Omega v. Costco before the Supreme CourtIf the U.S. Supreme Court sides with Swatch Group's Omega watchmaking unit in its war with wholesale club giant Costco, U.S. consumers -- and perhaps workers -- could lose big. Luckily for consumers, however, the tea leaves suggest that Costco (COST) will beat Swatch's (SWGAY) Omega.

At issue are "gray market" goods -- items originally sold abroad, brought into the U.S. and resold here. Why would a retailer go to the trouble to buy something overseas -- say, a very expensive Omega Seamaster watch -- to resell here? Because in many foreign markets, that watch is much cheaper than it is here. That means the retailer -- say, Costco -- can make a profit by importing it and selling it for a third less ($1,299 versus $1,995 in the Seamaster's case) than the suggested retail price of the identical watch intended to be sold here.

The watches are literally identical because the imported ones are still brand new, not used. The foreign purchaser is essentially a middleman, buying them new with the intent of selling them to a U.S. retailer. As USA Today explained a few years ago, one way gray-market goods can differ, however, is that the manufacturer can refuse to honor the product's U.S. warranty. That's not an issue with the Omega watches sold by Costco, however, because according to its brief, Costco gives the watches a better guarantee than Omega itself does.

Stakes High All Around -- Even for Libraries

From a consumer's standpoint, gray-market goods offer substantially reduced prices, although consumers need to pay attention to warranties. As a result, if the Supreme Court agrees with Omega that U.S. copyright law prohibits Costco from selling the foreign-manufactured, foreign-sold watches, many bargains will disappear from store shelves. Arguing against that result, Public Citizen claims that giving Omega the ability to "control downstream sales might allow it to more effectively control prices among different markets. But protection of Omega's preferred business model is not an interest that the Copyright Act protects."

In addition, consumers' ability to use the property they purchase in whatever way they wish is also at stake, argues Public Citizen and, separately, a group of librarians and public interest groups. The librarians claim that an Omega win could jeopardize "used bookstores, libraries, yard sales, out-of-print book markets, movie and video-game rental markets, and innumerable other secondary markets." That's because such markets depend on the "first-sale" doctrine, which says someone who legitimately buys a copyrighted work can do what they like with it -- including sell it to someone else -- without getting the copyright holder's permission.

That makes intuitive sense, has a centuries-long legal basis and is codified in federal law. An Omega win would limit the first-sale doctrine and, the argument goes, endanger secondary markets.

Losing Billions of Profits

The stakes for manufacturers are huge, too, because the gray market is estimated to cost them billions. A 2003 study by KPMG and an anti-gray-market alliance of info-tech companies found the gray market cost the IT industry $5 billion in profits each year. Deloitte did a study for Bloomberg last year and found that the gray market cost companies $63 billion in lost sales (not profits) a year, though not a large percentage for any one company. A company with $10 billion in sales would lose $450 million, or 4.5%.

And it's not just watches (or other goods) at issue, warns an Omega-supporting brief from the Association of American Publishers. Rather, a Costco win would "substantially harm copyright owners and the public, impairing the incentives to create and disseminate copyrightable work, the quality of published works, and the vitality of domestic publishers."

Nor is Omega's "preferred business model" the only one at stake. The movie and music industries explain how a Costco win threatens them:
"In the motion picture industry, for example, a studio will frequently treat national markets separately for purposes of theatrical and home video releases. The studio's ability to do so can be critical to a film's commercial success. In the music industry, recordings are often released at different times in different countries, depending on the strategic considerations of the local territory. Unauthorized importation could undercut these important practices and reduce the value of U.S. movie and music copyrights."
A Blow to the U.S. Economy?

One group that could feel the impact of the Court's ruling-to-be is manufacturing workers. Costco claims that if Omega wins, manufacturers have an incentive to move factories overseas because then they'll enjoy greater copyright protection. That's because the key Supreme Court precedent in this case, Quality King Distributors, Inc. v. L'anza Research International, Inc., decided at a minimum that it was OK to make something in the U.S., sell it for the first time overseas to one of these middlemen and have it be resold here. That is, the first-sale doctrine did apply to imports of goods made here but sold for the first time overseas. So if Omega was making the watches sold by Costco here, it would have no basis for complaining.

Indeed, the key legal question is whether Quality King applies only to copyrighted goods sold abroad for the first time regardless of where manufactured, or does it apply only to goods that were manufactured here. Would manufacturers relocate factories they otherwise wouldn't to ensure they could control the distribution chain of their products in the U.S.? I'm not sure that losing 4.5% of total sales would be enough to do that, but the incentive certainly exists.

Google (GOOG), eBay (EBAY) and a couple of Internet trade groups forcefully make the argument that an Omega win would hurt the U.S. economy by shifting factories overseas, endangering small businesses that don't know where their distributors got their merchandise and stifling secondary markets, including consumer-driven ones.

