Exposed: Dangers of the Gray Market

Rules Meant To Be Broken?

Distribution--particularly in the public sector--is necessary for vendors to accommodate solution-provider demand for products and services. But in a market that so often rides on price, rules that keep partners shackled to a single channel may be driving some toward unauthorized product sources.

Many vendors, including Cisco Systems, sell direct only to their largest partners--typically known as direct value-added resellers, or DVARs--and send the rest through distribution. Vendors will often add a clause to indirect-partner agreements that prohibits sales of product between solution providers.

"For smaller resellers, the 'norm' is to drive them through distribution so the vendor doesn't have to be directly involved with small order sizes and less-than-stellar creditworthiness," says Rick Marcotte, president and CEO of DLT Solutions, Herndon, Va., and a member of the GovernmentVAR advisory board. "Many large resellers push the vendor to buy direct, and, depending on the reseller's clout and the vendor's channel policy, that's sometimes allowed. However, most vendors do not allow 'distributor shopping' and force a somewhat permanent relationship between distribution partners and major resellers."

There are always exceptions. As the reseller grows and sells significant volume, vendors will start working direct with them and provide them with better pricing. Or if a larger systems integrator is having trouble meeting sales goals or needs to do more work with small business, a vendor may direct certain solution providers to purchase through that larger partner. Such changes in policy can be frustrating for the distributor and confusing to solution providers, causing some to seek out other options.

"Changing policy causes disturbing behavior, and then what happens? The vendor has to go to the end customer, a federal agency, and say, 'you may have some counterfeit products.' How does that make them look?" asks Bob Laclede, vice president and general manager of Ingram Micro's government and education business. "This is the ugly part of the business."

That disturbing behavior is even more pronounced in government, where small businesses have a hard time winning bids on commodity products that are entirely determined by price.

"It's a pricing game; if vendors would pass discounts through distribution only and let the channel do its job, this wouldn't happen," Laclede says. "Instead, everyone bids the same switch and resellers shop around for the cheapest price; distribution is roughly the same, so they say 'where else?'"

The answer, often, is larger partners that are willing to sacrifice a part of their margin to win the business. At the same time, solution providers may be directed by their prime contractors to contact particular businesses for product fulfillment.

Robert Castro, president of American Data and Computer Products, says that he is often asked by systems integrators to purchase products on their behalf from small companies. Often, it's a one-time deal, "but we do it because our customers ask us to," he says.

However, to other solution providers, stepping outside the bounds of authorized channels--whether knowingly or not--does nothing but negatively impact the process.

"This 'throw it into the channel and let them fight it out' mentality doesn't serve anyone's interest--vendor, distributor or reseller," Marcotte says, even if it does result in a lower price for the customer. "[It leads to a] classic case of playing with fire and getting burned. These resellers who go around the system in an attempt to save a few bucks have no perspective of a long-term business strategy."

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