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Amazon's counterfeit problem is getting worse, and sellers are enraged

CNBC CNBC 8/07/2016 Ari Levy

Amazon.com (AMZN) is hard at work promoting next week's Prime Day and the more than 100,000 deals available to subscribers. As with all things Amazon, it's intended to be a major party for consumers.

But longtime Amazon sellers like Jamie Whaley are in no mood to celebrate.

A licensed nurse, Whaley started a bedding business on Amazon that reached $700,000 in annual sales within three years. Her patented product called BedBand consists of a set of shock chords, clamps and locks designed to keep fitted bed sheets in place.

Whaley and her husband found quite an audience, selling up to 200 units a day for $13.99 a set. BedBand climbed into the top 200 selling products in the home and kitchen category. That was 2013.

By mid-2015, the business was in a tailspin. Revenue plummeted by half and Whaley was forced to lay off eight employees. Her sheet fastener had been copied by a legion of mostly Chinese knockoffs that undercut BedBand on price and jumped the seller ranks by obtaining scores of reviews that watchdog site Fakespot.com determined were inauthentic and "harmful for real consumers."

"Toe to toe we'll compete with anybody," said Whaley, who recently moved her family and a warehouse full of straps, clamps and chords from Texas to the mountains of Montana. "When you try to cheat or copy our products, it's a whole different story."

Whaley still counts on Amazon for 90 percent of her revenue, but she's actively trying to drive traffic to her own website and partner with other retailers. She's lost all trust in Amazon.

Spend any time surveying Amazon sellers and Whaley's narrative will start sounding like the norm. In Amazon's quest to be the low-cost provider of everything on the planet, the website has morphed into the world's largest flea market — a chaotic, somewhat lawless, bazaar with unlimited inventory.

Always a problem, the counterfeiting issue has exploded this year, sellers say, following Amazon's effort to openly court Chinese manufacturers, weaving them intimately into the company's expansive logistics operation. Merchants are perpetually unsure of who or what may kill their sales on any given day and how much time they'll have to spend hunting down fakers.

Facebook (FB) and WhatsApp groups have formed for sellers to voice their complaints and strategize on potential fixes.

In May, CNBC.com reported on a Facebook group, now consisting of over 600 people, whose members have seen their designs for t-shirts, coffee mugs and iPhone cases show up on Amazon at a fraction of the price of the originals. The designers described it as a game of whack-a-mole, where fakes pop up more quickly than they're taken down.

It's not a topic you'll likely hear CEO Jeff Bezos discuss. Especially ahead of the second annual Prime Day on Tuesday, when Amazon Prime members get access to new deals about every five minutes. During the inaugural event last year, consumers bought 398 items per second, even as social media blew up with jokes about the quality of the offers.

While Amazon's focus has always been on consumers, the company is plenty aware of emerging seller angst.

In early June, at an invitation-only event for about 300 of the top marketplace merchants, the company's senior vice president of seller services Sebastian Gunningham was grilled by frustrated store owners, according to people with knowledge of the meeting.

During a fireside chat at Amazon's Seattle headquarters, Gunningham was asked repeatedly how the company was going to deal with the many ways that Chinese manufacturers were gaming the system, said the sources, who asked not to be named because attendees had to sign non-disclosure agreements.

An Amazon spokesperson declined to comment.

Outside merchants are a large and growing piece of the Amazon pie.

More than 40 percent of Amazon's unit sales now come through its third-party marketplace. Much of the expansion has occurred since Amazon started opening the floodgates to Chinese manufacturers, who previously had to count on middlemen, brands and private labels to reach global consumers.

Sales from Chinese-based sellers more than doubled in 2015 on Amazon's marketplaces, while the company's total revenue increased 20 percent. And recently, Amazon even registered with the Federal Maritime Commission to provide ocean freight, simplifying the process for Chinese companies to ship goods directly to Amazon fulfillment centers, cutting out costs and inefficiencies.

That's why you can get a box full of Chinese kitchen goods from a variety of sellers delivered in two days from a warehouse in Kentucky.

Critics say Amazon hasn't put the necessary checks in place to manage the influx of counterfeits.

To unsuspecting consumers, fake products can appear legitimate because of the Fulfillment by Amazon program, which lets manufacturers send their goods to Amazon's fulfillment centers and hand over a bigger commission, gaining the stamp of approval that comes with an FBA tag.

Furthermore, Amazon's commingled inventory option bundles together products from different sellers, meaning that a counterfeit jacket could be sent to an Amazon facility by one merchant and actually sold by another.

"Amazon is making money hand over fist from counterfeiters, and they've done about as little as possible for as long as possible to address the issue," said Chris Johnson, an attorney at Johnson & Pham LLP, which focuses on intellectual property and brand enforcement and represents clients including Forever 21, Adobe (ADBE) and OtterBox. "Word is out in the counterfeit community that it's open season on Amazon."

It's not just niche brands like BedBand feeling the pain.

Birkenstock has seen of dozens of stores at a time hawking its Arizona Sandal for $79.99, a full $20 below the retail price. The names of the online storefronts change all the time, one day including the monikers Silver Peak Wine Cellar and Ryan Hollifield and the next Keila*Knightley and Bking sewneg. 

The only way to contact the sellers is by going to their storefront and clicking the "Ask a question" button. On a single day in mid-June, CNBC sent notes to seven sellers on the list, asking how they're able to price the product so cheaply. Every response was the same: "It is a secret."

