Beril Toktay, Associate Professor

Georgia Institute of Technology

Abstract

Secondary markets in the Information Technology (IT) industry, where used or refurbished equipment is traded, have been growing steadily. For Original Equipment Manufacturers (OEMs) in this industry, the importance of secondary markets has grown in parallel, not only as a source of revenue, but also because of their impact on these firms' competitive advantage and market strategy. Recent articles in the press have severely criticized some OEMs who are perceived to be actively trying to eliminate the secondary market for their products. Others have policies that enhance their secondary markets. The goal of this paper is to understand how an OEM's incentives and optimal strategies vis-a-vis the secondary market are shaped contingent on her relative competitive advantage, product characteristics and consumer preferences. The critical tradeoff that we examine is whether the indirect benefit from maintaining an active secondary market (the resale value effect) can outweigh the potentially negative effect of the sales of used products at the expense of new product sales (the cannibalization effect). To that end, we develop a model where the OEM can directly affect the resale value of her product through a relicensing fee charged to the buyer of the refurbished equipment. Moreover, we introduce a measure of the consumers' willingness to return their used products to account for the fact that the higher the price offered by a third-party entrant, the higher the ratio of returned products at their end-of-use. We analyze the OEM's strategy in both the monopoly and the duopoly cases, characterize the optimal relicensing fee set by the OEM, and draw conclusions on the conditions that favor stimulating or deterring the secondary market.