Costco's Swatch Sales May Lead High Court to Limit Gray Market

In the early 2000s, Costco Wholesale Corp. worked out a way to sell Seamaster watches made by Swatch Group AG’s Omega unit for a third less than the suggested retail price.

Costco found a distributor offering watches originally sold overseas, where Omega charged less than it did in the U.S. for its goods. The discount let Costco, the largest U.S. warehouse club, sell the watch for $1,299, compared with the $1,995 suggested retail price.

The purchase was part of the multibillion-dollar “gray market,” whose future is in the hands of the U.S. Supreme Court. The court today hears arguments in Washington on Omega’s bid to use a copyrighted logo on its watches to block Costco’s sales. Costco’s allies, among them EBay Inc. and Amazon.com Inc., say a ruling for Omega would also imperil sales of second- hand items and even the lending of library books.

“It would have devastating consequences,” said John Mitchell, a Washington lawyer who filed a brief backing Costco on behalf of trade groups that represent video-game, home-video and music retailers.

Whether that claim is hyperbole is one issue the justices will tackle as they try to determine how much power Congress intended to give copyright holders. Omega and its backers, including the Obama administration, say it is Costco’s interpretation of the law that would mark the major change, depressing copyright values by forcing holders to level the prices they charge around the world.

Parallel Sales

“What the case is about is the relentless determination of Costco and entities like it to keep lowering prices notwithstanding any other consideration,” said Charles Sims, a New York lawyer who filed a brief supporting Omega on behalf of the Washington-based Association of American Publishers. “The fact is that Congress in the copyright law imposed some other considerations.”

The gray market, also known as parallel sales, costs manufacturers as much as $63 billion in sales a year, according to a Deloitte LLP analysis conducted for Bloomberg last year. A manufacturer with $10 billion in sales can lose as much as $450 million, Deloitte found.

The Supreme Court case turns on the scope of the first-sale doctrine, which says a copyright holder can profit only from the original sale of a product. In 1998, the Supreme Court unanimously ruled against copyright holders by saying the doctrine applies to U.S.-made products sold overseas. The court said copyright holders can’t block those goods from being brought back into the U.S. through unauthorized channels.

‘Anomalous Result’

The question now is whether that same reasoning applies to goods manufactured abroad. A San Francisco-based federal appeals court said it doesn’t, ruling that Omega could block importation of its foreign-made watches.

The administration’s support for Omega likely reflects a desire to protect U.S. manufacturers who make their goods abroad, says Nathaniel Edwards, a copyright and trademark lawyer at Lewis and Roca LLP.

“I think the Obama administration is concerned that the same thing could happen here to U.S. companies that happened to Omega,” Edwards said.

Even so, the administration said in a court filing that its interpretation would create an “anomalous result.” Copyright holders would be able to bar importation only if they made the items in a foreign country, acting U.S. Solicitor General Neal Katyal said.

EBay and Google

A ruling favoring Omega “would push even more manufacturing overseas,” said Scott Schwartz, a Philadelphia intellectual property attorney with Cozen O’Connor. “Manufacturers will no doubt revisit their manufacturing strategies to avail themselves of the benefits of such a ruling.”

Katyal’s position mirrors that taken by his former boss, Elena Kagan, the ex-solicitor general who is now on the Supreme Court. Kagan isn’t taking part in the court’s consideration of the case, creating the possibility of a 4-4 split that would leave intact Omega’s appeals court victory.

EBay, in a brief also signed by Google Inc., says a ruling favoring Omega would “stifle secondary markets” -- those for previously sold goods. The companies argue that participants wouldn’t know whether products were foreign-made and still protected by copyrights.

Costco, based in Issaquah, Washington, also has the support of GameStop Corp. and Target Corp., both fellow retail chains; Intel Corp., the world’s biggest chipmaker; Public Citizen, a consumer-advocacy group; and six library associations.

Library Impact

The libraries say they would risk infringing a copyright every time they lent a foreign-made book.

“Without a clear exception, libraries may hesitate to lend materials in their collections,” three groups including the American Library Association argued.

Sims, the lawyer for the publishing industry, said those contentions don’t reflect the “real world.”

“There have been exclusive publishing agreements over the past 100 years and libraries have gotten along very well,” he said. “School teachers don’t get arrested in the real world. Libraries don’t get indicted in the real world.”

Omega has support from the film and music industries, office equipment makers including Seiko Epson Corp. and the Intellectual Property Owners Association, a trade group whose members include drugmakers, oil companies and computer companies. Swatch is based in Biel, Switzerland.

The case, which the court will decide by July, is Costco v. Omega, 08-1423.

To contact the reporter on this story: Greg Stohr in Washington at gstohr@bloomberg.net.

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net.

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