Buying into IT rental

Traditionally, local companies have owned all assets, including IT equipment, but in recent years, many companies supplying desktops, servers and printers on a rental basis have been able to expand their business. On the surface, this seems to imply SA is following the trends of Europe, where up to 30% of IT equipment is rented.

At the beginning of this year, many local computer rental companies were extremely optimistic about the market potential. They claimed significant growth in business and made what appeared to be a strong case in favour of the rental option.

In the last quarter of the year, the upward trend of the computer rental industry would appear to have continued. "In 2002, we doubled the previous year`s turnover and this year we are predicting doing the same," says Spartan computer rentals MD Donald Goldfain. "The past few months have been record months."

Others are a little more guarded in their enthusiasm, but most expect an upturn in coming months. Dell financial services GM Stuart Lewis says the market is a lot more mature than it was even a year ago and the initial excitement has probably worn off. "But at the same time, I don`t think we have topped out."

Lewis says there are a lot more players in the market and market share has been eroded all round, but many of the new competitors are companies that formerly provided asset-based financing for photocopiers and fax machines. He predicts these companies will begin losing some market share as customers begin realising that instead of IT rental, they have been given a financing lease which is "as good as paying cash or going to the bank in terms of the flexibility it gives".

RentWorks sales and marketing director Gary de Souza says the IT market has stumbled a bit in the past year, but the market is on the verge of picking up again. He says companies that upgraded for Y2K are sitting with three- to four-year-old equipment. Goldfain agrees. "Many companies` machines are ready to fall over and are hopelessly underpowered."

Renting means never owning the asset; it always has to go back to the provider of the rental agreement.

Ravi Patel, senior sales specialist, IBM global financing

He says the need to upgrade, together with lower interest rates and the fact that "SA is finally moving out of the dark ages when the culture was to buy hardware and push it to its limits", means that conditions are highly favourable for the computer rental industry.

Most ascribe the market`s initial resistance to the strong ownership mentality that was so pervasive in local business through the years of isolation and negative experiences with rental agreements for photocopiers and fax machines. "Office automation rental scared a lot of people due to the high rates they charged and the fact that some rental companies continued to charge rentals instead of notifying customers when rental periods came to an end," says ATR technology rentals MD Johann Basson. "That definitely hurt the rental market, but some confidence has been regained as understanding has increased."

"Another problem we faced initially was the perception that rental was the poor man`s option," says Lewis. "As people began to understand that IT was a rapidly depreciating investment, they realised that by renting or leasing, the cash could be better used to generate returns for shareholders." He says the perception has changed in the past four years, resulting in the IT rental and leasing market growing quickly.

Things may be changing, but a number of companies say they are not yet convinced of the advantages. Rental companies may be upbeat about the potential growth of the market, but there still seems to be a lot of work to be done in persuading companies, particularly the smaller enterprises.

According to one company, rental is "too troublesome", requiring careful planning and tracking to avoid incurring penalties. The company says continually falling computer prices and a positive cash flow made it preferable to buy IT equipment, depreciate it over three years, and then sell. Goldfain comments that "buying equipment may save money in the short-term, but once a piece of equipment is bought, the buyer is stuck with it and there are no upgrade options".

Rental is not only a financial solution; it is a solution that consists of many customised value-added services.

Johann Basson, MD, ATR technology rentals

"One of the key issues with companies of 50 to 150 employees is that they don`t acknowledge the depreciating value of IT equipment or the ongoing technology cycle they have to keep up with," says Lewis. "Secondly, they probably can get away with sweating assets up to six years, so renting is not such a strong proposition."

However, he points out that it is unlikely to be cost-effective to hold on to equipment for so long if the company`s productivity is being affected. "Smaller companies don`t take into consideration the cost of maintaining older equipment, which is often very expensive and difficult to maintain or upgrade."

The small and medium enterprise (SME) market is believed to account for about 60% of IT spend and for this reason many of the IT rental companies are now pursuing this market. "In the middle market there is a lot of opportunity and potential because that is where rental probably lags behind overseas trends," says De Souza. "For SMEs, IT rental is an extremely viable option," affirms Datacentrix infrastructure MD Ahmed Mohamed.

