perspective, all counterfeit goods have to be distributed from their manufacturing facility to the point of sales; this constitutes another lucrative business within the illicit trade. In many countries of Latin America, a network of several small companies are focused on providing this type of service to illicit manufacturers, especially carrying perfumes, apparel, luxury handbags, tobacco, alcoholic beverages, among other products. Illicit manufacturers The higher risk is taken by the illicit manufacturers, which are generally located in areas with low visibility or control from local authorities and easy access to raw High profit margins attract materials and packaging. This risk comes with some manufacturers to a greater reward, as their profit margins can illicit activity. be at least 30% higher compared to their legal counterparts, depending on the type of product manufactured. The pricing strategies of illicit products vary across industries. For example, sometimes the selling price of counterfeit products, with the exception of luxury and premium products, tends to be similar to the price of licit products, as the main purpose is to take advantage of a brand image by selling the counterfeit product as original, but with an attractive price. For example, in 2014, the average price per litre of counterfeit wine in the Czech Republic was estimated at USD$4.3 while the original products were sold at USD$4.8, a price gap of 10.4% per litre. In Colombia, counterfeit aguardiente (sugar cane spirit) sold at formal stores, is priced similarly as the legitimate brands, as retailers ignore the illicit origin of those products. For more exclusive products, like luxury handbags, designer accessories and apparel, the pricing strategies of counterfeiters are more aggressive, as they intend to sell high volumes at very low prices. For example, a designer bag that usually costs US$3,000 can be sold as low as US$35 in street markets in big cities. Furthermore, illicit manufacturers face lower costs as a result of evading taxes and not paying for marketing or advertising activities, which produces overall higher margins. 14 EUROMONITOR INTERNATIONAL 2015

19 Winners and Losers of Illicit Trade Additionally to the revenues generated from the illicit trade of products, these manufacturers often get other benefits associated to their illicit activities, like money laundry, for example. The connections between criminal groups and illicit manufacturers is a reality in many countries, hence the illicit trade has become an easy way to launder money and take control over strategic regions, such as those located close to national borders. Consumers From the consumer perspective, the illicit trade generates three main benefits, which together with the social acceptance of some illicit practices help drive the demand for these products. First, through contraband, consumers have access to lower priced products due to the fact that these products reach the consumer without paying required taxes and tariffs, allowing distributors to charge lower prices for them, while The main benefits of illicit trade to consumers are lower prices and greater brand variety. still benefiting from a healthy mark-up. For example, in Mexico, the price gap between licit premium perfumes and smuggled ones can reach 46%. It is clear that the main driver behind contraband is mainly price. In other occasions, consumers value increased access to some brands as a result of the illicit trade, most notably through purchasing contraband. Illegal distributors have found a business opportunity in rural areas or smaller towns where licit brand owners have limited supply or no supply at all. Regulatory frameworks can also be a hindrance to brand availability, as for some products the supply is intentionally limited due to government regulations. For example, in the tobacco and alcoholic beverages industries, the distribution channels are controlled, while the illicit trade is outside of any regulations, therefore consumers can freely have access to these products. A similar situation occurs with pharmaceuticals, as the supply of smuggled products is not controlled, and sometimes prescription drugs can be bought without one. While not included in the definition of illicit trade, consumers are also able to benefit from increased brand availability through parallel imports. As previously mentioned, this is a common practice in industries like alcoholic drinks, tobacco, beauty and personal care products, apparel and consumer electronics, amongst others. As the supply of original branded products is carried out outside authorised channels, consumers can access the products in informal channels or through direct sales, thus increasing availability. It is also important to mention that, in some instances, increased availability of some brands comes with other benefits, such as ease of payment (e.g., weekly installments) and home delivery in rural areas. EUROMONITOR INTERNATIONAL

