How IoT Device Manufacturers Can Combat Gray Market Risks

Like many manufacturers, IoT device makers often outsource their manufacturing processes to third parties. While this can reduce costs and increase efficiency, it also introduces the risk of the “gray market”, which consists of trading through unofficial channels or distribution sites.

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Eric FreeEric Free

According to Gartner, by 2020 there will be about 20.8 billion Internet of Things (IoT) devices in circulation. As IoT continues to boom, intelligent device manufacturers need to pay close attention to the risks they are up against. Like many manufacturers, IoT device makers often outsource their manufacturing processes to third parties. While this can reduce costs and increase efficiency, it also introduces the risk of the “gray market”, which consists of trading through unofficial channels or distribution sites. These third-party manufacturing shops are actually over-producing devices and selling the overage stock on the gray market for personal profit.

The devices distributed on the gray market are not actually counterfeit as they are made to the original device manufacturer’s specifications. The products are identical in every way to the legitimate products, but they are sold on the gray market for a fraction of the price. This means valued dealers and channels are competing with unauthorized dealers who are selling the same devices at a much lower price. This disturbing trend is putting the true manufacturer’s brand at risk and profits in jeopardy. So, what are they to do?

Fight Gray Market Abuse Through Software Licensing

The value IoT products provide is based on the software embedded within the devices. Think about an MRI machine — the machine itself is rather useless without the software that allows it to scan and create images. Unlike the physical device, software can be easily modified or updated if proper software licensing technology is implemented.

Software licensing can be used in a number of ways to combat gray market abuse. For example, manufacturers can require that any new device “call home” to a cloud-based license server to get an activation license that ultimately allows the device to become operational. If a device has been manufactured illegally, it will not be granted an activation license and will not be able to function. While this strategy does not prevent the illegal manufacturing of extra-contractual devices by third-parties, it prevents those devices from functioning, rendering them useless.

The device manufacturer can also provide licenses for only a specific number of devices. Once the third-party manufacturer hits that number, they can no longer get licenses and are therefore unable to produce any additional devices. When the devices are turned on, they check for a license before continuing to boot up.

Software licensing can also allow manufacturers to turn device features and capacity on and off as needed. This is commonly used by IoT companies to offer various versions of products without needing to manufacture different devices. This goes to show that it is not the device itself, but rather the power of the software within it that makes the device valuable to consumers. Think about it: Do you enjoy using your smartphone because of the actual phone, or because of all the features and applications on it?

With this in mind, manufacturers and their official dealers or channel partners hold the key to turning on capabilities, charging for those capabilities and, when appropriate, turning those capabilities off. If manufacturers are smart about how the software in these devices is developed, they can have the power to disable illegally manufactured products.

Where to Go From Here

The benefits of using software licensing to combat gray market exploitation are clear. However, getting started is a different story. Manufacturers must embrace two best practices to really utilize the full potential of their software.

First, they need to be smart about how software licensing strategies can help the business. Software licensing is a great option for preventing gray market abuse, and it can also be used to grow top-line business performance. Proper licensing can prevent overuse, as well as monetize the value manufacturers deliver through feature sets, services, volume/user thresholds and upgrade rights.

Second, manufacturers should implement comprehensive systems for accurately tracking and managing software entitlements. Purpose-built entitlement management systems are necessary if a company wants to reduce operating costs, improve up-selling and renewal opportunities, have better visibility into the channel and improve overall insight into market dynamics. Software license data can provide valuable insights that can help drive the business forward.

When these two practices are combined, they can have a powerful impact on a device manufacturer’s business performance. Without effective software licensing practices, manufacturers will struggle to prevent unauthorized resellers from selling devices bundled with the associated software. When the power of software licensing is tapped into, it opens up the door not only to tighter control of manufacturing, but also to potential business growth. Software is flexible, adaptable and constantly evolving. The IoT industry stands to gain a lot by realizing all the possible opportunities that lie with software licensing.

Eric Free is SVP of Strategic Growth at Flexera Software.

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