Reprinted with permission from CIO Magazine.
by Scott Berinato
Executive Summary
In the wake of the 1990s technology bubble, there is so much used hardware available—and so much emphasis on cutting costs—that secondary market hardware is now a mainstream business. And once buyers get used to wholesale prices, it's unlikely that they'll go back to buying retail. CIO's survey of 187 IT executives showed that 77 percent are purchasing secondary market equipment and 46 percent expect to increase their spending on used machines next year. The savings from buying used can amount to 25 percent of operational costs, as it did for Tenneco Automotive. Meanwhile, some hardware vendors are trying to make purchasing on the secondary market sound as unappetizing as possible, implying that the cheap equipment comes from the semi-illegal "gray market." They tell buyers it will cost thousands to recertify the boxes. And they threaten to withhold support. CIOs who call these bluffs will find that the sales reps will either start trying to sell support services or they'll cut the price of their new gear. Buyers also gain leverage from the emergence of third-party companies offering alternative maintenance contracts.
Full Story
In the early 1970s, when the government, as part of a lengthy antitrust action, forced IBM to sell equipment and not just rent it, companies such as Comdisco and Forsythe-Macarthur bought IBM S360s and entered the leasing business. Thus, the secondary marketplace—where used hardware is bought and sold—was born. It was a niche business, and it stayed that way for 25 years. Until everyone lost his mind.
That was about five years ago. Flush with Internet cash, CIOs stocked up, buying a server for every application. With Y2K looming, they bought backups too. With the Web, there was no such thing as too much storage or networking capacity. Demand was massive, and supply strained to keep up.
Then, overnight, demand vanished. Companies that had been buying hardware in bulk—mainly telecoms and dotcoms—went out of business. Other companies decapitated their IT budgets and started consolidating servers and data centers. Most also decided that their old servers were good enough. Who needed the new new thing? Leases ended on a startling amount of equipment.
Put it all together, and you get a sudden and unprecedented surplus of perfectly good routers, switches, disks, servers, PCs and notebooks.
There is so much used hardware available now—and so much emphasis on cutting costs—that the secondary market is no longer a niche business. Nor does it appear to be a transient, post-boom phenomenon. Experts point to four factors to support this assertion: 1. chips don't wear out like automobile engines, meaning this gear will be marketable for years to come; 2. the sheer volume of hardware created during the late '90s can support the secondary market for years (consider that a startup, MicroCast, earned $880,000 in revenue between 1999 and 2000, filed Chapter 11 in late 2000 and left behind hardware valued at $40 million); 3. once buyers get used to wholesale prices, it's unlikely they'll willingly go back to buying retail; 4. the services developing to support the secondary market are making it easier and less frightening for buyers to participate. Soon CIOs won't be able to imagine not having the option to buy used.
This is a complex market. You can buy from brokers or tweeners or vendors. Or eBay. There are license transfers, inspection fees and third-party maintenance options. There's disposition to think about. (How do you throw this stuff out without running afoul of the Environmental Protection Agency?) Just learning the lingo is a chore. But as CIOs of enterprises both large and small are currently learning, the rewards for diving into the secondary market can be great.
Here, then, is CIO's tour of the secondary market—its characters, its characteristics, the products and the prices that are insane!
The Buyers
WHY THE CEO LOVES BILL HASER
Bill Haser might be bragging a little bit, but he has a right to. "In two years, we've driven out about a quarter of our operational costs," says the CIO of Tenneco Automotive, a $3.5 billion auto parts manufacturer in Lake Forest, Ill. "I told a CIO about that, and he thought I was joking. I'm not. The savings have been very substantial, and the chairman has recognized us for it. A large part of that savings has been leveraging the secondary market."
Haser is in a minority and a majority here. He's in a minority because he is one of only a few CIOs willing to speak on the record about the secondary market. Either through some sort of hand-me-down shame or maybe to protect relationships with vendors, many CIOs aren't.
But Haser is in a majority because, as he says, "Everyone is doing it."
Indeed, according to a recent CIO survey of 187 information executives, 77 percent are purchasing secondary market equipment, and 46 percent expect to increase their spending in that area next year by an average of 15 percent.
Forty-one percent cited lower capital costs as their primary reason for going used, which isn't surprising. The economics of used gear is hard to ignore. Samuel Brooks, MIS director of Keystone Property Management in Mount Pleasant, Mich., relies on the used market to get equipment he says he otherwise couldn't afford. His most recent deal was a $10,000 Dell file server that he got for $3,000. Asked if his chairman recognized him, the way Haser's had, Brooks says, "Nope. Now that they see this channel, they expect me to be there."
