Financing Pre-Owned IT Hardware

The robust trade of pre-owned computer, networking, telecommunications and other IT hardware on the secondary market is a reality. As price-conscious customers look for opportunities to improve their bottom lines without sacrificing quality, pre-owned name-brand IT hardware (typically offered at 65% to 85% discounts below new manufacturers' list prices) becomes an increasingly enticing proposition.

The trade in pre-owned IT hardware represents a tremendous opportunity not only for customers, but also for original equipment manufacturers and secondary market brokers, as well as lessors and other sources of equipment financing. To illustrate this point, a recent International Data Corporation (IDC) study valued the secondary market for just one well-known IT manufacturer's hardware, much of which still has a relatively long useful economic life, at over $3 billion.

Lessor Protection

Despite this reality, some lessors hesitate when asked by customers to lease or finance pre-owned IT hardware, citing concerns about quality, counterfeiting and questionable residual/collateral values. Informed lessors can nevertheless, with knowledge of the basics of the secondary market, safely and profitably lease and finance this hardware.

Understanding the pedigree of the pre-owned hardware lessors intend to lease or finance is the key to success and increased residual or collateral values. Just as most buyers wouldn't purchase a used car without first checking its Kelley Blue Book value, examining for damage, prior repairs and after-market upgrades, and even requesting a “CARFAX” report from the dealer, lessors shouldn't lease pre-owned IT hardware without understanding its quality, condition and handling from the factory floor until its ultimate resale.

As with used cars, understanding where pre-owned IT hardware came from, how it was refurbished and tested, and who is offering it for secondary market sale should help the lessor identify and mitigate the risks. Knowing the answers to the following three simple questions will enable lessors to enter into leases, installment sale agreements, and other forms of equipment financing transactions with a minimum degree of added risk.

Question 1: Who Is Really Supplying the Pre-owned Hardware?

Lessors contemplating a pre-owned IT hardware transaction may find it useful to contrast manufacturer-sourced pre-owned hardware against hardware that is secondary market broker-sourced. First and foremost, the lessor should identify whether or not the hardware it is leasing or financing is currently being sourced through the original manufacturer, who is in the best position to ensure effective quality control with certified refurbishment and reconditioning programs that feature stress-testing to ensure it meets performance standards. To continue our used-car analogy, is the car being offered as a “Certified Lexis Pre-Owned Vehicle,” or was it purchased from a generic “Ralf's” used-car dealer, which may not be in a position to vouch for the car's history from the time it rolled off the assembly line?

An original manufacturer sells manufacturer-sourced pre-owned IT hardware on the secondary market through its authorized distribution channels because the manufacturer is unable or unwilling to sell the hardware through more traditional new product distribution channels. Perhaps the hardware is a customer trade-in, demo or off-lease equipment, or perhaps it is merely factory surplus or “end of product life” or “end of sale” inventory that the manufacturer just wants to sell more aggressively. The key distinguishing feature of manufacturer-sourced pre-owned IT hardware is that the original manufacturer continues to authorize and control the ultimate distribution channels for that hardware, and so is in a unique position to validate the hardware's quality, chain of custody, embedded software licensing, warranty, packaging and post-sale support and maintenance.

Secondary market-sourced pre-owned IT hardware, on the other hand, does not, by definition, originate from a manufacturer-controlled source. Instead, this category of pre-owned hardware is sold through distribution channels by brokers with no relationship with the original manufacturer. In most cases, these brokers are neither authorized, vetted nor endorsed by the original manufacturer. Such brokers may buy the hardware on the open market (from sources other than the original manufacturer) or obtain it from customers as part of broker-supplied asset management services. The brokers then resell the hardware to other brokers or directly to customers, all without original manufacturer interaction or endorsement.

While most IT hardware manufacturers dislike the trade of their branded hardware by secondary market brokers, so long as the hardware being sold is not counterfeit and the manufacturer's embedded software license restrictions are respected, the market itself is legal.

Some well-known technology manufacturers even specifically authorize third-party wholesale programs outside of their normal distribution channels, which provide a reliable source of genuine, non-counterfeit equipment to select authorized secondary market brokers, but which may not provide the same level of testing, refurbishment and warranties offered by the manufacturers' own certified pre-owned programs.

If in doubt, the lessor should ask its customer to help determine just who is offering the pre-owned hardware for purchase.

