In the early 1970s, when the government, as part of a lengthyantitrust action, forced IBM to sell equipment and not just rent it,companies such as Comdisco and Forsythe-Macarthur bought IBM S360s andentered the leasing business. Thus, the secondary marketplace - whereused hardware is bought and sold - was born. It was a niche business,and it stayed that way for 25 years. Until everyone lost hismind.
That was about five years ago. Flush with Internet cash, CIOs stockedup, buying a server for every application. With Y2K looming, theybought backups too. With the Web, there was no such thing as too muchstorage or networking capacity. Demand was massive, and supplystrained to keep up.
Then, overnight, demand vanished. Companies that had been buyinghardware in bulk - mainly telecoms and dotcoms - went out of business.Other companies decapitated their IT budgets and started consolidatingservers and data centers. Most also decided that their old serverswere good enough. Who needed the new new thing? Leases ended on astartling amount of equipment.
Put it all together, and you get a sudden and unprecedented surplus ofperfectly good routers, switches, disks, servers, PCs andnotebooks.
There is so much used hardware available now - and so much emphasis oncutting costs - that the secondary market is no longer a nichebusiness. Nor does it appear to be a transient, post-boom phenomenon.Experts point to four factors to support this assertion: 1. chipsdon't wear out like automobile engines, meaning this gear will bemarketable for years to come; 2. the sheer volume of hardware createdduring the late '90s can support the secondary market for years(consider that a startup, MicroCast, earned $880,000 in revenuebetween 1999 and 2000, filed Chapter 11 in late 2000 and left behindhardware valued at $40 million); 3. once buyers get used to wholesaleprices, it's unlikely they'll willingly go back to buying retail; 4.the services developing to support the secondary market are making iteasier and less frightening for buyers to participate. Soon CIOs won'tbe able to imagine not having the option to buy used.
This is a complex market. You can buy from brokers ortweeners or vendors. Or eBay. There are license transfers,inspection fees and third-party maintenance options. There'sdisposition to think about. (How do you throw this stuffout without running afoul of the Environmental ProtectionAgency?) Just learning the lingo is a chore. But as CIOs ofenterprises both large and small are currently learning, therewards for diving into the secondary market can be great.
Here, then, is CIO's tour of the secondary market - its characters, itscharacteristics, the products and the prices that areinsane!
The Buyers - Why the CEO Loves Bill Haser
Bill Haser might be bragging a little bit, but he has a right to. "Intwo years, we've driven out about a quarter of our operational costs,"says the CIO of Tenneco Automotive, a $3.5 billion auto partsmanufacturer in Lake Forest, Ill. "I told a CIO about that, and hethought I was joking. I'm not. The savings have been very substantial,and the chairman has recognized us for it. A large part of thatsavings has been leveraging the secondary market."
Haser is in a minority and a majority here. He's in a minority becausehe is one of only a few CIOs willing to speak on the record about thesecondary market. Either through some sort of hand-me-down shame ormaybe to protect relationships with vendors, many CIOs aren't.
But Haser is in a majority because, as he says, "Everyone is doingit."
Indeed, according to a recent CIO survey of 187 informationexecutives, 77 percent are purchasing secondary market equipment, and46 percent expect to increase their spending in that area next year byan average of 15 percent. (To see the entire survey, go to"Second-Hand IT".)
Forty-one percent cited lower capital costs as their primary reasonfor going used, which isn't surprising. The economics of used gear ishard to ignore. Samuel Brooks, MIS director of Keystone PropertyManagement in Mount Pleasant, Mich., relies on the used market to getequipment he says he otherwise couldn't afford. His most recent dealwas a $10,000 Dell file server that he got for $3,000. Asked if hischairman recognized him, the way Haser's had, Brooks says, "Nope. Nowthat they see this channel, they expect me to be there."
Even more significant, 30 percent of survey respondents said thatthey're there because the performance of new equipment simply doesn'tjustify its expense. Last year's hardware, it seems, will run thisyear's applications perfectly well.
Haser says that he had assumed that the secondary market was litteredwith Jurassic hardware that wouldn't support his applications.Instead, he's buying used gear to support an SAP upgrade.
"We'll always look at this market as an option from here on in," Hasersays.
The Brokers - Crazy John. His Prices AreInsane!!!
Meet John Lynch. Has he got a deal for you!
How about a Cisco 12000, fully loaded, for 12 grand? Or a $55,000 SunStorEdge 9X73 657 GB T3 Array, new in the box. Lynch'll sell it to youfor seventeen-five. There's no reason, he says, to pay exorbitantprices for new hardware when there's so much good used gearto be had.
"There's $350 million of stuff at Enron. We just picked uphalf of it.
"Hold on," he says, taking another call.
He returns without missing a beat. "Sorry. Williams is another telecomthat put $247 million in gear out there. I've purchased over 200midrange Compaq servers in the last two weeks, and I'll get $12million more in Cisco gear in the next two weeks.
"Hold on," he says.
