Rice Business Professor Amit Pazgal found that in certain situations, gray markets can actually help manufacturers and retailers. Photo by Science in HD on Unsplash

A camera store in Taiwan buys Nikon cameras from an electronics shop in the Philippines, where photo equipment is cheaper. Then the store sells them to consumers in Taiwan at a lower price. The camera comes without a warranty and instructions are in Filipino – the buyers in Taiwan are happy to have a real Nikon for a lower cost.

The sellers and customers are operating in the so-called gray market – where genuine products are sold through unauthorized channels. Gray marketers buy goods in markets with lower prices, then ship them to a market with higher prices, where they will likely sell for a profit. Though the products are identical, consumers typically see gray market goods as inferior since they often lack benefits like after-sale services or warranty coverage.

For years, gray markets have posed a significant threat to both manufacturers and retailers, depriving both of customers and profits. It's estimated that around $7 billion to $10 billion in goods enter the U.S. market through gray market channels every year. The IT industry, for one, loses approximately $5 billion a year due to gray market activities.

No specific laws in the U.S. ban this practice outright, however. As a result, in recent years, retailers are increasingly taking advantage of potentially cheaper prices abroad, personally importing or using third parties to buy original goods not meant for direct sale in the United States – and then selling them here for less. Alibaba, China's most extensive online shopping site, offers its hundreds of millions of shoppers a large array of gray market goods to peruse.

Manufacturers usually respond to gray markets with knee-jerk hostility, urging customers to avoid gray market goods and even filing lawsuits against gray market peddlers. Nikon, for example, includes a website section to educate consumers on how to identify gray market products, to shun the gray market.

But is gray market commerce always destructive? Rice Business Professor Amit Pazgal joined then-Rice Business Ph.D. student Xueying Liu (now an assistant professor at Nankai University) to explore scenarios in which gray markets could be good for both manufacturers and retailers. Testing the theory in recent research, Pazgal and Liu found that there are indeed situations in which both manufacturers and retailers can profit thanks to gray markets, while the associated product also improves in quality.

To reach these conclusions, the researchers started by recruiting 118 participants between the ages of 25 and 45 to complete a gray market product survey. They found the majority had no problem buying gray market goods. Only 3 percent of consumers wouldn't consider buying cosmetics from a gray marketer, while 6 to 7 percent wouldn't buy electronics. Despite this, more than 90 percent of participants who were willing to buy required a price discount of 20 to 30 percent, showing the goods were seen as slightly inferior.

The researchers then tested responses to a model of a manufacturer selling a single product to two markets – or countries – that differed in size and in customer willingness to pay for the product. Consumers in one market would pay more, on average, for quality. For example, the Nikon D500 camera is sold for a 7.5 percent premium in Taiwan versus Thailand and a 10 percent price premium in Taiwan versus the Philippines.

Pazgal and Liu found that when the manufacturer sells their product directly to consumers in both markets when there is also a gray market, both the manufacturer's profit and product quality decrease. But when the same manufacturer sells their product indirectly to a retailer in at least one of these markets, both the manufacturer's and the retailer's profits can increase. So can the product's quality.

This occurs for several reasons. First, gray marketers increase total demand and profit for the retailer in the lower-priced market, or in the market where the gray marketer buys their goods. The manufacturer can set a higher wholesale price for the better quality product in a market where consumers pay more, and increase sales in both markets as consumers compare the regular, high-quality product to the gray market one. In fact, by offering a lower-priced, lower quality (that is, gray market) alternative to its own high-quality product, the manufacturer can better segment consumers in the higher-priced market.

Finally, the retailer in the higher-priced market becomes more profitable even though they lose some customers to the gray market. This is because increased product quality and price more than make up for lost sales. Researchers found that the results hold regardless of whether the gray marketer buys from the manufacturer or a retailer.

The bottom line: in certain situations, gray markets can improve profitability for both manufacturers and retailers (and, of course, the gray marketers). Counterintuitive though it is, manufacturers that sell through retailers shouldn't automatically see gray markets as an obstacle to their profits, rushing to demand that governments and courts shut them down. Instead, in some cases, companies could do well to embrace these gray markets, because they lead to overall improved profits.

Manufacturers can use this information to their advantage, Pazgal noted. Nikon, for example, could introduce a higher quality camera to the market, allowing it to set even higher wholesale prices and increase sales in both markets, far exceeding the cost of the higher quality product.

For consumers, meanwhile, gray markets are always beneficial because of lower prices. If companies heed Pazgal's findings, however, customers could also benefit from more innovative and higher quality cameras and other merchandise, as manufacturers hurry to create better products to bump up their profits.

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This article originally ran on Rice Business Wisdom and is based on research from Amit Pazgal, the Friedkin Professor of Management – Marketing at the Jones Graduate School of Business.

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Tesla recalling more than 375,000 vehicles due to power steering issue

Tesla Talk

Tesla is recalling more than 375,000 vehicles due to a power steering issue.

The recall is for certain 2023 Model 3 and Model Y vehicles operating software prior to 2023.38.4, according to the National Highway Traffic Safety Administration.

The printed circuit board for the electronic power steering assist may become overstressed, causing a loss of power steering assist when the vehicle reaches a stop and then accelerates again, the agency said.

The loss of power could required more effort to control the car by drivers, particularly at low speeds, increasing the risk of a crash.