Question 2: Was the Pre-owned Hardware Refurbished and Tested?

For manufacturer-sourced pre-owned IT hardware, the manufacturer's own remarketing unit (or a third-party remarketer acting on the manufacturer's behalf) takes the hardware into inventory, scans it for counterfeit components, and tests and refurbishes it to “like-new” standards. Many manufacturers use the same processes and procedures to refurbish pre-owned IT hardware that they use to service and repair newly manufactured equipment.

Like manufacturers, secondary market brokers may also test and refurbish pre-owned hardware before making it available for sale. However, since brokers typically have little knowledge of the hardware's original manufacturing processes and procedures, and lack access to the original manufacturer's repair lines and expertise, they may not be well positioned to refurbish the hardware to the same standards as the original manufacturer.

Identifying counterfeit hardware and components is another major area of concern. While many brokers actively scan their supply for counterfeits, without access to the ever-evolving brand-protection expertise of the manufacturer, even the most conscientious of brokers may find it challenging to weed out fake components from their supply.

Last, customers that purchase pre-owned IT equipment from brokers that are not “authorized” wholesalers may have to pay the manufacturer to have it inspected and relicensed in order qualify for necessary technical support and maintenance services.

Question 3: Who Is Going to Back Up the Warranty and Licenses?

Original manufacturers often bundle newly refurbished pre-owned IT hardware with the same warranty and maintenance terms they offer for newly manufactured hardware. Secondary market brokers may also offer warranty and maintenance terms for pre-owned IT hardware, sometimes even including terms that exceed those offered by the manufacturer. Lessors should dig deeper and establish whether or not the broker, who is likely more diversified, more thinly capitalized and less established than the original manufacturer, truly possesses the focus, expertise, infrastructure and stability to deliver high quality warranty repair and maintenance over the life of the lease or other financing arrangement.

Another consideration is “embedded software” or “firmware” ' special-purpose system software that controls the basic operation of machines or devices (or their components) that are not typically thought of as computers. Since valid licenses to use embedded software can be essential to the customer's full operation and use of IT hardware, manufacturers commonly provide embedded software licensing together with the newly refurbished hardware. In contrast, a broker with no relationship with the original manufacturer, or rights to sublicense the manufacturer's embedded hardware, cannot offer valid licenses for software embedded in the hardware. Both the customer and the lessor may be left holding the bag with useless equipment if an indifferent manufacturer simply refuses to relicense the software embedded in secondary market IT hardware or elects to charge a high relicensing fee.

Should You Lease Pre-Owned IT Hardware or Not?

If a lessor is willing to ask and properly evaluate the answers to these few questions, it will be able to lease pre-owned IT hardware with far less risk. Lessors should fully assess whether the pre-owned hardware they are leasing or financing: 1) has been thoroughly tested, refurbished and scanned for counterfeit components; 2) comes with the rights to utilize essential embedded software; and 3) is offered on reliable warranty and support terms closely mirroring that offered by the original manufacturer.

The investigation into these features may be simplified if the lessor is able to obtain certification from the original manufacturer that the pre-owned IT hardware is genuine and that the manufacturer will stand behind the product as if it were newly manufactured. If the leased equipment is secondary market broker-sourced, the lessor should look for brokers who have a formal “authorized wholesaler” relationship with the manufacturer or, at minimum, obtain proper contractual assurances from the broker that the equipment is genuine and that the broker can and will stand behind any warranties that it chooses to provide to the end-user customer.

While placing a call to the original manufacturer to confirm the broker's assertions will provide an extra measure of confidence, additional due diligence efforts may be warranted to assess the reputation and abilities of the broker to meet its contractual obligations with respect to the pre-owned hardware that it offers for sale in the secondary market.

Conclusion

Lessors that are able to deal directly with original equipment manufacturers in the secondary market (or to successfully complete and gauge the results of their due diligence efforts for secondary market brokers) can realize substantial growth in their equipment financing opportunities by exploiting the booming market for pre-owned IT equipment.

Stacie LeGrow is Director of Legal Services for Cisco Systems, Inc., where she supports the Pre-Owned Equipment line of business for Cisco Systems Capital Corporation. Raymond W. Dusch, a member of this newsletter's Board of Editors, is Senior Corporate Counsel for Cisco Systems, Inc., supporting Cisco Capital transactions for Cisco Systems' Global Enterprise Theatre and Americas Enterprise & Commercial teams.'

