Cisco set to fight aftermarket sellers

It will target 'gray market' dealers who sell used gear to primarily smaller businesses

Call Cisco Systems Inc. a victim of its own success. As its dominance in corporate routing and switching grows, so does the vigorous aftermarket for Cisco gear -- a subsegment that's reached a point the vendor can no longer ignore.

Used gear or "gray market" competition is among several issues in Cisco's sights, as it kicked off its annual Partner Summit in Las Vegas this week. Cisco is pointing to aftermarket numbers as making a visible dent in its equipment revenue. It estimates that the gray market sales take $200 million to $300 million in revenue away from Cisco -- approximately 7% of its total switch and router revenue in its last fiscal year.

"The largest used equipment broker in North America [Network Hardware Resale] has over 50 account managers calling on [Cisco] customers in [the] U.S. [and] did $140 million in sales in calendar year 2006," says a statement on the Partner Summit section of Cisco's Web site. Aftermarket Cisco brokers "have penetrated the government channels and have been on the GSA schedule ... [and] are effectively selling against Cisco in the Government space."

Cisco says used gear brokers are winning on the small side of the SMB market -- a nut Cisco has tried, unsuccessfully, to crack many times before.

"Cisco does not have an effective offering in the sub-100 market space," the company adds, "and our competitors [including aftermarket brokers] are doing well there."

Gray goes black

To counter this, Cisco's brand protection group is revving up an international brand protection campaign, with a simple message for Cisco partners and customers: Genuine Cisco gear only comes from Cisco and its partners.

"We're going to be stepping that up in our fiscal year '08, where we'll be putting much more emphasis in overall communications to end users and the channel," says Philip Wright, director of worldwide brand protection at Cisco.

Aftermarket dealers, who Wright says often spam and cold-call Cisco customers and channel partners, "are offering bargain-basement products and immediate availability -- enticements that sound too good to be true. And guess what, they almost always are."

Besides growing revenues, what's also alarmed Cisco about the aftermarket is an influx of counterfeit equipment. Three or four years ago, Wright says, this was less of a problem, as few aftermarket Cisco dealers were selling fake gear. Though he could not provide estimates on what percentage of the used market also consists of counterfeits, Wright says fake gear is on the rise.

"A successful manufacturer of anything has this problem, whether it's Louis Vuitton bags or ink-jet cartridges or routers and switches," Wright says. "The brokers who deal in counterfeit are smart enough to pass off the gear into the gray market channel and introduce it to [the] supply chain that way."

Because of this, buying aftermarket Cisco gear from dealers in the market runs "a good chance of picking up counterfeit equipment," he adds. "There is an important distinction to make between gray market and black market. But a key message is gray goes to black pretty easily."

The $138 million gorilla

Although Cisco does not identify Network Hardware Resale (NHR) by name, this Santa Barbara, Calif.-based company -- which says it made $138 million in 2006, not $140 million -- is among Cisco's biggest threats.

"Cisco does a decent job of painting the authenticity and quality of our products as low," says Mike Sheldon, president and CEO of NHR.

He takes exception to Cisco's lumping together aftermarket and black-market counterfeit gear. He adds NHR neither knowingly nor unknowingly has any fake Cisco equipment in its inventory of used Cisco gear -- an inventory, he claims, that is larger than many of Cisco's top distributors.

"We have rigorous testing methodologies in place," Sheldon says, to not only ensure [a product is] authentic -- that's a given -- but that it functions and looks, even, as new."

He says a staff of more than 100 engineers inspects and tests all products before they are shipped to customers, with a 48-hour guarantee, "which is not true of new equipment" shipped from many authorized Cisco channels, he adds. NHR also offers a one-year warranty on the Cisco gear it sells, which includes next-day equipment replacement.

An aftermarket strategy won't kill you

While the danger of getting fake gear through aftermarket dealers may exist, industry experts say incorporating used network equipment into an overall equipment-buying strategy can be a useful cost-saving tactic. One strategy is to use aftermarket Cisco switches as hot spares, letting IT staff replace failed equipment with working gear immediately and without paying for costlier same-day replacements from Cisco.

