business

"This Is Robbing Us of Millions"

The CEO of John Paul Mitchell Systems explains how the retailing of gray-market and counterfeit hair-care products hurts his company

In 1980, when John Paul DeJoria and Paul Mitchell borrowed $750 to launch their privately held hair-care outfit, their goal was "a company established by hairdressers for hairdressers," says DeJoria, chairman and CEO of the Beverly Hills (Calif.)-based company.

The partners traveled nationwide conducting no-cost product demonstrations for salon owners, who they guaranteed would be the sole means of product distribution. The manufacturer also pioneered such policies as allowing salon owners to return any unsold product for a full refund. As a result, De Joria says, John Paul Mitchell Systems became one of the fastest-growing privately held companies in the U.S. and now has annual retail sales of $800 million.

The popularity of the company's 90 products, however, has led to an unanticipated problem: counterfeiting and diversion of both phony and real Paul Mitchell products to retail outlets. The situation is so vexing that John Paul Mitchell Systems launched a multimillion dollar TV and print consumer-awareness campaign this year (see "A Gray Streak for Hair-Care Goods"). DeJoria recently spoke about product counterfeiting and diversion with BusinessWeek Special Correspondent Ann Therese Palmer. Here are edited excerpts of their talk:

Q: Why did you launch the product-diversion consumer awareness campaign?

A:

We want our customers to be aware that if they're buying products that look like they're ours -- [with] identical packaging -- they're not ours if they find them on the shelves at drugstores, supermarkets, [or] any other place that's not a beauty salon or a spa. These products are black-market, counterfeit, or illegally diverted.

Q: What's an illegally diverted product?

A:

We have contracts with about 20 distributors in the U.S. They have exclusive rights to distribute our products to beauty salons and spas within a geographic area. The beauty salons and spas have a contract with us to sell only to individual clients. Some beauty salons or spas are reselling our products, in violation of our contract with them, to consolidators who, in turn, sell our products to legitimate retailers like drugstores and supermarkets.

In addition, we've had problems with some of our distributors breaching contract with us and selling to unauthorized customers. Some [Paul Mitchell] product is also being illegally diverted and sold on the Internet on eBay (EBAY ) and drugstore.com.

Q: Do you have any way to determine how much of the product on the shelves in drugstores and supermarkets is illegally diverted product and how much is counterfeit?

A:

Counterfeits [are] constantly being mixed in with the gray-market product, so it's very difficult to determine what the exact percentages are and in which stores. Many retail stores, including Albertson's, CVS (CVS ), and Shop Co., get fooled into thinking that they're buying only gray-market product, when it may in fact be mixed with counterfeit product. However, all drugstores and supermarkets do know that they're not buying it from Paul Mitchell or from a Paul Mitchell Distributor.

Q: Since you launched the ad campaign on Sept. 1, by how much have calls to your hotline increased? In how many supermarkets and drugstores have you been able to stop your product from being sold?

A:

We've received many more phone calls on our hotline, but we're not sure how many stores may have stopped carrying our product. I spoke to the head of a major drugstore chain and asked him why he sold Paul Mitchell knowing that it was mixed product and not sold through our legitimate channels. His answer was that it is very profitable, and as long as the law allows it, he will continue to sell it.

The laws are very lax. The only repercussion is that [retailers] have to remove each bottle that can be proved to be counterfeit. This is why the public needs to know [that] the only real Paul Mitchell product is sold from licensed beauty salons.

Q: What do you think of the new company Profound Beauty's approach to foiling rip-offs and diversions (see "A Way to Turn Gray to Green")?

A:

In the late 1980s in the Washington, D.C., area, top hairdressers and the local hairdressers association started a similar company. They went out of business within one year. Profound Beauty is small. They can do this. It's a new twist on private labeling. We can't do a product right now that has every salon's name on it. We'd have to make out 70,000 [separate] inventories. For us, this isn't a realistic solution to the problem.

Q: How many supermarkets and drugstores do you estimate are selling illegally diverted Paul Mitchell products today?

A:

We don't know that the product is where it shouldn't be until our customers notify us. We know it's out there, but I can't tell you every single mom-and-pop, drug, grocery, or discount store that has it. It's a majority of [major chain retailers] but varies region to region."

Q: What's the response of heads of drugstore and supermarket chains when you tell them that they're selling illegally diverted products?

A:

It's very discouraging. They tell us that the law allows them to do it. As long as it's the real thing, there's nothing that stops them. They're not interested in any contractual relationships we've got with our suppliers or salons. The laws are so lax that, to protect ourselves, in 1985 we started adding the following warning on every bottle of product we manufacture: "This product is not guaranteed when sold by any drugstore or supermarket. It is only guaranteed when sold by a professional stylist."

Q: Why do you think drugstore and supermarket chains persist in doing this?

A:

It attracts customers, and they can make 10% to 20% return on what they're spending to purchase the product.

Q: Efforts to stop these practices don't seem to be working. BusinessWeek reporters have found Paul Mitchell products everywhere they've looked nationwide.

A:

We had a major bust in Florida, but the laws, as currently enforced, are against us. We've got to go into a store, buy as much of the product as we can, determine which bottles are counterfeit and which are illegally diverted, and then go into court. Once we get a court ruling and go to the store, most of the product is gone. If we bring the press into a store, the store will remove the product, but then they put it back again. This is robbing us of millions of dollars in sales.

Q: When you look at the industry as a whole, where do you rank the problem of illegal diversion?

A:

Instead of spending millions in advertising to glorify our product, we're spending millions educating consumers on this issue. It's the most serious problem in the industry.

Q: Can you put a dollar figure on how much you lose annually because of illegal diversion?

A:

It's about 2% of revenues.

Q: That's a minuscule percentage. Are there other ways in which these practices harm the industry or individual consumers?

A:

It's not just about revenues and profits. It's about public safety and consumers not getting the real thing that they're paying for. Our products are natural products. If a product is 3 to 5 years old, it's not going to perform as it would if it were new. The consistency isn't the same. It doesn't work the same way. If people think this is the real Paul Mitchell product and it's really an inferior product, they're not going to be repeat purchasers.

Edited by Thane Peterson

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