Non-deceptive Counterfeiting and Consumer Welfare: A Differential Game Approach

Abstract

Counterfeiting, which is defined as illegally copying genuine goods with a brand name, is a widespread phenomenon and is imposing a huge cost on owners of trademarks. As a consequence, to deter counterfeiting authorities fine anyone producing or trading (in) fake goods. Yet, consuming counterfeit products is not prosecuted in certain countries, like the US or the UK, whereas it is in France or Italy. Why is it so? To tackle this issue we study how the entry of a counterfeiter affects the legal firm’s pricing and advertising strategies and profits when there is no public nor private enforcement of property rights. The rationale for focusing on price and advertising is in fact straightforward. First, it is probably the high margin, that is, the difference between the price and the (comparatively very low) production cost that makes counterfeiting financially attractive. Second, the high willingness-to-pay by consumers is driven by the brand image or reputation, and this asset is notably built through advertising. Third, public enforcement of property rights is often lax or imperfect and not all legal firms can afford private enforcement policies. Our results are as follows: First, we obtain that counterfeiting affects negatively pricing and advertising strategies before and after entry occurs. Thus counterfeiting never stimulates the building of brand reputation. Second, we show that while counterfeiting always reduces the profits of the owner of the genuine product, there are circumstances under which consumers benefit from this illegal trade (in this case the decrease in the price of the genuine good compensates the decrease in the brand reputation of this good). Such a result can rationalize the observation that fining producing and trading in fake goods can go in pairs with non-fining consumers of fake products.