The robust trade of pre-owned computer, networking, telecommunications and other IT hardware on the secondary market is a reality. As price-conscious customers look for opportunities to improve their bottom lines without sacrificing quality, pre-owned name-brand IT hardware (typically offered at 65% to 85% discounts below new manufacturers' list prices) becomes an increasingly enticing proposition.

The trade in pre-owned IT hardware represents a tremendous opportunity not only for customers, but also for original equipment manufacturers and secondary market brokers, as well as lessors and other sources of equipment financing. To illustrate this point, a recent International Data Corporation (IDC) study valued the secondary market for just one well-known IT manufacturer's hardware, much of which still has a relatively long useful economic life, at over $3 billion.

Lessor Protection

Despite this reality, some lessors hesitate when asked by customers to lease or finance pre-owned IT hardware, citing concerns about quality, counterfeiting and questionable residual/collateral values. Informed lessors can nevertheless, with knowledge of the basics of the secondary market, safely and profitably lease and finance this hardware.

Understanding the pedigree of the pre-owned hardware lessors intend to lease or finance is the key to success and increased residual or collateral values. Just as most buyers wouldn't purchase a used car without first checking its Kelley Blue Book value, examining for damage, prior repairs and after-market upgrades, and even requesting a “CARFAX” report from the dealer, lessors shouldn't lease pre-owned IT hardware without understanding its quality, condition and handling from the factory floor until its ultimate resale.

As with used cars, understanding where pre-owned IT hardware came from, how it was refurbished and tested, and who is offering it for secondary market sale should help the lessor identify and mitigate the risks. Knowing the answers to the following three simple questions will enable lessors to enter into leases, installment sale agreements, and other forms of equipment financing transactions with a minimum degree of added risk.

Question 1: Who Is Really Supplying the Pre-owned Hardware?

Lessors contemplating a pre-owned IT hardware transaction may find it useful to contrast manufacturer-sourced pre-owned hardware against hardware that is secondary market broker-sourced. First and foremost, the lessor should identify whether or not the hardware it is leasing or financing is currently being sourced through the original manufacturer, who is in the best position to ensure effective quality control with certified refurbishment and reconditioning programs that feature stress-testing to ensure it meets performance standards. To continue our used-car analogy, is the car being offered as a “Certified Lexis Pre-Owned Vehicle,” or was it purchased from a generic “Ralf's” used-car dealer, which may not be in a position to vouch for the car's history from the time it rolled off the assembly line?

An original manufacturer sells manufacturer-sourced pre-owned IT hardware on the secondary market through its authorized distribution channels because the manufacturer is unable or unwilling to sell the hardware through more traditional new product distribution channels. Perhaps the hardware is a customer trade-in, demo or off-lease equipment, or perhaps it is merely factory surplus or “end of product life” or “end of sale” inventory that the manufacturer just wants to sell more aggressively. The key distinguishing feature of manufacturer-sourced pre-owned IT hardware is that the original manufacturer continues to authorize and control the ultimate distribution channels for that hardware, and so is in a unique position to validate the hardware's quality, chain of custody, embedded software licensing, warranty, packaging and post-sale support and maintenance.

Secondary market-sourced pre-owned IT hardware, on the other hand, does not, by definition, originate from a manufacturer-controlled source. Instead, this category of pre-owned hardware is sold through distribution channels by brokers with no relationship with the original manufacturer. In most cases, these brokers are neither authorized, vetted nor endorsed by the original manufacturer. Such brokers may buy the hardware on the open market (from sources other than the original manufacturer) or obtain it from customers as part of broker-supplied asset management services. The brokers then resell the hardware to other brokers or directly to customers, all without original manufacturer interaction or endorsement.

While most IT hardware manufacturers dislike the trade of their branded hardware by secondary market brokers, so long as the hardware being sold is not counterfeit and the manufacturer's embedded software license restrictions are respected, the market itself is legal.

Some well-known technology manufacturers even specifically authorize third-party wholesale programs outside of their normal distribution channels, which provide a reliable source of genuine, non-counterfeit equipment to select authorized secondary market brokers, but which may not provide the same level of testing, refurbishment and warranties offered by the manufacturers' own certified pre-owned programs.

If in doubt, the lessor should ask its customer to help determine just who is offering the pre-owned hardware for purchase.

Question 2: Was the Pre-owned Hardware Refurbished and Tested?