Lynch, 46, is CEO of Asset Recovery Center (ARC), one of the largestcompanies on the secondary market. ARC will take in about $50 millionthis year, up from $1 million two years ago. Lynch believes that thetop line will grow to $100 million next year. At any given time,there's about $80 million worth of used gear in its Eatontown, N.J.,warehouse.
That is in part due to Lynch. His brassy Jersey accent seems to puteverything he says into italics. Someone else might say, "That salewas worth about $1 million." Lynch says, "I picked up a million andchange on that deal." Lynch's strength (as he'll agree) is his abilityto foresee the secondary market's ebbs and flows - which products willbe in demand and which will just take up space in his warehouse. He'sbeen doing this for 25 years since the days when "10MB hard drivesweighed 120 pounds." He got his start when, as he was eating anItalian combo sub on a loading dock, he saw some Digital equipmentnearby, waiting to be scrapped. The next day he put on a tie, boughtthe lot and turned it around for $98,000, four times his annual salaryat a company called Associated Food, where he ran the cash-and-carrydivision.
The fact that Lynch is both knowledgeable and colorful has landed himon NBC, in Fortune magazine and at the dais lecturing hundreds of WallStreet's heaviest heavyweights. He has become the public face of thesecondary market, and it's a face that has struck fear into hardwarevendors watching their customers being lured away by the titillatinglylow prices Lynch and his ilk can offer.
"You'll save money just by entertaining me," says Richard Hart, whoowns used hardware vendor H and H Technologies in Hickory, N.C. "Tella vendor you're looking at used gear, and they'll start cutting theirprices immediately. You're foolish not to at least inquire."
Brokers range from small-time entrepreneurs such as Hart to websiteslike Usedrouter.com to large outfits like ARC and Optimus Solutions, a$125 million company.
Brokers will trade 10 servers for five routers. If you ask them to,they'll hunt down a hard-to-find storage device. If you want, they'llrent you hardware. Everything's available. Everything'snegotiable.
Many buyers find this refreshing. Mainstream vendors can often seemunfriendly and downright stodgy next to a guy who's willing to knockoff 10 grand if you'll trade in that pile of laptops in thecloset.
"I'm on my way to our warehouse now," Lynch says. "I've got four MCIreps coming in looking to off-load some equipment. I sold amillion-six of Cisco 6509s to Credit Suisse First Boston. I'm workinga deal with Qwest. They're trying to get rid of a whole warehouse ofgoods. It's worth $50 million. They want $22 mill. I'm offering $9million.
"Hold on...."
The Vendors [part 1] - indenial
It's no fun competing against yourself, trying to sell this year'sserver for $10,000 while some wheeler-dealer is hawking last year'sserver (which is really just as good) for $3,000. This dynamic hasdivided the vendor community into two groups: those learning to livewith the secondary market and those in denial.
You can see the denial in how some sales reps will try tomake a sale.
First, they will question the provenance of the hardware. They mightsuggest that the broker is selling "gray market" equipment, meaning itmight contain illegal parts, and wouldn't the buyer be better offbuying a server that a big vendor stands behind?
Lynch at ARC says Cisco sales reps told a prospective buyer that itwould be "unpatriotic" to buy from Lynch and suggested that thehardware Lynch was selling was "contaminated" with asbestos dustbecause it had come from offices near the World Trade Center. (About$10 million in gear was recovered from the WTC site. Lynch confirmsthat the hardware he was selling in this deal came from there butdenies that it was contaminated and denies beingunpatriotic.)
Says a Cisco spokesperson, "Customer satisfaction is a core value ofCisco's culture. Any behavior that doesn't support this value isunacceptable."
There are other ways to make purchasing on the secondary market lessappealing.
"I've got EMC stuff, still in the box, still sealed shut with EMCtape," says Jeff Archuleta, who owns secondary vendor Arch Consultingin Sandy, Utah. "It's in perfect condition. And EMC is telling thebuyer it has to be recertified for eight grand before the buyer canget a support contract."
Greg Winner, CIO of real estate firm Hamilton Partners in Chicago,called his Cisco sales rep to inquire about license transfers andsupport on a large volume of Catalyst 5500 switches and VXR 7200routers from companies that had filed Chapter 11. He was going to usethem to offer high-speed access to Hamilton Partners tenants. Thesales rep told Winner that before Cisco would agree to support thegear, it would have to inspect it. That would cost as much as $6,000for each piece of used equipment. Furthermore, Winner would have tobuy new software licenses for as much as $3,150 per year perunit.
"This is like GM asking for a royalty when I buy a used car," Winnersays.
If the buyer is still leaning toward purchasing used equipment, thesales rep can play his trump card: He can say his company will not beable to provide support. That happened to Tim DuBose, who ownsRiverside Technology Group in Riverside, Calif. He was selling $1.6million worth of high-end Sun servers to a large company, but says thebuyer dropped out after Sun said it could not support them.
Brokers say that nine out of 10 times the support ploy is a bluff. Butit's a good one. No one wants unsupported gear. Still, CIOs andbrokers say that if the buyer calls the bluff, the sales reps willstart trying to sell services, or they'll cut the price onnew gear.
