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China's Back Door to Discounted Designer Fashion

Tuesday, 19 Jul 2011 | 1:45 PM ET

Imagine snagging an Ann Taylor silk taffeta V-neck bridesmaid dress that retails for $215, for only $35, or a Guess by Marciano Cierra lace-up dress that is usually priced at $168 for only $40.

Source: (L) shopbob.com | (R) taobao.com

These deals aren't from a new flash-sale website, and they aren't counterfeit. Instead, saavy shoppers are able to buy limited quantities of clothing directly from the Chinese factories that make these labels.

Roughly 40 percent of all American clothing that is imported is made in China, according to American Apparel & Footwear Association. But about 5 percent of the clothing that is produced there never finishes its journey to the US. Instead, the clothing is slipped out of the factories and into the hands of Chinese consumers, who purchase it at a significantly discounted prices from independent sellers on websites like Taobao.com and Chinese eBay.

However, this is usually done behind the back of a factory's foreign client because it is a practice that is largely forbidden and sometimes illegal.

This 5 percent—usually 100 to 200 pieces of each design—typically consists of overruns, which are extras that are made in case of defects that can occur during the manufacturing process. Creating overruns is a common and necessary practice in the apparel industry, according to Ru Jin, a veteran online vendor who sells extra clothes of a major American retailer whose name she prefers not to mention.

“They are almost the same as full-price products, but a lot cheaper—a relatively high quality-to-price ratio,” said Zhang Li, a long-time online shopper. “It is welfare for consumers.”

Most online shoppers who fish for these clothes understand that they are getting a good deal, though they sometimes risk receiving products of a slightly compromised quality.

There are generally three types of overruns. The best are from the original contracts and consist of clothes that are exactly the same as the ones sold in the US, with labels and sometimes even with the price tags they will sport overseas.

Another type is clothes that are made with the extra fabric that is not “confiscated” by the retailer. Sometimes these items lack rationed material such as labels, buttons, or ornaments like belts and flower pins.

And there are clothes that are damaged during manufacturing, with washable stains, skip-stitches, or small holes. These defects are usually small, sometimes barely visible, making the leftovers sellable.

Some factories sell directly from their warehouses. Others distribute to independent vendors, who then sell to consumers both online and offline.

From the factories to the sellers, the clothes are priced not according to their brands, but their fabric, according to Ru. A chiffon top may be sold for $8, but a silk one would fetch $12, she said. Similarly, a chiffon dress may be priced at $14, but a silk one could cost $18 to $34.

Storeowners, who are often more familiar with the status of Western brands and prices of clothing on the Chinese market, will then adjust prices to fit the expected demand. Still, the clothing will be priced substantially lower than what these products will command in US stores.

While some value brands like Abercrombie & Fitch , Forever 21 and H & M seem less concerned about their products abounding on the Internet, high-end brands monitor their manufacturing process closely, allowing virtually no extras to leak out.

The most popular ones for consumers who shop this market fall something in between. They are mid-ranged labels such as Ann Taylor, Guess, J.Crew , Club Monaco and Kate Spade—clothes with a reputation for quality.

Source: (L) jcrew.com | (R) taobao.com

Most of these labels do not sell in China, and therefore the overruns do not affect the companies’ retail business as it is only a small quantity being sold to a niche audience who wouldn’t otherwise pay full price for branded clothes. Nevertheless, the practice is somewhat troublesome as more and more American retailers start selling in China. Also, American consumers are learning ways to access to these clothes as well.

Still, there are concerns that selling somewhat defective clothes may affect the brand’s image. Also, there are certain legal issues such as breach of contract and sometimes trademark infringement.

How “leftovers” should be disposed of varies by contracts, according to Susan Scafidi, a law professor at the Fashion Law Institute of Fordham University. “Some trademark holders insist that they be destroyed, some allow them to be sold within a specific geographic area, others, less concerned with exclusivity and scarcity, will allow the products to be sold,” Scafidi said.

According to Ru, most extras are not allowed to be sold, making them difficult to acquire, a point sellers sometime exploit to promote the exclusivity of the deal.

Obviously, it can be a touchy subject for retailers. Forever 21, for example, declined to comment on the practice, and J.Crew didn't provide an immediate comment.

Apart from contract issues, selling overruns with labels or displaying the brands is more serious offense—it can be seen as a violation of a company's trademark.

As a result, vendors are asked not to mention the brands, and to either cut the labels off or conceal them in pictures. By minimizing the involvement with the brand, the matter is made a lot easier as fashion designs are rarely protected, at least in China and the US, according to Scafidi.

“Once the labels are removed, they have no idea which brand it is,” Ru said, “and they don’t care about designs.”

But storeowners are counting on the labels to sell the items at a richer premium. Some drop hints to potential buyers, such as “the label starts with the letter G,” or “the brand is very sensitive,” which is a phrase used to indicate it is a designer labels. Some insert asterisks in brand names, replacing some letters, to make it unsearchable. And there are those daredevils who mark the labels and risk getting caught.

Fashion houses, now aware of the practices, work closely with shopping sites and conduct routine searches on brand names online to detect unauthorized sales of labeled clothes.

Websites like Taobao.com only carry legal responsibility when they know of a particular infringement case, probably from warnings of retailers, but fail to act on it, according to Liu Ming, a Peking University law professor, who specializes in copyright and internet law.

The punishment for each discovery is far from effective as a deterent. Usually, it simply results in the product being taken down for a few days. After the dust settles, it often is reposted online for sale again.

However, there are more serious ramifications. For factories, it may mean either stricter rules or the end of a lucrative contract. For online vendors, it may mean a smaller inventory or a less profitable business.

So both factories and vendors are wary. Factories often deal with only vendors who have connections. “After all this is small money, if something happens, it is the factories that take the heat,” Ru said.

In fact, these violations rarely ends up as the cause of a lawsuit, but rather it results in the termination of a contract.

“[A lawsuit] might not be worth the money, and it is time consuming,” said Susan Scafidi, “if the factory is cheating you, you might as well change to another factory.”

Questions? Comments? Email us at consumernation@cnbc.com. Follow Christina Cheddar Berk on Twitter @ccheddarberk.

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