Libraries also sided with Costco because the first-sale doctrine is essential to libraries' existence. Because many books are now manufactured overseas, often with no indication of that, librarians worry that they won't know if they're buying gray-market books illegally and would incur substantially higher costs by obtaining lending licenses for books not clearly made here. At a time when libraries face funding cutbacks nationwide, that would have a big impact on their collections. As a result, the librarians are asking that if Costco loses, the Court protect libraries by ruling, for example, that library lending constitutes "fair use."

Maybe This Isn't Even a Copyright Case

One interesting brief filed in support of Omega by the Intellectual Property Owners Association (IPO) points out that perhaps this case shouldn't really be a matter of copyright law, because the only thing copyrighted on the Omega watch is a tiny logo Omega put on the watch's back for the sole purpose of invoking copyright protection to stop gray-market goods. That is, the copyrighted material is purely incidental. As Costco points out in its brief, for years Omega didn't mind what Costco was doing. But after U.S. retailers selling full-price watches in competition with Costco complained, Omega added the symbol and objected to what Costco was doing.

The IPO supports ending such game-playing and allowing gray-market goods, but it wants to avoid using the first-sale doctrine to achieve that end. As a result IPO would have the Court send the case back to determine if copyright law really should apply to the watches in the first place.

Unfortunately for libraries and consumers, the IPO defines books as among the goods that, unlike watches, should have copyright protection, and if the Court agrees with IPO's logic, libraries and secondary markets would be threatened, at least as far as goods like books are concerned. And because it's possible that courts would ultimately decide that copyright law did cover the watches, all of the other concerns at stake wouldn't be definitely resolved.

Applying U.S. Law Overseas?

Generally speaking, U.S. law -- including copyright law -- isn't supposed to be used "extra-territorially." That is, outside the U.S., foreign laws apply, not U.S. law. So when the first-sale exemption speaks of items "lawfully made under [U.S. Copyright law]," does that mean goods made in the U.S. only, or also goods created in compliance with U.S. copyright law regardless of where they're made?

That question is complicated by another provision of copyright law that allows copyright holders to control imports so that if the first-sale doctrine applies to goods manufactured overseas, that import control right is very limited.

Costco also has support, perhaps surprisingly, from Intel because patent law has a very similar doctrine that's important to the chipmaker. However, Fuji Film and others side with Omega and take Intel (INTC) on directly, accusing it of trying to hijack the case and turn it into one about patent law. (Fuji disagrees with Intel on the patent issue.)

Good Omens for Costco

The federal government supports Omega because it believes a Costco win would apply U.S. law extra-territorially. But the U.S. supported Omega while Justice Elena Kagan was the government's top litigator as the Solicitor General, so she won't help decide this case. That makes a 4-4 tie theoretically possible. While it's a fool's game to bet on how the Supreme Court will ultimately decide a case, some omens look good for Costco.

First, the Court rules for the party seeking to change the lower-court outcome most of the time, and it reverses decisions of the Ninth Circuit Court of Appeals (where this case came from) slightly more often than cases from other circuits. Second, although when the U.S. weighs in, the Court usually agrees with it, so far this time it hasn't: The U.S. opposed the Court's decision to hear the case. So maybe the Solicitor General's mojo isn't working this time. Third, the Quality King case was a unanimous decision, with Justice Ruth Bader Ginsburg filing a one-paragraph concurrence, not joined by any other justice, suggesting that extra-territoriality might be a big concern in a case like the one today. That suggests a majority in 1998 might have seen things Costco's way.

Of course, four of the Quality King justices are no longer on the court -- Justices William Rehnquist, Sandra Day O'Connor, David Souter and John Paul Stevens -- and perhaps their replacements -- Justices John Roberts, Samuel Alito and Sonia Sotomayor -- won't see the issues similarly. (Again, Justice Kagan is sitting this one out.)

Good omens for Costco aside, it'll be a few months before we really know how this one turns out.

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gail and theresa

Everybodies talking like omega is taking a loss, quite the contrary they are making their profits on this product. Costco is also making a profit as well, all though it's a small profit they are making it up on volume. A two thousand doller watch is a slow moving product and if there's a surplus then there just taking up valuble retail storage space. A bird in the hand is worth two in the bush and money is only made when the products move off the shelves.

November 15 2010 at 10:28 PM Report abuse +1 rate up rate down Reply

I always presumed Grey Market Goods meant a copy not made by he original producer.Is the Omega watch sold in a Costco store a knockoff of the original . Could a foreign company fair trade a product in the U.S,A.? Are fair trade laws still legal in U.S.A.? Marahi

November 15 2010 at 7:17 PM Report abuse rate up rate down Reply

Its called capitalism-----buy low - sell for a profit- not rocket science----omega is just pissed because the didn't get their normal fleecing of the U.S. consumer--- too bad so sad--- good lookin out costco.

November 15 2010 at 6:41 PM Report abuse +1 rate up rate down Reply

I love a well-thought-out, well-presented article that discusses legal issues even-handedly.

November 15 2010 at 5:37 PM Report abuse rate up rate down Reply

Wait untill Jerry Brown finds out about this. The Union didn't get their 33% mark up. Jerry will be mad that Califorians didn't have to pay double the price. What's with Costco to give Califorian's a break. Somthing we can't get our Union based government to do.