20 Winners and Losers of Illicit Trade In regards to luxury brands, consumers can satisfy their aspirational wishes through counterfeit, as sometimes they ignore the lack of authenticity of the brands purchased, or it is socially acceptable to buy a fake product if the status of the brand would be the same. Government Finally, an argument can be made that the illicit market generally benefits the local economy by generating employment in the informal sector, absorbing unemployment found in the formal sector. Euromonitor International has found that for some industries, especially the ones that do not represent a high health risk, this effect is not concerning to local governments because it allows more More illicit activity sometimes translates into lower unemployment and less demand on public welfare. members of its population to sustain themselves economically. Consequently, more inhabitants are less dependent on public welfare programs and social assistance and have more financial resources to potentially stay out of or emerge from poverty, all of which supports government efforts to improve the lives of their populace. The losers Most stakeholders study and track the illicit trade because of the many negative effects it has on consumers, industries and governments, which are considered the main losers. Despite the fact that some actors benefit from the illicit trade, it does not justify any criminal activity and should not be used as an argument in its favor. In general, when there is an impact on consumer health or when large scale organised crime and tax fraud is involved, governments tend to pay more attention to the problem. Nevertheless, actions are required in all instances, regardless of the magnitude of the problem, because ultimately, the negative effects of the illicit trade significantly outweigh the positive ones, producing a negative net impact on society. 16 EUROMONITOR INTERNATIONAL 2015

21 Winners and Losers of Illicit Trade Negative Effects of Illicit Trade Consumers Government Industries Health risk Source: Euromonitor International Fiscal loss Cost of health issues Increased criminal activity Greater instability Damaged brand image Unfair competition Consumers For consumers, the main risk is health related problems due to the consumption of illicit products, which do not adhere to the same safety standards as regulated products in the formal market. Popular examples of illicit products that pose a risk to consumers are expired and counterfeit Illicit products pose serious pharmaceuticals, counterfeit and refilled health risks to consumers. alcoholic drinks and artisanally-made products. A recent example of consumers being negatively affected by illicit products occurred in June 2015, when at least 25 people died in Mumbai, India, after consuming homemade alcohol that had hazardous levels of methanol. Looking specifically at illicit pharmaceuticals, consumers not only face the risk of their medicine containing harmful ingredients, but also of the medicine not containing the properties they need, causing an interruption of medical treatment for a potentially life-threatening condition. This is the case with many counterfeit pharmaceuticals, which are made out of a combination of ingredients that sometimes include flour, sugar, coloring agents and toxic materials. In Honduras, at least nine women died last year due to the intake of counterfeit drugs supplied in a major public hospital, as they interrupted their medical treatment 6. EUROMONITOR INTERNATIONAL

22 Winners and Losers of Illicit Trade Government From the government perspective, the situation is also adverse, as the negative effects are not limited to direct impacts, such as fiscal loss and health issues in the population, but other side effects, like increased criminal activity and greater instability in the country. In regard to fiscal loss, the story of illicit cigarettes helps to underscore how big of a problem this can be. In 2013, the volume of illicit cigarettes consumed in the world was approximately 570 billion sticks with an estimated value of US$39 billion, which was nearly identical to the value of revenues that were not collected in taxes if the products were sold in the licit market. This means that governments from around the world lost US$40 billion in tax revenue that could have been spent on improving their countries 9. It is also important to analyse the existing links between illicit trade and criminal groups, as it poses a serious risk for governments due to negative effects on social stability, law enforcement, violence and other social conflicts. Illicit trade tends to encourage other illicit activities, such as money laundering and narcotic drugs trafficking thereby increasing the overall criminal activity within a country. According to the World Customs Organisation, trafficking in cigarettes is assumed to be one of the main sources to fund terrorist activities in the sub-saharan region where criminals involved in this trafficking closely cooperate with regional terrorist groups 4. Industry Without a question, the brand owners and licit manufacturers are also losers as they have to compete against illicit players that operate outside of any regulatory framework. There are several negative impacts, from damaged brand image to unfair competition. Illicit trade reduces tax revenues and increases instability. Illicit trade steals market share and damages brand image of licit manufacturers. 18 EUROMONITOR INTERNATIONAL 2015