"Companies facing serious challenges in upgrading their hardware and software at the same time are seeing that the new strategy should be a phased approach to replacing equipment, and the rental option makes it less painful," says Goldfain. "Equipment rental means that companies are able to follow the trends as closely as necessary without the capital outlay."

Part of the challenge facing rental companies appears to be convincing financial directors of the benefits. "There are a lot of FDs who still believe IT equipment should be on a balance sheet, but we see the renting route as investing funds in opportunities that can grow your business," says Basson. "Keeping it on the balance sheet means that within 12 months any equipment that is bought will be worth 50% of its market value, but if you invest that money in something else, you can achieve 40% return on investment."

IBM personal computing division executive Oliver Fortuin says the SME environment is expected to be the fastest growing part of the market for quite some time. "In response to this fact, IBM aims to put more and more end-to-end solutions into this space."

Traditionally handling only corporate accounts, IBM soon plans to introduce a set of IT finance options designed to meet the service needs of the SME market. "The Maestro offering, which has already been launched in Europe, provides customers with a PC base of between 200 and 1 500 machines, good low-cost total IT management tools, as well as a set of software tools and services that integrate end-to-end, probably for the first time in the SME market," says Fortuin.

While IBM has newly set its sights on the SME market, Spartan has long had a wide range of customers from big corporates to small family businesses. "We are one of the few companies that do low-end deals," says Goldfain. "SMEs represent about 40% of Spartan`s customers."

However, Goldfain does not expect this percentage to increase because of high administration costs relative to the size of the deals. "In deciding which customers to take on, rental companies need to be able to identify those customers who have the potential to grow." Smaller companies could also find rental options less cost-effective than corporates. "The increased risk on smaller deals is offset by a higher rental," Goldfain points out.

Until recently, IT rental agreements have been most popular with corporates. This is partly because many multinationals follow the same IT procurement models as their overseas counterparts. IBM global financing manager Alf Montepara explains that rental is a cost-effective way of procuring IT equipment for corporates because having that equipment off balance sheet results in huge tax savings. "Even extending the rental can represent good value because corporates can often negotiate rates of as little as 10% of the original monthly fee."

One of the biggest reasons the corporate market remains strongly favourable towards rental is the high rate of obsolescence. "There is a huge cost benefit in being able to upgrade IT equipment when necessary," says De Souza. "The rapid obsolescence of equipment in the corporate market suits rental down to the ground."

Traditional third-party finance companies are more likely to increase monthly payments for the new technology because they do not have the same flexibility as IBM to restructure agreements.

Alf Montepara, manager, IBM global financing

The flexibility of rental agreements does not end with the ability to refresh technology when required, it also means being able to restructure IT components as needs change. Lewis explains: "If a company is downsizing, it can return a portion of its PC base and replace it with something else, such as storage."

With all the different terms used to describe the kinds of IT procurement agreements on offer, there is little doubt that many of the companies unhappy with their deals were victims of miscommunication. One of the biggest problems is that many people use the terms 'rental` and 'financing` interchangeably, but IBM global financing senior sales specialist Ravi Patel explains there are accounting differences between them. "A finance agreement is a generic agreement that could be rental, a deferred payment, a lease, or a hire-purchase. Renting means never owning the asset, it always has to go back to the provider of the rental agreement. Rental is just one of many different ways of structuring PC finance."

On closer examination, it becomes clear that what is broadly referred to as the computer rental industry has financing at its core. "In essence, computer rental companies are finance organisations, which means that revenue is derived from interest income as well as value-added services such as insurance, trade-up options and maintenance," says Goldfain. He says another important source of income is short-term rentals and the sale of equipment to the second-hand market. "Spartan has tried to take the mystery out of IT finance. At the end of the day we are selling a piece of equipment on extended terms linked to the prime overdraft rate, bundled with various value-added products."

For SMEs, IT rental is an extremely viable option.

Ahmed Mohammed, infrastructure MD, Datacentrix

Although computer rental companies are finance organisations, most in the industry emphasise that rental should not be seen in isolation and that it involves a lot more than finance. "Rental is not only a financial solution, it is a solution that consists of many customised value-added services," says Basson. "This means clients can source the best product at the best price."

