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Capturing the benefits of high-tech leasing.

Leasing's pay-as-you-go approach to financing and its hedge against obsolescence have long afforded businesses a way to conserve cash and better manage equipment. About eight out of 10 American corporations lease at least part of their equipment portfolios, according to the Equipment Leasing Association, an Arlington, Virginia-based trade group. And in fact, equipment leasing has continued to grow even after the Tax Reform Act of 1986 eliminated major tax incentives for this form of financing. The U.S. Department of Commerce estimates that leasing volume totaled roughly $120 billion in 1990, up from $45 billion 10 years earlier.

Leasing information technology equipment is particularly advantageous because the technology evolves so rapidly that some computers become outdated, in terms of the original user's purposes, within months of their installation. When a company has invested heavily in purchasing its own computer system, it cannot as easily take advantage of newer, more versatile equipment without incurring great expense or until the existing hardware is fully amortized. And unless you're an equipment expert, it is very difficult to know how to remarket these assets yourself to receive appropriate compensation.

Most business can count on savings with short-term operating leases. Because there is a strong market for used high-tech equipment, leasing companies can offer equipment at a discount and then sell or re-lease the same equipment to another user. In fact, many businesses use a strategic mix of new and used equipment. With new and used equipment price/performance dropping by 20 to 50 percent each year, companies can typically save 40 to 70 percent by leasing or purchasing used equipment--without significantly sacrificing performance.


As in so many other areas, the name of the game in leasing these days is value added. An independent industry consultant, the Gartner Group, Inc., recently reported that "... leasing [of high-tech equipment] can provide financing and asset management services that are not necessarily inherently in a lease and that purchase does not provide. Considering leasing as a suite of services, each with a cost and benefit, may be more appropriate."

Demand for high-tech lease financing is growing because management of these assets is becoming more complex. Companies are going global, reengineering their systems, and shifting applications from mainframes to local area networks while trying to maintain or increase performance levels and pare expenses.

So, sophisticated high-tech lessees are demanding much more than fair lease rates. They are seeking total solutions: strategic planning, consultations, equipment remarketing, and backup services to manage all the "what ifs" that will arise before a lease has expired.


The best assurance of negotiating the right lease agreement for your company's needs is to fully know your options, and get everything in writing.

Just common sense, you say? Perhaps. But growing financial pressures on businesses, lawsuits in the computer leasing and remarketing industry, and the need for better asset management make it very important to follow these basic rules.

In our experience, companies upgrade or replace about 95 percent of the equipment they lease within three years in order to meet their changing needs and take advantage of declining price/performance ratios. Thus, the best leases give the lessee flexibility to adjust to future demands. Leasing terms and conditions that restrict your options mean added costs in the long run.

Lawsuits filed within the computer leasing and remarketing industry as recently as May raise questions about subleasing and such other options as parts substitution during upgrades. Though these practices were once commonplace in this industry, some leasing companies are far less flexible today than others because of the uncertainty these lawsuits have caused.

A case in point is New Hampton, Inc., a $400-million catalog company. New Hampton's agreement covering its leased equipment stated only that the lessor would not "unreasonably withhold" its consent for New Hampton to sublease equipment to another firm--until very recently, standard wording in lease contracts.

New Hampton found out the hard way that its failure to get its options spelled out in writing made subleasing to another leasing company impossible. Bob Kramer, New Hampton's vice president of information systems, estimates that subleasing restrictions recently cost his company $180,000. When it came time to add memory to the mainframe the company was leasing, an upgrade that could have been accomplished for $50,000 if New Hampton could have subleased its existing memory, ended up costing $230,000.


To hammer out the best master lease agreement, you need to scrutinize terms and conditions and negotiate them carefully. Getting the best "T's and C's" will ensure cost-effectiveness and flexible solutions throughout the term of your lease.

The ability to sublease to other leasing companies is an important option to clarify, up front and in writing. Avoid those vendors that refuse to do so, or that otherwise restrict your mid-lease options.

Other terms and conditions to clarify in writing include:

* Options for new, used, and plug-compatible upgrades--Make sure your contract addresses upgrades. Look for leases that allow you to upgrade equipment with new or used components made by any manufacturer and supplied by any vendor. When specific conditions are met, the leasing company should also agree, in advance, to finance upgrades.

* Parts substitution--In the event that subleasing or equipment upgrades are necessary, parts substitution gives lessees the option of returning systems at the end of a lease with like-for-like, or "fungible," components, provided that the machine is returned to the original lessor in equivalent or better condition. Many companies find it impossible to return systems at the end of a lease with the exact parts with which they were first leased, given the numerous components of today's computer systems and the ways in which users upgrade them. In maintaining computer equipment, it is commonplace to simply replace memory cards, for instance, rather than fix them. Even though parts substitution has been a common industry practice, it too, like subleasing, has been challenged by recent lawsuits.

