One result of the recent recession: a growing gray market for surplus computer and telecom equipment.

In fact, there is such an abundance of new and used IT equipment being sold by failed dot.com and struggling start-up businesses to resellers, brokers and e-auction houses who then remarket the gear, that some industry observers put the market at around $20 billion for 2002.

Companies selling computer and telecom equipment to free up cash for new projects are fueling the recent activity in the gray market. Eager buyers wanting the latest whiz-bang technology purchased some of it initially; other gear was bought in anticipation of much heralded impending Y2K disasters. Much of the equipment is brand new and under manufacturer warranty; some of it is still in its original boxes.

Most computer and telecom OEMs don't buy back surplus equipment. Companies strapped for cash are turning to resellers and e-auction houses for help. These businesses buy the gear for cents on the dollar of the original purchase price and resell it to other buyers, often entrepreneurs looking to begin new ventures. Other times, buyers are corporate purchasing managers looking for savings on computer and telecom equipment. Even the U.S. government has purchased IT equipment through these resellers.

One such reseller is Asset Recovery Center, Eatontown, N.J. Founded by former AT&T and Lucent Technology managers in 1990, ARC remarkets surplus computer and telecom equipment, discontinued products, distressed inventories and bankruptcy liquidations.

"We have a number of companies contacting us with multi-million dollars worth of equipment to remarket, sell, or buy outright," says CEO John Lynch who is now in the process of liquidating some of Enron's IT assets throughout the U.S. and Canada.

Lynch says much of the equipment ARC recovers is sold to businesses overseas—the Philippines, Hong Kong, France, Spain, Germany—and in the U.S. to enterprising individuals who, having lost their jobs with Fortune 500 companies, are looking for, say, $20,000 in equipment to build a data center for a new project. ARC has also sold equipment to big corporations like Credit Suisse First Boston in New York and to the U.S. Army.

"In many cases, corporate buyers are compensated for cost savings," he says, telling of being contacted by a tech lab thinking of purchasing some branded IT equipment. The lab has a 38% discount with the manufacturer and would pay $68,000 for one piece of equipment. They want to buy five units and some other parts. They can purchase gear for $120,000 from ARC that would cost $400,000 from the manufacturer, which is a 70% savings off the company's discount. What's more, they have about $300,000 left in their budget to make other purchases.

Companies such as ARC "give purchasing managers who work for major corporations opportunity to look outside of the manufacturers," says Lynch. "The bottom line is that manufacturers won't buy their equipment back. They don't put any value on it. So, if I am selling it at 20 cents on the dollar of its original cost, that has got to be the value. It could be state-of-the-art equipment still in the box. How can it not have any value?"

Simply put, Lynch explains that if the manufacturers buy the equipment back, their revenue shrinks. Meanwhile, they want to manufacture and sell new products. But buyers now are not replacing products as quickly as they used to, and since their company networks are up and running, probably won't until maybe 2004. There's a glut and it's going to be here for a while.

Much of the equipment, some purchased by Fortune 500 companies in anticipation of impending Y2K disasters in 1998 and 1999, is still under manufacturer warranty. Many of these warranties are not set to expire until 2004 and 2005.

While most manufacturers balk at servicing the gear, resellers like ARC can usually convince them otherwise. "They should be thrilled because their biggest income now is not from sales of new equipment, but from service contracts," says Lynch. ARC, for its part, isn't interested in servicing computer and telecom equipment.

Meanwhile, to help educate buyers about illegal or deceptive brokering or diversion of products and to address the unauthorized flow of products to the gray market, Compaq, HP, Xerox, Apple, 3Com and Nortel Networks have formed the Anti-Gray Market Alliance (www.agmatoday.org).

The group of OEMs, joined recently by Cisco Systems, describes the term gray market as the unauthorized transfer of brand name computer hardware and software outside of authorized channels. Typically, computer and telecom companies sell their equipment directly to customers or through a network of authorized distributors and resellers.

"A study we commissioned by KPMG indicates that unauthorized resellers or brokers reap about $20 billion in profits from diverting product from the authorized channel," says David Colten, executive director, AGMA . This $20 billion is the sum the brokers extract from the entire distribution cycle. It impacts authorized resellers and distributors.

"It's important to be upfront and clear that we understand there is a big difference between legitimately used product and gray product," says Colten, adding that the alliance has no issue with used product—perhaps a company overpurchased or was acquired by another company—legitimately sold as used product. "As long as the consumer understands that it's used, that's terrific."

He says that some manufacturers buy back their equipment: Each has its own individual business model; some are very supportive of the secondary market for "formerly new product." These companies try to work with the consumer to offer extended warranties and service upgrades—whether it's adding more capability or replacing software as new updates become available.

What the alliance is focusing on are individuals who take products that are new and divert them from the authorized channel while handling it in a way that's harmful to the end user who believes he or she is purchasing new product. The product may, for instance, be designed with software or power supplies for use in another country. The manufacturer then cannot honor the warranty because the equipment is not being used for its intended purpose.

"Often, however, one of our members will try to service the customer anyway because the relationship is important," says Colten. "We are completely supportive of the used market as long as the consumer understands that the product he or she is purchasing is used. We're concerned about used products being repackaged and sold as new. We've found through our investigations that some brokers are hollowing out products—replacing hard drives, memory modules, fans, and power supplies with counterfeit items. These illegal brokers are getting two bites of the apple. Not only are they selling used equipment as new, but they also have original parts now to resell as new."

As such, AGMAS message to consumers is to make an informed choice, i.e., ensure that the manufacturer backs the products they are purchasing.

"Our goal is primarily to educate the consumer, the channel, and the manufacturers," adds Colten. AGMA is publishing a white paper on the subject.