Gray Matters

Far from hiding in the shadows like clandestine gray marketers, these distributors openly tout their independent status and back up their aggressive prices with service some solution providers claim is superior to that of authorized distributors.

Yet just as the independents are gaining ground, vendors, notably Hewlett-Packard, are stepping up their efforts to squash sales of their products through unauthorized channels. HP, which defines the gray market as any product sold outside authorized channels, maintains that its crackdown, which has included fining solution providers buying products from unauthorized distributors, is having an impact. “I think we&'ve seen a positive effect of that. With everything there are ups and downs along the way, but certainly we think we are having some effect,” said HP CEO Mark Hurd in answer to a question about the gray market during the company&'s quarterly earnings call last week.

Despite some vendors&' stated efforts to halt their progress, unauthorized distributors claim they are seeing dramatic sales growth. Arbitech, Irvine, Calif., for example, which bills itself as the nation&'s leading independent distributor of tier-one computer products, including those from HP, IBM and Cisco Systems, said it has annual sales approaching $200 million and has claimed a spot on Inc. Magazine&'s 2004 annual list of fastest-growing companies.

CRN&'s own research bears out the rising profile of the independent, unauthorized distribution channel. While the exact volume of product sales through unauthorized sources is difficult to trace, CRN&'s 2005 Sourcing Study showed that solution providers are upping their product purchases from online auctions and other alternative sources, while those from authorized distribution channels have declined.

VARs tell CRN that the crop of these unauthorized distributors, including Arbitech, Sky Electronics, Origin Micro and Aqua Systems, are definitely winning the hearts and wallets of a growing number of solution providers. Arbitech said it counts as customers some of the largest resellers in the world, as well as many smaller, regional players that have sought to tap the pricing and product benefits previously only available to Gold and Platinum resellers.

‘A Touchy Subject&'
Why would these VARs risk their relationships with their vendor partners to source products from unauthorized distributors?

Some solution providers, who did not want to speak on the record because they feared retribution from the vendors, said they are spending a higher percentage of their dollars with unauthorized sources because of the flat-out better pricing and services. “They help me beat Dell,” said one longtime solution provider executive. “We get a better price than the authorized distributors would give us, with great service.”

Said George Cross, vice president of sales at Origin Micro, a nine-year-old distributor in Portsmouth, N.H.: “It comes down to customer service and keeping our customers happy. We focus on a lot of smaller VARs who may not buy something every month. Every order means a lot to us. We do things the bigger guys may not want to do.”

A CEO of one of the top unauthorized distributors, who did not want to be identified, said his company and others called gray marketers by the vendors play a critical role by offering better terms and pricing to small and midsize solution providers. “Small and midsize VARs need us to compete in the marketplace,” the CEO said.

It is a misnomer to call companies like his gray marketers, the executive said. “I call it the ‘open market.&' People need to know there are good companies in this alternative channel,” he said. “We don&'t have any alignments with any of the manufacturers, and I don&'t want them. Then I&'d be subject to the same column pricing as the other distributors. I wouldn&'t be a benefit to the small and midrange resellers if I was under contract with the vendors.”

However, the benefits solution providers may receive don&'t come without risk, such as fear of retribution from the vendors. Vendors said authorized solution providers that buy products from unauthorized sources can be in violation of their vendor contracts.

“It&'s a very touchy subject,” said one solution provider that holds authorizations from HP, IBM, Cisco and others. He said that he occasionally purchases HP ProLiant servers from Arbitech. “It&'s never a model with the current Intel processor; it&'s always one rev old,” he said. “But often that&'s what the customer wants.”

He notes he can sometimes buy HP servers 30 percent below his costs for the same products from Tech Data or Ingram Micro. “And this is new-in-the-box stuff, and the customer doesn&'t care because the warranty follows the serial number.”

But that may not be the case. Palo Alto, Calif.-based HP, for one, said that when products are purchased outside of authorized channels, the warranty is void. “Someone like Arbitech, who is not an authorized HP distributor, is prohibited from buying restricted products [including PCs, notebooks, servers and enterprise storage] directly from HP or from an authorized HP distributor or reseller,” said John Thompson, vice president and general manager of HP&'s Solution Partners Organization, Americas. “If any company is sourcing restricted products in an unauthorized fashion, we definitely have consequences associated with that up to and including termination of the contract and other settlements that I can&'t speak about. We will stand behind authorized partners, but we will not stand behind unauthorized partners. Warranties on unauthorized sales are not valid. We have stepped up enforcement.”

