Costco (NASDAQ:COST) was caught red-handed selling knockoff Tiffany (NYSE:TIF) diamond engagement rings, and despite protesting its innocence, a U.S. federal court judge said "no rational finder of fact could conclude that Costco acted in good faith in adopting the Tiffany mark."
It means the warehouse club is going to have a serious, though not fatal, dent put in its finances, but how much is the question.
Although the judge recommended the two sides reach a settlement, suggesting the dispute won't get before a jury -- a potentially really expensive outcome for the retailer -- Tiffany is not likely to give in too soon. It's pursued the case even though Costco immediately stopped marketing the rings as soon as the jeweler contacted it, indicating Tiffany wants to use this as a "teachable moment" to anyone else contemplating infringing on its trademarks and reinforcing the notion its brand is more than just a little blue box.
The great, unwashed masses
The warehouse club got busted after a customer wrote Tiffany to say she was disappointed the jeweler was selling its rings at Costco. Although a number of high-end brands have sought to democratize their products by offering them at a discount -- and here "discount" is a relative term -- they still need to ensure they retain an air of exclusivity. It's the thought that you're entering some rarefied air that allows luxury retailers to sell their goods at exorbitant prices.
A Tiffany engagement ring from Costco guts that experience, and the jeweler had already experienced what it felt like to cheapen its brand several years ago when it came out with a line of silver bracelets that just about any mall rat could afford. Its sales plunged as shoppers turned their noses up at jewelry that was now seen as bourgeois.
Yet this was different because Tiffany had not partnered with the warehouse club. It sniffed that it would never "sell its fine jewelry through an off-price warehouse retailer like Costco."
Not feeling the love
The jeweler's investigation revealed the warehouse club was hawking six-pronged diamond rings it called "The Tiffany" on signs and through employee presentations. After contacting Costco to cease and desist, the retailer removed the signs and eliminated the reference to the luxury brand, and it even sent letters to customers who had purchased the rings offering to refund their money if they were dissatisfied.
But here's why Costco can expect Tiffany to hang onto this like a pitbull: After Tiffany filed a lawsuit against the warehouse club -- on Valentine's Day, no less -- charging it with trademark infringement and trademark counterfeiting, Costco tried to invalidate those marks, arguing a "Tiffany" setting was a generic term and the jeweler was inappropriately trying to prevent others from using it.
Brands risk losing millions of dollars if they don't protect their trademarks. You might pull up your zipper, ride an escalator, and drink from a thermos, but at one time all of those items were brands that have since been colloquialized, at a cost to their prior owners. It's why Kimberly-Clark is fastidious about ensuring people only use Kleenex brand tissues and Johnson & Johnson makes sure it's a Band-Aid brand of adhesive bandage that covers your cuts and scrapes.
A fortress with a moat
Tiffany has 97 separate trademarks related to its name and calls its namesake setting "the most famous ring of all time." It's manufactured to strict specifications with the jeweler noting that 99.96% of all gem-grade diamonds fail to make the cut to be used in one of its settings. Those that do pass the test come with a full lifetime warranty.
The judge essentially sided with Tiffany on every aspect of its lawsuit, except when it came to the jeweler trying to recover profits from the 'halo effect" the warehouse club earned on its sales of memberships by promoting the rings. Tiffany said it should be entitled to as much as $22 million just for that, but the judge said that was hard to reconcile, though he did allow Tiffany to seek damages from Costco through a jury trial. That would expose the retailer to extreme uncertainty and gives it a great incentive to settle.
Tiffany has no such imperative, and has the luxury of wrangling the steepest settlement it can from Costco. The judge says it can also try to disgorge profits from the warehouse club related to the rings going all the way back to 2007.
Costco generated $34.8 billion in sales last year, 11% of which came from its softlines segment, which houses the jewelry department. Jewelry itself contributed only a small portion to the total, or to the $697 million in total net profits it reported. So while any settlement is bound to be expensive, it won't be debilitating. But it will prove a point and should serve as a warning to others that may try to encroach on Tiffany's trademarks.
Rich Duprey has no position in any stocks mentioned. The Motley Fool owns and recommends Costco Wholesale. The Motley Fool recommends Johnson & Johnson and Kimberly-Clark. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.