Ultimately, that kind of aggressive selling is myopic, argues EricJohnson, associate professor at the Tuck School of Business atDartmouth University in Hanover, N.H. Vendors may grab back somebusiness in the short term, but already third-party companies arestepping up to offer alternative maintenance contracts, and somebrokers are getting into the support business.
What the big vendors should concentrate on, says Johnson, issafeguarding their relationship with their customers, not protectingnext week's sales.
Vendors are beginning to get this to varying degrees. IBM's GlobalFinancing division, which includes both leasing and used sales,accounted for 10 percent of IBM's 2001 profits. Forty percent ofHewlett-Packard's Financial Services division revenue last year camefrom the secondary market. Dell's revenue from used gear went fromzero in 1999 to $200 million last year. Cisco set up the CiscoAuthorized Refurbished Equipment (CARE) program in 2000. But unlikeDell, HP and IBM, Cisco does not maintain a storefront on eBay, whichthose vendors use as a primary marketing channel. And a Ciscospokesperson says, "We do not see the used market as significant interms of its impact on our business."
The Vendors [part 2] - learning tolove the secondary market
Selling used gear may seem to be at odds with being the originalmanufacturer, but maybe it's an opportunity," says John Sheaffer, CEOof Westmont, Ill.-based Sysix, which sells both new and used gear."Hey, margin is margin. Money is what matters. Like it or not, thismarket is in play."
Irv Rothman gets it. "If you don't control the secondary market foryourself, someone else will," says Rothman, CEO of HP FinancialServices. "And they will use your equipment against you."
To prevent that, HPFS's Andover, Mass., office has 470,000 square feetof offices and storage space and labs and parts shops and loadingdocks that operate around the clock, taking in leased and repossessedequipment for a lavish technical wash and wax. Refurbishing used gearincludes wiping hard drives, replacing components, testing chips,restoring basic configurations and sucking the dust out of a system.At any given moment, HPFS has 50,000 used assets here. Half-a-millionpass through in a year. Skids hold yellowed, junky monitors that willsoon meet an environmentally conscious death. There are palletsstacked with notebooks like giant plates of nachos. In the back,45,000 square feet of warehoused gear is stacked to the ceiling,waiting to ship out to HP's services group, or to brokers, or to a CIOwho got herself a deal on a 20-year-old VAX system.
The Andover facility (it was Compaq's before the merger) didn't existsix years ago. IBM has built 20 refurb houses worldwide, taking in15,000 assets a week. These vendors are not in denial; they're takingthe brokers on.
In general, vendors can't beat brokers on price because their overheadis much higher. But vendors do have certain advantages. Trustedbrands. Deep knowledge of the systems. Extensive services groups tosupport the gear. Dealing with the vendor directly certainly providesthe least complicated license transfer and maintenance contracttransfer process. This is where the secondary market is going. "I'llpay a little more and deal directly with the vendor rather than pay alot less and go through a broker," says Brooks, Keystone Property'sCIO.
The vendors are as scientific about the secondary market as thebrokers are seat-of-the-pants. HP's warehouse is entirely automated.There are equations that determine the value of used gear - whether,say, it's more valuable in parts than as a whole. "We have tuned thedemand," says Af Assur, IBM's director of global remarketing forGlobal Asset Recovery Services, which is part of IBM Global Financing,the leasing group. "We know the inflow and outflow about two months inadvance, so we plan and know exactly what to do with the asset when itcomes in."
It has been a coldly corporate ramp-up, which is why Rothman thinksfewer people know about his business than they do Lynch's. "It's notas sexy a story as, you know, some broker-making-millions story,"Rothman says. "Look, 40 percent of our [division's] revenue is fromthe secondary market. That's a big number."
The Market - who sets the price?
Paradoxically, the complexity of the secondary market was spun out ofthe simplest notion: supply and demand. When demand ruled, so didvendors. They set prices; they determined the value, or lack thereof,of used gear. Now supply rules, and CIOs have a great opportunity tograb the power to define value.
HP's Rothman calls it the law of the jungle. ARC's Lynch calls it theAmerican way.
Malcolm Fields, CIO at Hon Industries, a $1.8 billion office furnituremanufacturer in Muscatine, Iowa, calls it his fiduciaryresponsibility. Fields is a self-described tightwad. He says thatrecently his units have fallen in love with the secondary marketbecause demonstrating ROI is a cinch when capital costs can bereduced.
"We've started browsing the hardware section of eBay. I've bought gearon there three or four times," says Fields. "We'll search on a type ofequipment just to get a sense of the market. Then we typically buyfrom smaller, independent players, direct. We insist on strongwarranties."
Fields, like Haser at Tenneco, was impressed by the amount of goodstuff he's found. Like Haser, he was happy to discover that more andmore services are supporting the market. Like Haser, his company isnoticing his effort to reduce costs. "I've already saved us hundredsof thousands," he says.
And, like Haser, Fields has found a new way to do his job. He'ssetting a price, and the market moves to meet it. That's a big change.And change is good. Especially for CIOs.