Late last year, HP started sending letters to solution providers instituting penalties for buying products from unauthorized distributors like Arbitech.

Vendor Theatrics?
Indeed, while vendors like HP, Cisco and others have publicly declared war on the gray market, some solution providers said those cries of foul are nothing more than theatrics. They claim vendors could stop the gray market dead in its tracks by going after those moving large volumes of serial-numbered products to unauthorized distribution sources.

An HP-authorized distribution executive said the authorized distributors have asked HP to look into the practice. “In many cases, we&'ve provided some serial numbers back to HP,” he said. “We do not see HP doing anything about it.”

More than a few solution providers viewed the crackdown as ironic. “HP plays both sides,” said one HP solution provider. “[Independent distributors] buy some equipment from HP and they allow it, but then HP doesn&'t allow anyone to buy it unless they buy it from an authorized distributor.”

When asked if HP had ever sold products to unauthorized distributors, an HP spokeswoman said, “Our policy on that is that we sell to our authorized distributors.”

One reseller executive said vendors could snuff out the gray market any time they want. “They could stop it in a second,” said the executive. “They don&'t want to. The bottom line is the bottom line. It&'s a feeding ground to allow companies to make their quarterly numbers. It is very easy to cut off the gray market since every product has a serial number.”

Some VARs also said the rise of a new crop of unauthorized distributors has been helped along by distribution giants like Ingram Micro and Tech Data, which have not been competing as aggressively as they could for the business of smaller solution providers.

One notable advantage the unauthorized distributors provide, VARs said, is more flexibility on product returns and better turnaround on replacement of defective products. “All the big distributors wait for the manufacturers to approve returns,” said one solution provider, who has increased his purchasing with the unauthorized distributors. “If you buy a lot of product from these other sources, you are going to be covered.”

Yet, executives at authorized distributors said VARs are taking chances buying products through unauthorized sources. In addition, while they maintain the volume of products sold through these alternative sources does not impact their own businesses, distributors said they often pass information on to vendors to investigate. And then don&'t hear anything back. “Typically, they&'re receptive when you give it to them,” one distribution executive said, “but it&'s hard to get any follow-up on what you gave them.”

None of the independent distributors have caused a panic at traditional distributors, executives said, in part because the volumes are not great. At worst, they are a nuisance, said one executive.

Threat of Counterfeits
Cisco, which says it is aggressively moving to shut down the gray market on all fronts, believes there is another risk for VARs buying from unauthorized sources—the dramatic rise in counterfeit products. These products, which carry the Cisco trademark or logo but are fake, can even end up taking down a network, the company said. San Jose, Calif.-based Cisco said it sees the gray market as a threat to customer satisfaction based on Cisco&'s bulletproof product reputation. Cisco said it has invested heavily in educating customers about the unintended consequences that can come with buying Cisco products from unauthorized sources. As part of that effort, two years ago it began requiring that all end-user customers who relicense software from Cisco for their used/gray market products be required to register the serial numbers for those products online.

Arnie Bellini, president of ConnectWise, a Tampa, Fla., solution provider and also the maker of the ConnectWise professional services software for solution providers, said vendors must do a better job of educating VARs about unauthorized distribution sources. “I wouldn&'t know that these are not valid sources,” he said. “We would not necessarily know the difference between a valid source for HP product and a gray market source unless we were educated by HP.”

Another solution provider executive who is HP-authorized but has been purchasing HP servers from Arbitech for years was surprised to hear HP may be cracking down. “I don&'t need a fine and I don&'t want HP upset with me,” he said. “We are straight arrows here and we do everything by the book. At least I think we do.”

Bellini, for his part, said that although many VARs shop around for price on a large bulk purchase opportunity, he sticks with his traditional distributors because of their stellar reputation and delivery track record. Bellini said the gray market is a “conundrum” for the vendors because, at the end of the day, vendors are trying to move more products through the channel. They may not actually want to shut the market down because they could be “shooting themselves in the foot.”

“The vendors need to decide what their strategy is and send very strong letters and messages to gray market distributors if they indeed want to close it down,” Bellini said. “For them to go after the reseller and not the distributor doesn&'t make much sense to me.”

One solution provider executive said the independent distribution channel ultimately rewards unauthorized VARs at the expense of VARs that invest time and money in maintaining vendor authorizations. “If you&'re not authorized by HP you can buy all you want from nonauthorized distributors and HP can&'t touch you,” he said. “But if you&'re authorized and you get caught, you&'re screwed.”

SCOTT CAMPBELL contributed to this story.