* Small-ticket equipment substitution--In addition to the right to return like-for-like parts and components at the end of the lease, lessees should also be able to return like-for-like systems for such small-ticket items as PCs, printers, and terminals, when these items are leased in multiple quantities.

* International provisions--Multinational corporations may want to consider negotiating one master lease agreement encompassing all their worldwide subsidiaries. Specific terms and conditions of each location's acquisition should be covered under separate equipment schedules attached to the global lease. This way the company gains centralized control yet doesn't interfere with subsidiaries' hardware acquisition decisions. The global lease lets you establish, in a single "umbrella" lease, standard lease terms and conditions for all of your worldwide subsidiaries. The result, in addition to better control, can be savings in legal and financial fees and from negotiating better lease agreements.


As I mentioned, many leasing companies provide value-added services to solve a variety of high-tech problems.

One such service is electronic asset management. The explosive increases of individual PCs and networks and increased international operations has created logistical nightmares for managers charged with tracking high-tech equipment. Many companies now use asset management software systems that allow them to purchase or lease equipment from their vendors of choice, track thousands of assets, and analyze important financial data, all from their desktop computers.

Other services, such as disaster recovery programs, plan for the "what ifs." A recent example of the need for such programs occurred when floodwaters surged through downtown tunnels and office basements in Chicago this spring, saturating telecommunications and power equipment. A number of businesses relied on vendors' disaster recovery services to continue their operations.

Helping businesses prepare for unforeseen needs is the theme of another new market strategy called "just-in-time computing." Large, fast-growth companies must be prepared to react almost immediately to changes in business applications and new technology. One solution to this problem, albeit a costly one, is to acquire more computer power than needed and absorb the excess capacity.

Just-in-time computing lets a company map out a strategic plan that supplies incremental capacity levels at preset prices. When Occidental Petroleum faced consolidating its three data centers into one, for example, company officials at first considered outsourcing the data center operations. Instead, the company turned to a just-in-time program, in which Occidental predicted future data processing growth rates at 12 to 14 percent annually and now pays at preset levels for increased computer power when it needs it. This flexible game plan will incrementally increase the company's computer speed and storage capacity over the next five years. Ed Barrows, director of Occidental's corporate data center, is already seeing yearly expenses drop $10 million while efficiency has increased. Another advantage: Unlike outsourcing, his plan keeps operational control inside.

Don't be overwhelmed by the number of players in today's market. You can easily streamline the negotiation process by targeting potential vendors that offer both a wide range of flexible leasing options and the equipment expertise to help you define your organization's current and long-term high-technology equipment requirements. Specifically, look for independent leasing companies that can recommend--and provide--equipment from several manufacturers, not just one. This keeps pricing competitive and gives you more selection. Many companies select several low bidders for contract negotiation, letting these vendors know they're being considered, and then offer the contract to the bidder with the most favorable terms and conditions.

Involve those people in your firm with high-tech expertise as well as financial experience. Leasing is an important financial consideration that in large transactions should involve representatives of the accounting, legal, operations, and treasury departments as well as top management.

A couple of high-profile computer lessors went bankrupt in the late 1980s, bringing into focus the need to select a financially sound vendor. Studies show, in fact, that financial stability is one of the top three considerations companies give for selecting a vendor. So you should consider the leasing company's management, experience, cash flow, net worth, liquidity, and customer references.

Even if your lessor should go bankrupt, however, you would probably experience difficulties only if you needed to make mid-lease changes; otherwise you'd simply continue to make monthly payments on your leased assets to another financial institution until the lease ends.

When selecting a lessor, choose one that can custom-tailor solutions to meet your individual requirements. Look for these specific characteristics:

* Flexibility--Evaluate the vendor's ability to make changes mid-lease or to offer creative financing tools.

* Stability--Investigate the vendor's financial status and years in business to ensure that it will remain in business for the duration of your lease term and beyond.

* Services--Select a vendor that offers the types of value-added services you require of such an important partner. And, if the lessor provides used equipment, make sure the equipment is certified to be eligible for maintenance.

* Knowledge--Enlist the expertise of your company's information systems professionals to assure you that the company you are considering can talk the same language as the equipment experts you have in house.
COPYRIGHT 1992 Financial Executives International
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
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Title Annotation:Special Report: Information Management; planning the leasing computer equipment
Author:Vosicky, John J.
Publication:Financial Executive
Date:Jul 1, 1992
Previous Article:A password to computer security.
Next Article:The property puzzle.

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