23 Winners and Losers of Illicit Trade According to the International Anti-Counterfeiting Coalition, the US Department of Homeland Security seized over US$1.7 billion of counterfeit goods at the borders in In the same year, European customs authorities detained almost 36 million items suspected of violating intellectual property rights, according to the Commission of Taxation, Customs, Anti-fraud and Audit. Meanwhile, popular Chinese e-commerce platforms Jumei and Jingdong Mall were recently caught up in a scandal of hosting vendors who sell fake luxury goods. In addition, luxury fashion company LVMH claimed that 90% of the designer items sold on auction site ebay were fakes 8. For premium or luxury brand owners, their image is the most important asset to protect, thus the strategies to fight against the illicit trade are a core component of their operations. According to Euromonitor International research, in spite of the efforts of manufacturers, counterfeit products, which are particularly numerous in luxury accessories such as luxury bags and sun glasses, are likely to continue to threaten sales 1. For other products like consumer electronics, ink cartridges, vehicle lubricants and pharmaceuticals, functionality of the product, is strongly affected by counterfeit versions, either falsifications or tampered products, eroding consumer trust in a brand and leading to a long-term negative impact on brand revenues. Another main concern from brand owners and licit manufacturers is the lack of control related to the supply chain for products imported and distributed through unauthorised companies (parallel imports) or illicit importers (contraband); this situation allows products to be sold at different retail channels that are not always aligned with the brand target market. For example, in Bangladesh, despite the availability of original famous branded fragrances in luxury stores, there are a huge number of counterfeit products available, which are usually sold in bazaars such as Chowkbazar 10. Overall, as licit manufacturers and brand owners comply with all industry regulations, the competition with their illicit counterparts is completely unfair. They are playing in the same field but with a different set of rules. Unfortunately, some public strategies meant to tackle the illicit trade or harmful consumption, conversely distort the rules even more. A clear example of this are regulations and taxation policies that affect only the licit manufacturers and distributors, but for which illicit players use non-compliance as part of their competitive strategy such as producing and selling without any restrictions or tax burdens. EUROMONITOR INTERNATIONAL

24 Winners and Losers of Illicit Trade As mentioned before, from the consumer perspective, illicit products are attractive if they are more accessible (in different channels, avoiding laws banning products and free of any controls on purchases) and lower-priced (tax evasion). For the licit companies, the fact that consumers have access to lower-priced substitutes increases the pressure to reduce prices, in order to compete. Nonetheless, local brand owners and distributors are not alone in this fight. Global organisations have joined forces with leading industry players to raise awareness about the negative effects derived from the purchase and trade of illicit products. A good example is the global campaign Fakes cost more I buy real, led by The International Chamber of Commerce s Business Action to Stop Counterfeiting and Piracy (BASCAP). This campaign is based on extensive research on what drives consumers to purchase counterfeits and download unauthorised content and what might convince them to stop these activities EUROMONITOR INTERNATIONAL 2015

25 ILLICIT ALCOHOL IN LATIN AMERICA: A CASE STUDY Over the past four years, Euromonitor International has conducted research in 17 countries in Latin America to estimate the size and shape of the illicit market in the alcoholic beverages industry. By using a standard methodology and consistent definitions, we provide cross-comparable data that not only helps track the market changes through time, but also identifies the main drivers behind the market. According to Passport, Euromonitor International s global market research database, the licit alcoholic beverages market in 80 countries reached 252,740.7 million litres in 2014, US$1,506.6 billion in retail value. Latin America represented almost 15%, consuming 36,967.2 million litres in the same year. Globally, beer is the most consumed alcoholic beverage representing 78% of the market in volume terms, followed by wine and spirits. In Latin America, the share of beer consumption is higher, approximately 88% of the total market. On average, we estimated that 24% of the alcoholic beverages consumed in Latin America are illicit. EUROMONITOR INTERNATIONAL

