Buying into rental
Local companies are at last getting over their traditional resistance to IT rental - but it might not be the best solution for everyone.Traditionally, local companies have owned all their assets, including IT equipment; but recently many companies supplying desktops, servers and printers on a rental basis have been able to expand their business. On the surface, this implies South Africa may be following European trends, where up to 30 percent of IT equipment is rented.Earlier this year, South African computer rental companies were extremely optimistic about the market potential. They reported significant growth and made what appeared to be a strong case in favour of the rental option.Their claims still seem valid. "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 more guarded, but most expect an upturn in coming months. Dell financial services GM Stuart Lewis says the market is a lot more mature than 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." Out of the dark agesLewis says there are a lot more players in the market now and market share has been eroded all round. However, many of the new competitors are companies that formerly provided asset-based financing for photocopiers and fax machines and he predicts they will begin losing market share as customers realise 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 notes that the IT market has stumbled a bit in the past year, but 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."He says the need to upgrade, together with lower interest rates and the fact that "South Africa 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 rental to the strong ownership mentality pervasive in local business - which can be ascribed to years of isolation and negative experiences with rental deals on photocopiers and fax machines. "Office automation rental scared a lot of people due to the high rates 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."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."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 it is bought the buyer is stuck with it and there are no upgrade options."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 believe they can get away with sweating assets up to six years, so renting is not such a strong proposition."He believes it is unlikely to be cost-effective to hold on to equipment if the company`s productivity is being affected. "Smaller companies don`t take into consideration the cost of maintaining older equipment." The hot spotThe small and medium enterprise (SME) market is believed to account for about 60 percent of IT spend, so many rental companies are pursuing this sector. "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.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 percent of its market value, but if you invest that money in something else, you can achieve 40 percent return on investment."IBM personal computing division executive Oliver Fortuin says SMEs will be the fastest growing part of the market for quite some time. Traditionally handling only corporate accounts, IBM soon plans to introduce a set of IT finance options designed to meet the service needs of SMEs. "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. The size issueWhile 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 percent of Spartan`s customers."But Goldfain doesn`t 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.The fact that IT rental has until recently been most popular with corporates is partly because many multinational subsidiaries have the same procurement models as overseas counterparts. IBM global financing manager Alf Montepara explains that rental is a cost-effective way of procuring IT equipment for corporates because having the equipment off balance sheet means huge tax savings. "Even extending the rental can represent good value because corporates can often negotiate rates of as little as 10 percent of the original monthly fee."Another reason corporates remain in favour of 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 flexibility of rental agreements does not end with the ability to refresh technology, 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." Rental or finance?A big problem, though, is that many people use the terms "rental" and "financing" interchangeably. IBM global financing senior sales specialist Ravi Patel explains that there are accounting differences between the two concepts. "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 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 rental 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."Although computer rental companies are finance organisations, most 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 IT equipment off our asset list, we are able to 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." The risk factorDe Souza says not everyone is in a position to take residual risk by investing cash in multi-million 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."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."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. Crystal ball gazingAlthough rental companies quickly list the plethora of benefits to be derived from renting computer equipment, most concede that IT rental is not for everyone. "There are times when it makes sense to pay cash," says Goldfain.What of the future? "We are moving into wonderful new territory," says De Souza, "into putting structured finance solutions into place. By introducing tax benefit and risk management structures, you are moving out of commoditised rentals towards structured finance solutions."
30 November 2003
Local companies are at last getting over their traditional resistance to IT rental - but it might not be the best solution for everyone.
Earlier this year, South African computer rental companies were extremely optimistic about the market potential. They reported significant growth and made what appeared to be a strong case in favour of the rental option.
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