November 15 2010 at 4:26 PM Report abuse +1 rate up rate down Reply

I fail to see how this is lost sales to Omega. If they applied the same price to everyone in the world, Costco would buy directly from Omega. It seems to me that the world believes Americans are rolling in the cash, so lets make them pay more for our product. How come nobody is asking why do we Americans have to pay more for the same product that cost less in other countries? If Costco buying products from other countries and shipping the products here and the result is still cheaper than if you purchashed directly from Omega tells you they were marked up because we are Americans.

November 15 2010 at 3:57 PM Report abuse +2 rate up rate down Reply

You people talking about unions don't have a clue.You have watched to many Jimmy Hoffa news clips.The Mafia? That was 60-80 years ago.American workers have been utilizing their right under federal law to unionize since the 1800's.It began with the railroads.With the rise of the industrial revolution, brought forth the steel industries,coal mines,oil refineries and more track.Working 12 hours a day,7 days a week for slave wages is what they fought against.And the american workers unionized all of these industries.And things did get bloody during the great depression.I was young and I was there.Right there in Chicago.The Mafia did back the union american workers.But not with the same vision.The Mafia seen the union as a vice for racketeering.The union worker seen the Mafia as a vice for clout with the federal government.The seperation of the american workers union from the Mafia was bloody.As was with the companies being organized.It became a fourway fight when Roosevelt sent in the national guard.Roosevelt pleaded with the companies to allow the unionization and start paying their workers better.This is the history that most of you remember.But that is the past.What you people don't know is that union american workers only fought for the 10% of profits that all companies set aside for labor.American workers negotiate a contract with their employers.The employers negotiate(in good faith) and give the amount they see fit to cover wages and legacies.The american workers vote amongst theirselves how much goes towards wages,pensions and benefits.This is the workers pay.They can vote to put more into wages and less in pensions and benefits.And a contract is written.Under federal law the companies books are opened up to the unions.The fair negotiation is overseen by the National Labor Relations Board.In other words the union workers cannot rape the employer and the employer cannot rape the american worker.And american workers unions always stay within the 10% alloted to labor costs.They negotiate every contract year to keep the wages abreast of inflation.Most non-union workers don't realize union workers pay their union to fight for the non-union workers rights in court.Unions fight for fair wages everyday in federal courts for all americans,not just union.They fight for a higher minimum wage.With the absence of inflation do to our treasury,the minimum wage remains at 7.65 bucks an hour.It should be 15.00 bucks.To give working americans a chance to live a descent life.With the advent of NAFTA under Clinton,corporate america has shown its ugly head.They began to cut wages,hours below 40 so they don't have to pay insurance and pensions.And move the jobs overseas.While blaming unions even though they were not unionized.The unions tried to organize Walmart.The company told their workers the same as all companies do.They would lose jobs and hours.Instead of saying that management would have to take a cut in pay if the company doesn't want to lose any profit.Or the company could say that they would split the cost between management and profits.Nope,their answer is you will lose you swine workers.Now all you people with a non-union job making a descent living.What happens tomorrow when you get told you are losing 5 bucks an hour and your hours will be cut.Don't think that,that will happen?Tell that to all the other people whose jobs just went overseas.Who will you blame?

November 15 2010 at 3:07 PM Report abuse rate up rate down Reply
1 reply to ruthsgardens's comment

Does that mean you would support getting rid of Social Security and having the Federal Government provide Pensions based upon the Union scale. All Americans would then share in this Gravy Train. Retirement at 55 sounds pretty good and 90% of our wages including overtime in the last 3 years. You said you are fair and this would be fair to all. Public and Private being treated the same.

November 15 2010 at 4:31 PM Report abuse rate up rate down Reply
Brian Workman

COSTCO doesn't care if "OMEGA" goes out of business as long as they can made an easy dollar at any ones expense!! U.S.Supreme Court is correct!

November 15 2010 at 2:55 PM Report abuse -3 rate up rate down Reply

I agree with n8doggod9. This is an arbitrage case, and I wonder what the implications would be for Wall St. if The Court decides in favor of Omega. They frequently, throughout the day, will buy stocks, for instance, on one market and sell on another, taking advantage of fractions of a point to make a profit on volume. The copyright issue is incidental and the case should be sent back to the lower court. Is the U.S.-market product's warranty worth $900 per watch? Or is this just another excuse for a company to charge more for a product on the U.S. market than overseas, like the drug manufacturers do?

November 15 2010 at 2:15 PM Report abuse +4 rate up rate down Reply

If companies like OMega would just set a fair equitable price on their goods, then they wouldn't have a problem from second sales. It's their own greed which makes them vulnerable to this kind of situation. One could say that they acutally make more sales this way, becuase the first buyer is buying an inflated number of watches in order to "secon sell" them. If they couldn't do this, we would probably buy far fewer overly inflated Omega watches than we do, and they would sell less. This is just one more example of how Companies take advantage of the United States, then cry fould when we find a way around their rip offs!!!

November 15 2010 at 2:10 PM Report abuse +4 rate up rate down Reply