26 Illicit Alcohol in Latin America: A Case Study Illegal Alcohol, Latin America, Share of Volume LAE, 2013 Peru, 5% Brazil Mexico Colombia, 5% Colombia Peru Venezuela Ecuador Argentina Bolivia Mexico, 18% Brazil, 63% Dominican Republic Chile Costa Rica El Salvador Honduras Nicaragua Panama Trinidad & Tobago Source: Euromonitor International In 2013, Peru exhibited the highest share of illicit alcohol with 30.6%, compared to Panama s 2.4%. However, in volume LAE (litres of alcohol equivalent), the biggest markets in the region are Brazil, Mexico, Colombia and Peru. In general, there are two main types of markets: those with sanitary issues such as higher consumption of counterfeit, artisanal homemade products and surrogate alcohol and those with fiscal issues such as higher consumption of contraband or tax leakage. While some countries like Brazil are mainly affected by artisanal (home produced) alcoholic drinks, others like Peru and Colombia struggle the most with counterfeit and contraband. In volume terms, the most common categories of illicit alcohol in Latin America are illegal artisanal beverages (42.1%) and counterfeit (39.4%); together they represent the main issue for local governments and industry players. 22 EUROMONITOR INTERNATIONAL 2015

27 Illicit Alcohol in Latin America: A Case Study Illicit Alcohol by Category, Share of Volume LAE, % 90% 80% 22.6% 5.3% 70% 60% 42.1% 55.6% 15.9% 35.9% 50% 40% 12.8% 6.2% 30% 20% 39.4% 38.2% 59.2% 45.5% 10% 0% Latin America Brazil Peru Colombia Counterfeit Contraband Illegal Artisanal Surrogate Tax Leakage Source: Euromonitor International Given the size of the problem in terms of lost revenues for companies and government, let alone the health risk implications, industry players, trade associations and local governments are joining forces to tackle this issue. Over the past years, awareness campaigns have increased in countries like Peru, Colombia, Ecuador and El Salvador, among others. Even so, the actions are yet not enough as the illicit industry takes advantage of the weak regulatory environment, the increasing demand for low price products and institutional corruption that allows poor enforcement. Based on the results of studies conducted in the region, Euromonitor International has identified firsthand solutions that can be implemented to help reduce the size of the illicit market, including: Private sector should participate as a key partner of the government, providing resources and knowledge about this phenomenon when lacking. Collaborative effort between industry, government and other stakeholders to execute awareness campaigns about the negative effects of illicit trade in society in general. EUROMONITOR INTERNATIONAL

28 Illicit Alcohol in Latin America: A Case Study Given that ethanol is the main ingredient used for counterfeit and illicit manufacturing of alcoholic beverages, it is important to implement mandatory regulations for the denaturing of ethanol in countries where these do not exist. This measure should be considered at the regional level to tackle illicit cross-border flow. The traceability of volumes of produced and imported ethanol is also key to reduce the size of the illicit alcohol market. In this sense, it is recommended to implement a registry of producers, importers, traders and buyers of ethanol, in order to keep track of all volumes commercialized and its end usage. 24 EUROMONITOR INTERNATIONAL 2015

29 WHY ILLICIT TRADE MATTERS As this paper emphasises, the illicit trade can have serious negative impacts on consumers, governments and industries, especially related to: Health of consumers Government tax collection Law enforcement and adherence to regulation Brand image of licit manufacturers This phenomenon is not exclusive to a particular industry but touches a wide range of products and markets. Globally, there are some industries leading the focus on this topic, such as tobacco, pharmaceuticals and alcoholic drinks. However, with the potential to negatively impact almost every industry, illicit trade warrants broad attention from all stakeholders. While global organisations are increasing awareness of the negative effects of the illicit trade on consumer health, Euromonitor International research has found that there are many industries in which consumer health is not at risk, but that could benefit from researching the illicit trade due to its negative impact on the licit business community. In these industries, the illicit trade is costing brand owners and legitimate manufacturers millions of dollars in lost revenues. EUROMONITOR INTERNATIONAL