Glenrand MIB benefit services IT manager Paul Landman concurs. "Rental gets our IT equipment off our asset list, we are able trade-up whenever we need to, and the most important factor is the support we get in terms of refresh, maintenance and repairs. The ability to refresh about every two years is perfect for us to keep pace with our software applications."

SA would seem ripe for switching to computer rentals with the next refresh cycle likely to begin and computer marketing campaigns effectively driving demand for new technology. However, considering all the different options available and positions taken by rental companies, deciding which company to approach is probably much more important and difficult than deciding to take the rental route in the first place.

When it comes to IT rental, choosing the right company and the right deal could make the difference between success and failure. Before renting, a company needs to have a clear idea of the benefits it expects to derive, say industry players. It is then important to find a rental company that can provide an agreement to deliver those needs. Finally, both companies involved need to make sure they understand the expectations and limitations of the other to avoid any nasty surprises.

When it comes to computer rental companies, size does count. This is particularly important in determining whether a company is independent enough of margin earnings to offer competitive rates through various subsidies.

In any normal deal, a rental company will borrow money at one rate from a bank and lend it at a slightly higher rate, taking the margin as profit. Larger companies, however, are more likely to be able to take the margin up-front than smaller players. Similarly, only bigger companies with significant financial backing are able to cut rates well below those offered by traditional financial institutions by taking residual positions.

De Souza says not everyone is in a position to take residual risk by investing cash in multimillion-rand transactions. "RentWorks has about R130 million in upfront residual investment on total assets of R2 billion. To do that, you have to have a sizeable balance sheet, access to cash and the ability to invest long-term."

Rental gets our IT equipment off our asset list, we are able trade-up whenever we need to, and the most important factor is the support we get in terms of refresh, maintenance and repairs.

Paul Landman, benefit services IT manager, Glenrand MIB

Companies attached to vendors are able to provide a one-stop facility. Dell Financial Services (DFS) offers a direct model. "The customer deals with the vendor and the finance house directly, without having to go through a reseller," says Lewis. "Contact between Dell and DFS is closer, therefore access is easier, after-sale access is better, and there is good communication between the two because DFS is part of the Dell package." Lewis says DFS also takes residual investments in all transactions. "The residual is an investment of our own equity, giving the customer all the benefits of rental, but at payments based on the equipment value less the residual."

IBM global financing has a similar relationship with IBM. "We are able to offer attractive deals because of our proactive way of dealing with IT refresh and our proven experience worldwide," says Patel. He says computer rental is merely a subsection of all the financing solutions on offer. "IBM global financing operates differently to most third-party financiers because we have to uphold the IBM reputation and therefore we are careful to maintain integrity, transparency and honesty."

Montepara adds that unlike banks and other financiers, IBM global financing can provide an end-to-end financing solution that includes financing for software licences, services and hardware. "Being one company, IBM can swap out the equipment and extend the payment stream. Traditional third-party finance companies are more likely to increase monthly payments for the new technology because they do not have the same flexibility as IBM to restructure agreements."

De Souza says this is standard industry practice known as 'blind discounting` where hardware discounts are used to subsidise rental agreements.

Although rental companies will quickly list the plethora of benefits to be derived from renting computer equipment, most of them concede that IT rental is not for everyone. "There are times when it makes sense to pay cash," says Goldfain.

While some rental companies concentrate exclusively on the corporate market and others go after the SME market, it appears both sectors can derive benefits from renting, but for different reasons. SMEs benefit from being able to satisfy their IT needs without having to spend any capital, and corporate companies benefit from the balance sheet structuring opportunities.

Having looked at the past and present of IT rental in SA, what of the future? "We are moving into wonderful new territory," says De Souza, "into putting structured finance solutions into place, so it is a rental with a structured finance solution sitting behind it. By introducing tax benefit and risk management structures, you are moving out of commoditised rentals towards structured finance solutions."

All things considered, it seems the trick to IT procurement lies in knowing when to buy, when to lease, when to rent, and most importantly with whom to conclude any of the aforementioned deals.