For manufacturer-sourced pre-owned IT hardware, the manufacturer's own remarketing unit (or a third-party remarketer acting on the manufacturer's behalf) takes the hardware into inventory, scans it for counterfeit components, and tests and refurbishes it to “like-new” standards. Many manufacturers use the same processes and procedures to refurbish pre-owned IT hardware that they use to service and repair newly manufactured equipment.

Like manufacturers, secondary market brokers may also test and refurbish pre-owned hardware before making it available for sale. However, since brokers typically have little knowledge of the hardware's original manufacturing processes and procedures, and lack access to the original manufacturer's repair lines and expertise, they may not be well positioned to refurbish the hardware to the same standards as the original manufacturer.

Identifying counterfeit hardware and components is another major area of concern. While many brokers actively scan their supply for counterfeits, without access to the ever-evolving brand-protection expertise of the manufacturer, even the most conscientious of brokers may find it challenging to weed out fake components from their supply.

Last, customers that purchase pre-owned IT equipment from brokers that are not “authorized” wholesalers may have to pay the manufacturer to have it inspected and relicensed in order qualify for necessary technical support and maintenance services.

Question 3: Who Is Going to Back Up the Warranty and Licenses?

Original manufacturers often bundle newly refurbished pre-owned IT hardware with the same warranty and maintenance terms they offer for newly manufactured hardware. Secondary market brokers may also offer warranty and maintenance terms for pre-owned IT hardware, sometimes even including terms that exceed those offered by the manufacturer. Lessors should dig deeper and establish whether or not the broker, who is likely more diversified, more thinly capitalized and less established than the original manufacturer, truly possesses the focus, expertise, infrastructure and stability to deliver high quality warranty repair and maintenance over the life of the lease or other financing arrangement.

Another consideration is “embedded software” or “firmware” ' special-purpose system software that controls the basic operation of machines or devices (or their components) that are not typically thought of as computers. Since valid licenses to use embedded software can be essential to the customer's full operation and use of IT hardware, manufacturers commonly provide embedded software licensing together with the newly refurbished hardware. In contrast, a broker with no relationship with the original manufacturer, or rights to sublicense the manufacturer's embedded hardware, cannot offer valid licenses for software embedded in the hardware. Both the customer and the lessor may be left holding the bag with useless equipment if an indifferent manufacturer simply refuses to relicense the software embedded in secondary market IT hardware or elects to charge a high relicensing fee.

Should You Lease Pre-Owned IT Hardware or Not?

If a lessor is willing to ask and properly evaluate the answers to these few questions, it will be able to lease pre-owned IT hardware with far less risk. Lessors should fully assess whether the pre-owned hardware they are leasing or financing: 1) has been thoroughly tested, refurbished and scanned for counterfeit components; 2) comes with the rights to utilize essential embedded software; and 3) is offered on reliable warranty and support terms closely mirroring that offered by the original manufacturer.

The investigation into these features may be simplified if the lessor is able to obtain certification from the original manufacturer that the pre-owned IT hardware is genuine and that the manufacturer will stand behind the product as if it were newly manufactured. If the leased equipment is secondary market broker-sourced, the lessor should look for brokers who have a formal “authorized wholesaler” relationship with the manufacturer or, at minimum, obtain proper contractual assurances from the broker that the equipment is genuine and that the broker can and will stand behind any warranties that it chooses to provide to the end-user customer.

While placing a call to the original manufacturer to confirm the broker's assertions will provide an extra measure of confidence, additional due diligence efforts may be warranted to assess the reputation and abilities of the broker to meet its contractual obligations with respect to the pre-owned hardware that it offers for sale in the secondary market.

Conclusion

Lessors that are able to deal directly with original equipment manufacturers in the secondary market (or to successfully complete and gauge the results of their due diligence efforts for secondary market brokers) can realize substantial growth in their equipment financing opportunities by exploiting the booming market for pre-owned IT equipment.

Stacie LeGrow is Director of Legal Services for Cisco Systems, Inc., where she supports the Pre-Owned Equipment line of business for Cisco Systems Capital Corporation. Raymond W. Dusch, a member of this newsletter's Board of Editors, is Senior Corporate Counsel for Cisco Systems, Inc., supporting Cisco Capital transactions for Cisco Systems' Global Enterprise Theatre and Americas Enterprise & Commercial teams.'