30 Why Illicit Trade Matters Given this reality, the involvement of the licit companies is required, especially in those industries under-researched by the global organisation community. By researching the illicit trade, decision-makers would be able to: Understand true commercial potential of a market Understand and dimensionalise potential threats to brand equity Inform and engage external stakeholders in constructive dialogue Inform a media and PR campaign to help protect consumers from potentially harmful products Give greater context to enforcement and tactical initiatives of brand protection teams Help track final destination of own products (i.e., where your product is actually being sold without your involvement) Identify potential commercial opportunities 26 EUROMONITOR INTERNATIONAL 2015

31 ABOUT EUROMONITOR INTERNATIONAL Euromonitor International is the world s leading provider of global business intelligence and strategic market analysis. We have more than 40 years of experience publishing international market reports, business reference books and online databases on consumer markets. As an independent company, we offer unmatched detail and unbiased content for every region, country, category and channel, from socioeconomic context to intimate detail on the smallest products or markets. Our expertise on illicit trade research goes from, but is not limited to alcoholic drinks, tobacco, beauty and personal care products and premium brands. In our custom research projects, we have partnered with global companies and organisations, helping them understand the illicit trade in more than 21 markets across Latin America, Africa, India and Eastern Europe. Research has included measuring the size and shape of the illicit market, in addition to identifying and understanding the main drivers and trends affecting it. Our research capabilities have helped our clients to develop effective strategies for countering the illicit trade, which have included educating partners in government and global non-governmental organisations of the seriousness of the problem in their industry. We have also shared our knowledge in international forums and conferences in Europe and the Americas, bringing an industry perspective to the global discussion on this topic. Request a consultation to learn more about illicit trade or our custom research solutions. EUROMONITOR INTERNATIONAL

32 THE AUTHORS PHILIP BUCHANAN Head of Consulting Latin America Euromonitor International, USA LinkedIn Philip Buchanan oversees all of the custom research projects that Euromonitor International executes in Latin America. Key responsibilities include ensuring quality control and best practices in research and project management, exploring new areas of innovation, overseeing large and complex projects, and helping to drive increased business in the region. Philip has experience managing projects across a wide range of industries, but has specialized in the agricultural and beverage industries. His projects have largely focused on international trade, market entry, global competitiveness, supply chain dynamics, and B2B matchmaking events. Philip holds a Master s degree in International Development from the Fletcher School at Tufts University and a Bachelor s degree in Economics and Spanish from Washington University in St. Louis. 28 EUROMONITOR INTERNATIONAL 2015

33 The Authors LOURDES CHAVARRIA Consulting Manager Euromonitor International, USA Lourdes Chavarria leads a team of consultants managing custom research projects predominantly in Latin America. Since joining Euromonitor International, Lourdes has worked in projects across a wide variety of industries such as Non-Alcoholic Drinks, Packaged Food, Agribusiness, Beauty and Personal Care and Consumer Finance, while developing an expertise in alcoholic drinks. For the past years, she has been the key team lead working on Illegal trade research, acting as a facilitator or a project manager. Due to her expertise in the illegal trade research realm, Lourdes has actively participated in different forums of discussion, sharing Euromonitor s learnings as a result of conducting this research in more than 20 countries of Latin America, Eastern Europe and Africa. Lourdes holds a Master s degree in e-business from Universitat Oberta de Catalunya, a Master s degree in Corporate Social Responsibility from Universidad de Alcalá, and a BA in Marketing from UNITEC (Universidad Tecnológica Centroamericana). EUROMONITOR INTERNATIONAL