The hidden cost of hardware

Michael Tague couldn’t believe his luck. As president of Win.Net, a Louisville, Ky.-based ISP, he had purchased several Network Appliances (NetApp) data storage systems in the past and was pleased with their performance. So, when he found a used but serviceable NetApp model on eBay for a mere $4,000 — a fraction of its original cost — he was delighted.

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But his delight turned to anger when he contacted NetApp to purchase a maintenance agreement for the used system. “They weren’t interested in negotiating the maintenance agreement until we paid $15,000 to relicense the operating system that came with the unit,” Tague says. “No way we were going to pay that. They got paid for the software when they originally sold the system. Why should they get paid again? So, that NetApp box is sitting in a corner — we’re not using it except for spare parts.”

Tague’s experience is increasingly common for those purchasing dedicated hardware systems secondhand. Manufacturers of systems with proprietary operating systems such as high-end routers, data storage devices, and a variety of telecommunications equipment, now generally say their software license agreements prohibit transfer of the software when the hardware is resold. It’s mostly Internet or gray-market bargain hunters who are encountering this policy, but it represents a variety of hidden costs that could eventually affect all IT customers.

Curtailing the Secondhand Market

Blanket prohibitions against license transfer have been standard language in software license agreements for many years. Only after the dot-com bust did it occur to hardware manufacturers that they could try to enforce them. IT managers report that Cisco Systems in particular has been aggressive in its demands for relicense fees.

Tague and others think the manufacturers’ restrictions are just not right. “It’s a flat out scam,” he says. “Just because it’s typical, just because the other guys are doing it too, doesn’t mean it’s OK.” It would be fair, Tague argues, for manufacturers to negotiate a maintenance agreement for their used equipment, as he was more than willing to do with NetApp. “That way, they would have a continuing revenue stream. By demanding we pay $15,000 just for the license, they get nothing.”

“$15,000 is still a good deal,” counters Frank Sowin, senior director of service marketing for NetApp of Sunnyvale, Calif., noting that the original price of the storage server was more than four times that. “If the ownership of a system changes, our contract says the software has to be relicensed. We have a price list for the software, just like any other product.”

Many customers are discovering that the actual cost of acquiring used hardware may go beyond the price of relicensing the software.

“I made the mistake of showing a visiting Cisco rep the 2611 router I’d purchased on eBay for $1,200,” says Mark Payton, director of IT at the Vermont Academy, a school in Saxtons River, Vt. “Not only are they asking me to pay to relicense the software, but they are expecting me to get a one-year SmartNet maintenance agreement and to pay an inspection fee.”

Although Cisco is only asking Payton for slightly more than $300 each for the software relicensing and the SmartNet agreement, the inspection fee alone is more than $850. Payton is still negotiating with Cisco. “If my sales rep can’t get some of those costs waived, the total cost to me for the 2611 router is over $2,700. Brand new through CDW without my additional discounts, I could get this same unit today with one year of SmartNet for $2,300.”

Cost-conscious Internet shoppers such as Payton might not be the only ones getting burned by the hardware vendors’ software licenses. Discouraging Internet and gray-market sales of used equipment through their licensing helps manufacturers keep prices for new hardware higher. Some sales reps explicitly warn customers that they will be punished if they are caught with equipment purchased on eBay.

Could Asset Transfers Be Next?

The restrictions may also reach beyond the secondhand market because theoretically they can be enforced in a transfer of corporate assets such as mergers, acquisitions, and divestitures. That’s because the typical license agreement prohibits all transfers of the software without written permission. The hefty price tag software relicensing requirements could add to mergers is almost incalculable.

For the moment, most manufacturers seem to be waiving their transfer prohibitions in the case of mergers and acquisitions, although they may require the acquiring company to take out a new service contract. “When one company acquires another, we will work with them to manage the transfer and might not require them to buy the licenses again,” NetApp’s Sowin says.

Two other companies contacted for this article — EMC, a rival of NetApp, and router vendor Juniper Networks — said they make similar exceptions in their relicensing requirements for mergers and acquisitions. Cisco Systems declined to comment, but a policy document on its Web site dated Sept. 15, 2000, states that the company does make an exception for “the purchaser of all or substantially all of the capital stock of the transferor."

Despite such exceptions, companies can still face steep relicensing bills after acquiring the assets of another firm.

“We encountered this fate with Cisco last year when we bought out the equipment of a [failed] dot-com,” said one IT manager who asked not to be named. “When we tried to get the used Cisco equipment relicensed, we found it would cost us as much as if we bought the equipment new.”

Legal experts have varied opinions on the enforceability of some transfer restrictions, but they agree on one point: If anyone is to be found guilty of violating the software license, it would be the original purchaser who resold the equipment. The first buyer, after all, is the one who had a chance to see the license agreement and know about the software transfer restriction.

Negotiate Your Terms

It is therefore possible that the original purchaser of a hardware device could incur costs long after the equipment has been disposed of. Manufacturers, purchasers of the used equipment, or both could demand compensation for the first buyer transferring the software in violation of the license agreement. But this ugly prospect also points out the best way for customers to fight back against the transfer restrictions.

“The way to get rid of these transfer restrictions is to use your negotiating leverage as a customer, and the right time to apply that leverage is when the equipment is being purchased for the first time,” says Randy Roth, partner at Corporate Contracts, an IT consultancy in Urbandale, Iowa. “You’re in the driver’s seat, so getting the manufacturer to strike the transfer clause is a real possibility.”

If nothing else, customers who express their distaste for transfer restrictions could force the hardware manufacturers to re-examine their policies. If IT customers don’t want the manufacturers playing hardball over license terms, they are going to have to play a little hardball themselves.