Even more significant, 30 percent of survey respondents said that they're there because the performance of new equipment simply doesn't justify its expense. Last year's hardware, it seems, will run this year's applications perfectly well.
Haser says that he had assumed that the secondary market was littered with Jurassic hardware that wouldn't support his applications. Instead, he's buying used gear to support an SAP upgrade.
quot;We'll always look at this market as an option from hereon in," Haser says.
The Vendors
IN DENIAL
It's no fun competing against yourself, trying to sell this year's server for $10,000 while some wheeler-dealer is hawking last year's server (which is really just as good) for $3,000. This dynamic has divided the vendor community into two groups: those learning to live with the secondary market and those in denial.
You can see the denial in how some sales reps will try to make a sale.
First, they will question the provenance of the hardware. They might suggest that the broker is selling "gray market" equipment, meaning it might contain illegal parts, and wouldn't the buyer be better off buying a server that a big vendor stands behind?
There are other ways to make purchasing on the secondary market less appealing.
Greg Winner, CIO of real estate firm Hamilton Partners in Chicago, called his Cisco sales rep to inquire about license transfers and support on a large volume of Catalyst 5500 switches and VXR 7200 routers from companies that had filed Chapter 11. He was going to use them to offer high-speed access to Hamilton Partners tenants. The sales rep told Winner that before Cisco would agree to support the gear, it would have to inspect it. That would cost as much as $6,000 for each piece of used equipment. Furthermore, Winner would have to buy new software licenses for as much as $3,150 per year per unit.
quot;This is like GM asking for a royalty when I buy a used car," Winner says.
If the buyer is still leaning toward purchasing used equipment, the sales rep can play his trump card: He can say his company will not be able to provide support.
Brokers say that nine out of 10 times the support ploy is a bluff. But it's a good one. No one wants unsupported gear. Still, CIOs and brokers say that if the buyer calls the bluff, the sales reps will start trying to sell services, or they'll cut the price on new gear.
Ultimately, that kind of aggressive selling is myopic, argues Eric Johnson, associate professor at the Tuck School of Business at Dartmouth University in Hanover, N.H. Vendors may grab back some business in the short term, but already third-party companies are stepping up to offer alternative maintenance contracts, and some brokers are getting into the support business.
What the big vendors should concentrate on, says Johnson, is safeguarding their relationship with their customers, not protecting next week's sales.
Vendors are beginning to get this to varying degrees. IBM's Global Financing division, which includes both leasing and used sales, accounted for 10 percent of IBM's 2001 profits. Forty percent of Hewlett-Packard's Financial Services division revenue last year came from the secondary market. Dell's revenue from used gear went from zero in 1999 to $200 million last year. Cisco set up the Cisco Authorized Refurbished Equipment (CARE) program in 2000. But unlike Dell, HP and IBM, Cisco does not maintain a storefront on eBay, which those vendors use as a primary marketing channel. And a Cisco spokesperson says, "We do not see the used market as significant in terms of its impact on our business.
The Market
WHO SETS THE PRICE?
Paradoxically, the complexity of the secondary market was spun out of the simplest notion: supply and demand. When demand ruled, so did vendors. They set prices; they determined the value, or lack thereof, of used gear. Now supply rules, and CIOs have a great opportunity to grab the power to define value.
HP's Rothman calls it the law of the jungle. ARC's Lynch calls it the American way.
Malcolm Fields, CIO at Hon Industries, a $1.8 billion office furniture manufacturer in Muscatine, Iowa, calls it his fiduciary responsibility. Fields is a self-described tightwad. He says that recently his units have fallen in love with the secondary market because demonstrating ROI is a cinch when capital costs can be reduced.
quot;We've started browsing the hardware section of eBay. I've bought gear on there three or four times," says Fields. "We'll search on a type of equipment just to get a sense of the market. Then we typically buy from smaller, independent players, direct. We insist on strong warranties."
Fields, like Haser at Tenneco, was impressed by the amount of good stuff he's found. Like Haser, he was happy to discover that more and more services are supporting the market. Like Haser, his company is noticing his effort to reduce costs. "I've already saved us hundreds of thousands," he says.
And, like Haser, Fields has found a new way to do his job. He's setting a price, and the market moves to meet it. That's a big change. And change is good. Especially for CIOs.