"Put the secondary-market gear in operation when you have a problem," says David Willis, chief of research at Gartner Inc., "and then swap it back out when you get the Cisco tech in for the service call" with the brand-new replacements. "Same-day service costs about 20% more than next day, so this strategy could cut your maintenance costs a little bit."

Willis says this strategy would be best used with simple or internally used network gear -- such as wiring closet switches -- as opposed to equipment facing the public Internet or advanced equipment such as security or VoIP products.

Fears that buying illegal fakes through a large Cisco aftermarket seller are probably somewhat unfounded, Willis says.

"Cisco has had some fraud, but it's very minor," he says. The idea that gray goes to black pretty easily "is akin to drug companies saying that drugs coming in from Canada are going to kill you."

But Willis says used Cisco gear -- or any used equipment -- should be used tactically, not strategically. "You really don't want to standardize your company on this stuff." Companies that want state-of-the art network technologies at a lower cost than new Cisco gear would be better off looking at competitors, such as HP ProCurve, 3Com, Foundry or Extreme, Willis adds.

Software controls

Besides spreading warnings about gray and black market gear to channels and customers, Cisco is also tightening its controls for software support through its SMARTnet program, through which new Cisco gear is licensed on an annual basis.

"With these products offered by [gray market brokers], technically, the software license doesn't transfer after the sale to the first end user," says Cisco's Wright. The company's policy is that any product bought off the secondary market, in order to get service support from Cisco, must have a valid software license. This can be given only after the gear has been inspected by a Cisco-designated inspection company.

"Cisco makes it very difficult to get any third party in the picture," says Gartner's Willis. "They really want you buying new gear; it's the best margins, and it lowers their support costs."

Increasingly, Cisco's emphasis on its Internetworking Operating System (IOS) software, and the tighter controls it has exerted over it, are an effort to squeeze more value out of the hardware Cisco sells -- whether new or old.

"Value is in the software for Cisco," Willis says. "Increasingly, they're putting more locks on software."

He cites the recent introduction of the Cisco License Manager tool, and the new distribution system for IOS software; new Cisco switches are shipped with full-load versions of IOS, which must be activated via a software key to unlock whatever level of feature the end user purchased. Previously, routers and switches were shipped with base versions of IOS, which end users upgraded themselves over the Web. After these upgrades, end users would contact Cisco to register the code and receive support.

"You see the writing on the wall," Willis says. "The equipment lasts for five years or more, so how is Cisco going to get revenue? They're going to enforce license restrictions and they're going to keep you on their maintenance and ultimately start charging you a lot more for software."

Caught in the middle

This squeeze is already being felt by Scott Pinkerton, communications infrastructure department manager at the U.S. Department of Energy's Argonne National Laboratory, which is part of the University of Chicago. The lab, which is negotiating a new campuswide SMARTnet contract, recently ran into an issue when a lower-level IT manager bought a used Cisco switch outside of the lab's channel provider, Pinkerton says.

As the lab is renewing its SMARTnet contract, it has to catalog and send in all serial numbers of the equipment it has to the channel partner providing the SMARTnet support. Since gray market gear is in the Argonne network, and support calls were made regarding the equipment, these unresolved and unaccounted for pieces of equipment stalled the renegotiations of Argonne's SMARTnet contract to the point where some of the SMARTnet contracts on equipment it purchased through first-market channels had expired.

"I'm stuck holding opened TAC [Technical Assistance Center] cases because of the nonsense of some [gray market] wiring closet switch someone bought," he adds. "That's my biggest side effect. We have real work to get done, and I can't open any new TAC cases.

"Three years ago, if I put a serial number on the SMARTnet [support] list that might have been a gray market product, I don't think Cisco would have caught it," Pinkerton adds. "Now Cisco is tightening its internal controls on catching this stuff."

This story, "Cisco set to fight aftermarket sellers" was originally published by Network World.

Copyright © 2007 IDG Communications, Inc.

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