Tesla isn't aware of any crashes, injuries, or deaths related to the condition.

The electric vehicle maker headed by Elon Musk has released a free software update to address the issue.

Letters are expected to be sent to vehicle owners on March 25. Owners may contact Tesla customer service at 1-877-798-3752 or the NHTSA at 1-888-327-4236.

Houston space tech companies land $25 million from Texas commission

Out Of This World

Two Houston aerospace companies have collectively received $25 million in grants from the Texas Space Commission.

Starlab Space picked up a $15 million grant, and Intuitive Machines gained a $10 million grant, according to a Space Commission news release.

Starlab Space says the money will help it develop the Systems Integration Lab in Webster, which will feature two components — the main lab and a software verification facility. The integration lab will aid creation of Starlab’s commercial space station.

“To ensure the success of our future space missions, we are starting with state-of-the-art testing facilities that will include the closest approximation to the flight environment as possible and allow us to verify requirements and validate the design of the Starlab space station,” Starlab CEO Tim Kopra said in a news release.

Starlab’s grant comes on top of a $217.5 million award from NASA to help eventually transition activity from the soon-to-be-retired International Space Station to new commercial destinations.

Intuitive Machines is a space exploration, infrastructure and services company. Among its projects are a lunar lander designed to land on the moon and a lunar rover designed for astronauts to travel on the moon’s surface.

The grants come from the Space Commission’s Space Exploration and Aeronautics Research Fund, which recently awarded $47.7 million to Texas companies.

Other recipients were:

  • Cedar Park-based Firefly Aerospace, which received $8.2 million
  • Brownsville-based Space Exploration Technologies (SpaceX), which received $7.5 million
  • Van Horn-based Blue Origin, which received $7 million

Gwen Griffin, chair of the commission, says the grants “will support Texas companies as we grow commercial, military, and civil aerospace activity across the state.”

State lawmakers established the commission in 2023, along with the Texas Aerospace Research & Space Economy Consortium, to bolster the state’s space industry.

Houston experts: Can AI bridge the gap between tech ambitions and market realities?

guest column

Despite successful IPOs from the likes of Ibotta, Reddit and OneStream, 2024 hasn’t provided the influx of capital-raising opportunities that many late-stage tech startups and venture capitalists (VCs) have been waiting for. Since highs last seen in 2021—when 90 tech companies went public—the IPO market has been effectively frozen, with just five tech IPOs between January and September 2024.

As a result, limited partners have not been able to replenish investments and redeploy capital. This shifting investment landscape has VCs and tech leaders feeling stuck in a holding pattern. Tech leaders are hesitant to enter the public markets because valuations are down 30 percent to 40 percent from 2021, which is also making late-stage fundraising more challenging. After all, longer IPO timelines mean fewer exit opportunities for VCs and reduced capital from institutional investors who are turning toward shorter-term investments with more liquid exit options.

Of course, there’s always an exception. And in the case of a slowed IPO market, a select slice of tech companies—AI-related companies—are far outperforming others. While not every tech startup has AI software or infrastructure as their core offering, most can benefit from using AI to revise their playbook and become more attractive to investors.

Unlocking Growth Potential with AI

While overall tech startup investment has slowed, the AI sector burns bright. This presents an opportunity for companies that strategically leverage AI, not just as a buzzword but as a tool for genuine growth and differentiation. Imagine a future where AI-powered insights unlock unprecedented efficiency, customer engagement and a paradigm shift in value creation. This isn’t just about weathering the current storm of reduced access to capital; it’s about emerging stronger, ready to lead the next wave of tech innovation.

Here's how to navigate the AI frontier and unlock its potential:

  1. Understand that data is the foundation of AI success. AI is powerful, but it’s not magic. It thrives on high-quality, interconnected data. Before diving into AI initiatives, companies must assess their data health. Is it structured in a way that AI can understand? Does it go beyond raw numbers to capture context and meaning—like customer sentiment alongside sales figures? Rethinking data infrastructure is often the crucial first step.
  1. Focus on amplifying strengths, not reinventing the wheel. The allure of AI can tempt companies into pursuing radical reinvention. However, a more effective strategy is to leverage AI to enhance existing strengths and address core customer needs. Why do customers choose your company? How can AI supercharge your value proposition? Consider Reddit’s strategic approach: They didn’t overhaul their platform before their 2024 IPO. Instead, they showcased the value of their vast online communities as fertile ground for AI development, leading to a remarkable first-day stock surge of 48 percent.

  2. Use AI as a customer-centric force multiplier. Companies with a deep understanding of their customer base are primed for AI success. By integrating AI into the very core of their product or service—the reason customers choose them—they can create a decisive competitive advantage based on delivering tangible customer value.

From Incremental Gains to Transformative Growth

This practical, customer-centric approach has the potential to help companies generate immediate growth while laying the foundation for future reinvention. By leveraging AI to optimize operations, deepen customer relationships, and redefine industry paradigms, late-state tech startups can not only survive but thrive in a dynamic market. The future belongs to those who embrace AI not as a destination but as a continuous journey of innovation and growth.

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Hong Ogle is the president of Bank of America Houston. Rodrigo Ortiz Gomez is a market executive in Bank of America’s Transformative Technology Banking Group as well as the national software banking lead for the Global Commercial Bank.