Red flags are everywhere. Michael Kors (KORS) has a signature tote bag listed as low as $101 by multiple stores, compared to its $198 retail price. Canada Goose's highly popular Expedition parka sells for $1,000 on its own site and is available for under $650 on Amazon, a price that sellers of the brand say is too good to be true.

"As long as the logo looks legit, people assume you have that item," said a Canada Goose seller, who asked not to be named so as not to cause strain with Amazon.

Representatives from Birkenstock, Michael Kors and Canada Goose declined to comment.

Counterfeiting online is nothing new of course, particularly when it comes to commerce. Alibaba (), the Chinese e-retail giant, has been dealing with it since launching in 1999.

Some form of the word counterfeit shows up 30 times in Alibaba's latest annual report, and founder Jack Ma said at a Bloomberg conference in San Francisco last month that cracking down has gotten more difficult because the fakes are of "better quality, better prices than the real products, the real names."

Amazon, by contrast, has tried to maintain its image as a clean venue and the trusted place for online buying. There's not a single use of the word counterfeit in its 2015 annual report, and only the last of its two dozen risk factors mentions potential liabilities associated with "fraudulent or unlawful activities of sellers."

Investors certainly haven't expressed concern, bidding the stock up 69 percent in the past year. Amazon's market value of $348 billion is equal to Walgreens (WBA), Lowe's, Costco, Target (TGT) and Macy's combined, after you tack on another $66 billion. It's the sixth most valuable company in the U.S.

The Amazon story has always hinged on giving customers what they want and with top-notch service and speed. Walter Price, a portfolio manager at Allianz Global Investors, said it's no different with counterfeiting.

"If customers can verify that they've bought counterfeit goods, Amazon will push sellers to refund the purchase or they kick the sellers off the site," said Price, who also owns a stake in Alibaba. "Amazon does stick up for the consumer. They put the consumer first, not the merchant."

Sellers that want to cheat have any number of tools at their disposal. One issue that's enraged merchants is the proliferation of hijacked listings, where sellers suddenly see random names jump into their product page and start promoting the item for a cheaper price.

Judah Bergman has been selling on Amazon for two and a half years and his products include a jewelry line under the brand Steeltime. Other merchants have regularly showed up in listings for his double-sided pearl earrings, offering them for under $10, compared to the $17.99 he charges.

While he's able to eventually get the hijackers removed, he loses sales in the process as customers opt for the lower priced option, and he's spent valuable time sending in takedown notices to Amazon.

Making matters worse, when buyers unhappy with the cheaper alternatives leave a bad review, it drags down Bergman's standing because the reviews are all thrown together.

"The next thing you know you've lost sales plus your good star rating," said Bergman. "If you want to fight them, you won't have time to do anything else."

Amazon has an anti-counterfeiting policy in place and responds to infringement notices, investigating and kicking off sellers who break the rules. But the fraudsters move fast, changing the names of their stores and relaunching as quickly as they're removed.

As a marketplace, Amazon isn't legally responsible for keeping counterfeit material off the site as long as it responds to complaints and takes action when it's brought to the company's attention.

Chris McCabe worked as an Amazon merchant account investigator for five years. Since 2014 he's been operating independently on the other side, helping third-party sellers navigate Amazon's rules and processes for staying compliant. He's often hired to help suspended sellers get reinstated.

McCabe said that Amazon's investment in preventing marketplace abuse, a task assigned to the transaction risk management team, is dwarfed by its focus on growth at the AWS division and other projects like the kindle and Amazon Studios.

"They've been reactive, not proactive," said McCabe, who's now based in the Boston area. "Amazon can't watch everyone all the time, and they don't pretend they can."

For Whaley and BedBand, the past 18 months have been a whirlwind since she discovered that copycats were all over her product.

Initially, knockoffs were using her patented shock chord functionality and ripping off her design, she said. Those blatant counterfeits have gone away, with most rival products now using generic elastic straps.

But there are plenty of other ways for competitors to game the system, such as manipulating product reviews.

BedBand, which now sells for $12.99, has over 3,750 reviews and a 4.5-star rating. In the sheet fastener category, it was the most popular item until late 2014, when a number of like products that Whaley had never seen started gathering hundreds of positive reviews, leapfrogging her in the ranking.

Today, after spending five years and $60,000 on patents, BedBand is the number two seller in the category, behind a brand called Nyche Designs, whose top-selling product is priced at $8.99. Nyche is based in China and registered a U.S. trademark in February, according to Trademarkia.

Based on the quality of reviews, Whaley has good reason to be upset. Fakespot, an independent site that judges the validity of reviews, gives Nyche an F because it "detected product exchange for reviews." In other words, it paid for positive feedback.

Bed Band has an A rating, according to Fakespot.

"We've never bought a review, and we've never taken the route to give products away for reviews," said Whaley.

Amazon has filed multiple lawsuits in the past year against sites that sell reviews, but Nyche's reviews still include language like this: "I received this item at discount in exchange for an honest and unbiased review."

Nyche did not respond to multiple requests for comment sent to the email address on its website.

Make no mistake, Amazon's business is humming along. Prime is adding members by the truckload, more products are available with faster delivery rates, the Amazon Echo smart speaker is looking like the next killer product and there's even some profit to show investors, thanks largely to the fat margins at AWS

But for a brand built on trust, there are an awful lot of loopholes, and sellers are wondering if their gripes will ever become so problematic that Amazon can no longer sweep them under the rug.

"Amazon is setting up an environment where people feel like they have to shortcut and cheat," said Whaley. "The whole system is being manipulated, and people don't know it."

CNBC's Josh Lipton contributed to this report.

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