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Leasing IT gear is more popular than ever, thanks to a host of new options. But more for lessees is not guaranteed.
Bob Violino, CFO IT
March 15, 2004
Lease or buy? Finance executives grapple with this decision constantly, whether it's for office space, furniture, vehicles, maintenance equipment, or scores of other products. Now, thanks to mostly flat sales in many types of computer hardware, the IT market is full of special finance deals. CFOs should negotiate not just on price, but also on terms.
"Every one [of the major hardware vendors] is working with its customers to find the most affordable way to fund customers' investments," says John Madden, practice director at Summit Strategies Inc., a technology research firm in Boston. "Vendors are eager to get new business and to keep the business they have."
Hardware manufacturers are offering an array of promotions usually associated with discount furniture stores: deferred payments, zero-percent-interest financing, consolidated monthly payments, and more. Meanwhile, Web-enabled leasing streamlines the paperwork by enabling customers to conduct transactions and manage accounts online.
The IT hardware market is one of the largest segments of the U.S. leasing industry, according to the Equipment Leasing Association (ELA), in Arlington, Virginia. The market in the United States is projected to grow from $23.8 billion in 2002 to $28 billion by 2005, a 6.5 percent average annual growth rate. From 1998 to 2002, it grew at just 1.5 percent annually.
The ELA says the key factors driving the rise in leasing include new enthusiasm on the part of vendors, which are more inclined to offer leasing as an option to win business; an equally keen interest in leasing arrangements on the part of captive finance companies such as IBM Global Financing, HP Financial Services (HPFS), and others; and the usefulness of the Internet as a more-efficient means of processing applications, providing status reports, and handling billing.
Most of the major IT hardware vendors are offering new leasing and financing options to drum up business. IBM last November launched a new program called IBM WorkPlace On-Demand services, which it says can help companies cut the cost of managing PCs, printers, copiers, fax machines, and mobile devices by up to 30 percent. Under the program, IBM provides these products and the associated financing as a "service," charging customers through a single bill a fixed monthly rate per user as part of an IBM Global Financing three-year package.
Ernie Fernandez, vice president of customer financing in the Americas for IBM Global Financing, says programs such as WorkPlace On-Demand and other pay-as-you-go offerings were developed in response to demand for more cost-effective acquisition schemes. One of these options is the Total Solution Financing program, which combines all hardware, software, and services, including non-IBM gear, into a single contract, making it easier for companies to track financed and leased assets, he says. IBM says customers can save substantially by paying only for the technology services they use, a claim made by several vendors.
Hewlett-Packard, for example, is also offering new lease options—such as a consolidated payment plan that lets customers finance hardware, software, and services from HP and other vendors, and a pay-per-use program for hardware—through its HPFS subsidiary. HP's pay-per-use program includes a suite of services that gives companies access to on-site servers, storage systems, and other IT hardware on a metered basis. HP uses a sophisticated metering technology installed on the customer's site to measure product usage, which represents an early example of the "utility computing" concept.
Dell Financial Services (DFS), which handles leasing and financing for Dell Inc., has launched several initiatives to make leasing more attractive. For example, DFS offers financing for equipment-return shipment services up front so companies don't need to worry about the expense at the end of the lease. That sits well with customers that want to spread the total cost over the life of the lease. Others that may decide to buy the equipment at the end of the lease or that aren't sure probably wouldn't be interested in this option, but it illustrates the new flexibility in terms that pervades the industry. DFS is also incorporating standard language on purchase orders, so companies with Dell Master Lease Agreements (MLA) can use their purchase order as their lease schedule, eliminating the need for additional signatures and paperwork each month. And Dell lets customers finance hardware and software from other vendors—in addition to Dell equipment—on a single MLA.
As proof that the leasing market is now a battleground, Sun Microsystems has come up with what it dubs the "HP Away" Migration Lease, in which HP customers get a new, low rate and make no payments and pay no interest for 90 days on a 24-month lease term when they lease (or buy) components of the Sun Infrastructure Solution.
A Premium on Flexibility
When Wells' Dairy Inc., a privately held ice cream and dairy processor in Le Mars, Iowa, needed new servers, it decided to lease machines from HP under the vendor's new pay-per-use program. While that actually pushed the monthly price up substantially, from $13,000 to $20,000, the company's processing power has increased fourfold, and, more important, it can control capacity based on usage. For example, during the day, its workload may require that 12 processors be kept humming, but at night, its computing needs may drop substantially.
