There has been no shortage of interest in third-party funding of IT asset management (ITAM) companies over the past years, and that’s been certainly true for the end-of-life phase of ITAM, known as IT Asset Disposition (ITAD).  Financiers, including private equity firms are attracted by the promises of a good return on investment, in particular if there are the two key components of environmental stewardship and data security involved in the value proposition.  These are words that still resonate among some investors, who see them as good selling points, and tend to attract capital into cash-hungry firms.

Although the classic ITAD sector is facing unprecedented uncertainty, there is still some investors out there looking for good deals. The November 1 announcement that Zelnick Media Capital (ZMC), acquired a controlling stake in IT Renew was not a surprise. It comes as a continuation of a series of such transactions that have happened for years.  The move is basically another indication that many core ITAD companies are naturally continuously looking for resources to fund their operations and grow. And that’s good news. [A side note: ZMC defines itself as a private equity firm … that invest and manage a diverse group of media and communications enterprises].

But often, the injection of fresh capital from an equity firm does not necessarily guarantee success. There have several cases of ITAD companies quickly imploding even after new money was injected. Perhaps one of the most known cases was that of the now defunct Intechra, which went on an out-of-control expansion spree after an injection of fresh money, only to collapse as a result of unchecked infrastructure growth and a too-aggressive strategy.  The company suffered from a “too-much, too-quickly” situation, while its customer base did not grow as fast to generate the kind of return its investors wanted.  The end result was that the company became up for sale, most likely at the lowest cost for the buyer, and Arrow picked it up.

the injection of fresh capital from an equity firm into an ITAD does not guarantee success.... Click To Tweet

While the Intechra saga could have been used by investors as a case study, a great deal of subsequent equity transactions that took place afterward lacked serious due diligence from the investors.  This is because many individuals involved in investment decisions have been attracted to the value propositions put forward in front of them. Excitement and  excessive exuberance have been leading factors of decision making, while there have been very little data and research on the industry and its outlook to make logical decisions.

So what to make of the most recent investment decisions made in active ITAD companies these days?  Well, firstly most of these companies are small businesses, considering their revenue and employment sizes.  As a business, getting funding is natural and even a matter of continuity and survival.  The business owners are correct in seeking all the help they can get.  There have been many of such cases over the past months, and IT Renew is the latest one, but it won’t be the last one.

For the investor, the challenge has been to jump too quickly into an industry that is poorly understood, and I am willing to bet that their conclusions during their vetting process in terms of the outlook are considerably off and out of line in relations to the real dynamics of the sector. One of the first question to ask is where is the ITAD sector headed?  On the enterprise side, core ITAD companies will likely have a high degree of difficulty sustaining their business models at they stands.  The risk is not just specific to them only, but for all the companies that do not own the relationship with the client.  About half of the large companies on the end-user side, that pay fees and rely on ITAD firms to handle their retired assets, already have the cost of decommissioning embedded in their new asset purchases.  Simply said, half of the large companies that purchase brand new hardware from OEMs and large distributors are already locked-in when it comes to their assets’ end of life. The handshake between the OEM and the end-user company limits any opportunity for core ITADs to displace the OEM, unless they serve the OEM as a contractor. Leased assets also mean that the leasing company owns the relationship.  In such an environment, not owning the client limits the core ITAD room-for-maneuvering and reduces its ability to sustain growth.

Here’s one example on how not owning a customer could be detrimental. Several years ago, I received a demo smartphone from a very large PC vendor who wanted to compete in the mobile phone business. The device was, in my opinion, one of the most beautifully designed phablets back then. The system featured a large screen, powered by Google’s Android operating system. Sadly, the company’s business model looked incredibly flawed.  It manufactured a device, that it was selling to consumer via telecom providers or retailers.  Once the sale transaction is concluded, the relationship ends there, and the user is essentially owned by two other types of companies: the mobile operator for telecom access, and in this case with Google (given the OS) for store access and advertisement.  The manufacturer may have made a lousy margin of no more than $5 per device, and lost the customer to other companies that are set to generate recurring revenues for as long as they can convince the customer to stick around.   Not owning the customer is never a good option, even if you make beautiful hardware.

Then there is the other half of the corporate world that does not embed ITAD cost up front. This is where the opportunity exists for core ITAD, because many very large companies are required to have several service providers as standard company policy.  That may be good news from a competitive context, but OEMs, leasing firms, and large distributors are currently working around the clock to redefine the concept of owning hardware assets.  Efforts are underway to convince buyers that they have interest in staying within their closed-loop lifecycle environment. Ideas such as reducing TCO and limiting data breaches through such things as “device-as-a-service” are advancing. They are not moving quickly and they are not new, but IT buyers are starting to revisit the numbers and some of them are likely to be attracted to the ideas of (1) saving on cost, (2) guaranteeing the latest technology, and (3) ensuring all sorts of compliance. Achieving this will not be easy for the large vendors.  Not only this will require substantial transformation in the way IT is used in the enterprise, but the vendors would also have to undergo internal transformation in terms of product offering, organizational structure, sales organization redesign, marketing, etc.