Many companies lease or buy enough gear to handle peak loads, but a usage-based system lets them avoid that kind of overbuying yet still have the capacity they need. Kim Norby, vice president of information services, estimates that the company will save 20 percent, or about $200,000, over three years compared with the older lease. Norby says Wells' will use the pay-per-use model for other systems because of the added flexibility. "There really are no drawbacks to this," he says. "It allows us to make better use of the products." Over the past five years, the company has moved away from buying toward leasing because the price is right, the nagging question of how to dispose of old equipment becomes someone else's problem, and three-year lease cycles keep the company current with technology improvements.
With computers as its lifeblood, Alabanza Corp., a Web hosting provider in Baltimore, says leasing servers from Dell under its deferred payment plan provides an economical way to keep technology up-to-date while it copes with high growth. Alabanza typically leases 40 servers and related pieces of equipment a month, using 36-month, fair-market-value operating leases.
By leasing, "we minimize the risk of obsolescence on the equipment," says Alabanza CFO Andy Fleischer. "And it helps us to straight-line the costs of the technology. In the past, we bought large blocks of servers up front. But by spreading out the payment terms over 36 months, we can match the expected useful life of the equipment with the payment stream. It [also] frees up cash." Fleischer estimates that Alabanza acquires about $1 million worth of IT hardware each year, so the available cash flow is significant. Hungry for bargains, the company does buy some hardware in the secondhand market, typically from failed dot-coms, but it now leases 80 percent of its hardware, up from 60 percent a year ago.
While vendors have sought to make leasing more attractive, experts caution that companies must stay on top of lease agreements and manage IT assets to ensure that equipment is not being underused or retired before its usefulness has expired. "In light of the ever-more-rapid rate of change in the IT world, it also makes sense to stay abreast of the latest FAS 13—qualified lease structures," says Robb Aldridge, president of Leasing Ideas, a Newport, Oregon, consulting firm that specializes in leasing. As flexible as leases are, companies still sacrifice some level of control: gear acquired in a great three-year lease (no interest, flexible terms, or what have you) that's no longer needed still has to be paid for, or a lease could expire on equipment that is still of lasting value and would have been smarter to buy up front. Notes Aldridge: "Technology-refresh and early-termination clauses can mitigate these risks somewhat, but they are seldom without cost." The key, experts say, is to devote some time to IT asset management rather than lease (or buy) and forget.
After a lease is signed and in place, organizations should continually monitor equipment usage, the organization's changing needs, whether equipment can be rolled into new leases with more-favorable terms, and what's available in the marketplace in terms of alternatives (upgrades, replacement with new or used equipment, and disposition) that impact the overall alignment of the installed infrastructure, says Dan Flagstad, co-CEO of Relational Funding Corp., an independent lessor in Rolling Meadows, Illinois, that helps organizations understand the financial impact of hardware acquisitions. "Most companies are making lease decisions based on price but are not monitoring" IT assets to optimize the utility and economic return on equipment investments that leads to reduced or contained IT spending, says Flagstad.
Experts also point out that slower IT sales have made outright purchases more appealing, especially for products that are relatively low in price and will meet a company's needs for several years or more. But better terms, increased flexibility, and the continuance of off-balance-sheet accounting may make leasing more appealing than ever. As Aldridge says, "Provided their companies are creditworthy, CFOs and CIOs are in the driver's seat. They can ask for more-flexible terms and options, and usually get them."
Bob Violino is a freelance writer in Massapequa, New York.
One Month at a Time
Hardware companies aren't the only players in IT that are looking for new ways to move the merchandise. Software companies now offer an expanding array of alternatives to traditional one-time, perpetual licensing, notably with subscription-based fees and "software as a service" payment models.
While this shift began several years ago, it is accelerating as customers show more interest in absorbing such expenses monthly versus taking a hit to the capital budget. Jeff Melton, vice president and partner at Bain & Co. in San Francisco, says another advantage is that customers don't have to guess how many licenses (or seats) will be needed over a period of time. And whereas companies used to "pay for the software up front but take years to see the benefits," Melton says, the pay-as-you-go schemes shorten the return-on-investment period.
As with smart leasing, management savvy is important. Motorola buys certain complex engineering-software programs that can list for as much as $1 million per copy, so the company is keen to buy only what it needs. It uses software from Macrovision, combined with some homegrown applications, to manage the contracts it has with a pool of approved software vendors. Dan Griffith, senior engineering manager at Motorola, says the company believes it has saved tens of millions of dollars over the past five years by improving the management and utilization of the software it licenses.