But efforts by big vendors to change practices are underway and the example of the smartphone industry is tightly monitored to provide clues as to what these large vendors may be offering.  The smartphone business as applied to the consumer market has the most up-to-date lifecycle practices that are the envy of the rest of the IT sector.  These practices, the mobile industry says, are beneficial to the industry and to the consumer, or so they say.  Data from Hyla Mobile shows that the mobile phone industry has been extremely successfully in redefining the terms of lifecycle.  Not only less people are buying and owning devices up front, but the vast majority now (79%) moved to the so-called Equipment Installation Plans (EIP), compared to 21% for standards two-year contracts.   EIP and leasing options are different in that in the EIP case you will own the phone at the end of the two year term, after which you could continue using or sell it to finance a new model.  You will pay more on the monthly basis than if you were to lease, since the lease option is continual.  Regardless of the method a buyer uses, the phone industry figured out a way to incentivize the users to upgrade quickly. Obviously, these upgrades require a tight coordination between the device manufacturers, who push for new technologies, and the channels, in this case the telecom providers.

The sector insists that consumers benefit from the shortening of life cycle to remain on top of the technology curve.  Although more data is needed to confirm such claim, some interesting figures show that money involved in buybacks and trade-in programs has been fueling the market in incredible ways.  Hyla’s third quarter data analysis shows the average age of an iPhone was 2.81 years, and other smartphones at 2.76 years.   This is an incredibly short life for devices that cost hundreds of dollars, prices that often exceed those of brand new PCs. Furthermore, Hyla finds that trade-in on newer devices like the iPhone 8 Plus are worth $446.43 on average, while the previous generation is only valued at an average $355.68 in the current market. Newer Android phones, including the Galaxy Note 8 and Galaxy S8+, are sticking closely to iPhone values at $423.57 and $361.76 respectively. Hyla calculates that in Q3, trade-in and buyback programs resulted in $581 million returned to customers, compared to Q2’s $384 million. This is a remarkable 50% increase. And for the industry to spend a half billion dollars in recovering less than 3 year-old devices, there has to be a secondary market that is X times bigger than that.  And yes there is!

value of trade-ins and buybacks was up 50% sequentially in 3Q17 to $581 million returned to customers Click To Tweet

For these shortened cycles to be successful, they require a tightly coordinated supply-chain and reverse logistics systems that involve armies of providers such as transportation, processing, re-packaging, reselling, etc.  The likes of Apple and Samsung also must feel the pressure in balancing the need to please consumers, with pushing for shorter life spans.  This is something that PC and IT hardware vendors have been unable to achieve, but are closely looking to test similar ideas. The process of bringing a new PC or IT system to market has been a daunting tasks for PC vendors. It takes too many months from product concept, to design, to production, transportation and marketing that attempting something close to what phone companies are doing would require a change in mentality.  But that’s exactly what some vendors want to achieve.  The old idea of a device-as-service is back again.

In this environment, where do ITAD companies fit?  Once again, it is worth looking at the phone market to see some potential scenarios forming ahead. In the phone trade-in and buyback programs, the biggest winners are those who own the relationship with the customer.  In this case, it is clearly that those are the AT&Ts, Sprints and Verizons of the world. Adjusting their subscription and lease terms is enough to sway millions of users to make lifecycle decisions, something that PC vendors could not mimic easily.  The device makers may not benefit directly from these trade-in and buyback programs, but a shortened lifecycle would guarantee a new market for their new devices. For a company like Apple, it is also about sustaining its extremely lucrative app market, and enhance its non-hardware business.  So for Apple, there is a clearer continuum, and that may be less obvious for Samsung.

This environment has created the need for a healthy and vibrant “smartphone-recovery” infrastructure, that both manufacturers and telecom companies cannot be direct players but can, and do influence.  Companies that no one has heard of are major players in this space, from transportation to everything else after a consumer returns-trades his/her device.  Some companies like FedEx are known, but many others are not, yet they are enormous.  What these companies, big and small, have in common, is the fact that they do not own the relationship with the customer but act as contractors to the likes of AT&T. Their focus and source of strength is to ensure that whatever core business they offer, it is well executed.  This environment could be one possible scenario that may develop in the future PC/IT hardware space.  To get there, the OEMs and manufacturers must operate with a different mindsets. On the customer side, they must start with the idea that they are not just a hardware maker, whereby the relationship with the customer does not end when the hardware sale transaction is complete. On the infrastructure side, and specific to the disposition sector, the owners of the customers must also ensure proper support for their ITAD contractors. These companies need all the technical and financial expertise that would help thrive as contractors and not worry about cannibalization or OEMs squeezing every little dollar away from them.

 

David Daoud | Analyst on EmailDavid Daoud | Analyst on LinkedinDavid Daoud | Analyst on Twitter
David Daoud | Analyst

David Daoud has researched the mainstream IT hardware market since 1996 and expanded into hardware disposition research in 2003. He has spearheaded the creation of IDC’s GRADE certification. Since then, David has been providing consulting and expert advice to companies looking to establish best practice in their IT equipment decommissioning and helped leading ITAD service providers assess demand, understand competition, and forecast what’s to come. David is currently the Principal Analyst at Compliance Standards, which focuses entirely on the end-of-life of IT equipment. He can be reached at 508-981-6937 or at ddaoud@compliance-standards.com


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