Today’s customers want to enjoy the benefits of equipment use without the hassles of ownership. Equipment finance structures are evolving to keep up with this trend. Monitor examines three types of servitization and the way these new structures will affect the future of the industry.
Most of us enjoy the benefits of servitization (also known as managed services or managed solutions) every day. In fact, you may be holding a piece of equipment that includes bundled services in your palm as you read this article. These days, most cell phone contracts are miniature versions of servitization. As users, we pay a monthly fee to enjoy the benefit of using a mobile phone, insurance to cover any necessary maintenance or replacement costs as well as the cost of mobile phone service, text messaging and data.
Take a quick look around your office, and you’ll be sure to find other examples of this trend in action. Servitization may be the latest buzzword in equipment finance, but the concept has been in play since the 1980s. Managed Solutions: Evolutionary or Revolutionary?, a study published by the Equipment Leasing & Finance Foundation and researched by The Alta Group, credits the Xerox Corporation as the first to offer fixed-term financing contracts for copiers on a cost-per-copy basis.1
Since the 1980s, the trend has spread to other asset classes, including technology, trucking and healthcare. Today, servitization options exist for just about every asset class. Vernon Tirey, CEO and founder of LeaseQ, an equipment finance marketplace, works with companies that provide servitization financing options for a wide range of industries, including robots and LED lighting, which include installation and ongoing maintenance needs.
With all the terms flying around to describe this type of financing — including SaaS, MST, bundled solutions or pay-as-you go, to name a few — it can be hard to nail down exactly what constitutes servitization. According to DLL’s recent white paper, Servitized Business Models: Organizing for Success, any financing package that creates value by adding services to manufactured products is considered a form of servitization.2
This trend is growing at a rapid pace. MarketsandMarkets forecasts the global managed services market will grow from $138.27 billion in 2016 to $257.84 billion in 2022, at a CAGR of 11.1% during the forecast period of 2017 to 2022.3
The ELFF forecasts that managed solutions are on track to reach 22% or more of the total equipment leasing and finance industry volumes over the next three to five years.
Beneficial to Customers & Manufacturers
DLL’s white paper demonstrates that both end-user customers and manufacturers have a lot to gain from switching to a servitization model.
“From the customer perspective, it’s all about driving cost down and increasing flexibility,” says Tom Meredith, DLL’s chief commercial officer and member of the executive board. “All businesses today are looking for ways to become more efficient, to reduce expenses and to get the best product available at all times. They want all of the benefits of usage without ownership.”
“Customers are asking for ideas and ways to save money,” says Theo Rennenberg, vice president of Global Fleet Asset Management at DLL. “There are some pretty bright customers out there that we’ve come across who have material and construction equipment and are looking at the utilization of an asset at the end of a contract and realizing they paid too much.”
“From the manufacturer’s perspective, they look at it as a way to differentiate themselves from their competitors,” Meredith says. “They are able to add value to their proposition that maybe some of their competitors don’t. They also see it as a revenue enhancer — they’re unlocking new opportunities to generate more revenue than just the sale of equipment. Finally, they are driven by the desire to control the asset throughout the entire lifecycle.”
DLL’s whitepaper outlines three types of servitization: product-oriented, use-oriented and result-oriented. Product-oriented models follow the more traditional structures established by equipment like photocopiers. The customer purchases the equipment and has the option to add a service package for an additional fee. But even this model is undergoing transformation.
“Historically it was all about leasing the equipment, but now, some manufacturers are also interesting in making it easier for their customers to acquire their consumables as well, so they package them together,” Meredith says. “We’re able to design programs where we provide payment options for the end-users’ purchase of consumables, and instead of having those payments managed by the vendor, they are managed by us.”
Meredith says in a recent utilization survey, DLL discovered that almost 90% of lessees across different industries were not utilizing 2017their equipment to the exact terms of their contract. This led to the creation of its newest product, the Lease by the Hour Solution.
“It’s an innovative product where we’re changing our normal focus from average or maximum hours per year to minimum per year,” Rennenberg says. “It’s a flexible lease based on the usage of the equipment. It’s meant to allow customers to return equipment at the lifecycle they determine in the beginning of the lease instead of focusing on max hours per year and dealing with underestimation/overtime at the end of the term.”
“If they end up using the equipment for less than what the contractual amount of hours are, they end up paying less over the life of the equipment,” Meredith adds. “If they use it for more, they pay more, and the term is thereby shortened. They are also getting that usage and the cost spread out over the lease instead of a big lump sum at the end.”
Meredith says results-oriented offerings will be the biggest trend, with the potential to replace traditional third-party service vendors. “In the technology world we are working with service models where customers or companies want the manufacturers to not only provide product, but to provide maintenance and consulting on what type of equipment they need. They want to be able to upgrade their equipment, turn it in and add or reduce it as their employee base increases or decreases. This is an attractive program in that they’re only paying for what they get and are able to become more efficient and outsource that entire IT service to the vendors.
“The results-oriented model is one where the end-user doesn’t necessarily take the equipment; he just wants a need to be solved and goes to the vendors for help,” Meredith continues. “The vendor picks equipment based on the needs of the customer and provides the installation, consulting and training until the end of the lease. The vendor takes care of everything. All the user needs to do is go to the vendor and share what their needs are, and the vendors work it all out from there. All of those different services can be bundled into the lease.”
“We’re meeting a demand but we’re seeing more and more of a demand increase,” Rennenberg says. “On the managed equipment services side, we’re seeing more customers looking for these outsourced services.”
Rental on the Rise
Tirey says the servitization trend is also shifting the focus from traditional finance models toward equipment rental options with ongoing monthly payments. “We have a robot company that is leasing the equipment to their customers and it includes servicing, but at the end of the day it’s a rental agreement,” he says. “The equipment is not owned by the borrower or the user of the equipment. They have to make that monthly payment forever, so it’s more like a rental agreement, or pay-per-drip.”
Tirey says many customers are willing to make ongoing payments, especially when they don’t have to put cash down for the equipment.
“I think rental agreements make a lot of sense. We see this a lot already in cloud computing where people are not buying client server technology but renting computer utility in the cloud,” Tirey says. “We see people who are paying for the ride instead of paying for a car that’s going to be sitting around in a parking lot. This idea will continue to morph into so much more and will continue in ways that haven’t even been thought of yet.”
Evolving Equipment Finance
How will the shift from traditional financing to servitization affect the equipment finance industry?
According to the ELFF’s report, the shift “will require a fair amount of rethinking and retooling of many individual industry practices, disciplines and functions, which comprise the overall business of providing equipment leasing and financing services today.”
Instead of adhering to more volatile transaction-based business models, DLL’s whitepaper suggests companies will need to shift to relationship-based models based on fees and contracted services, which will increase the stability and predictability of their revenue streams.
Meredith says the shifting models provide lessors with greater opportunity to partner with customers that may want to “tweak” typical financing options. “Having the flexibility to design programs based on the customer’s needs is a critical success factor for us,” he says.
Rennenberg points out an additional benefit for lessors: “With Lease by the Hour, we avoid those uncomfortable overtime conversations with customers at the end of a lease term, because we are getting the meter reads during the term, and there is no overtime with a flexible term lease. With traditional leases, we typically do not get any meter reads or mileage readings during the lease, and sometimes the vendors does not get them either. We are also shifting the focus from maximum usage to minimum usage and thereby chipping away at the usage overestimation problem so common to normal leases.”
“Trying to guestimate the maximum hours can be a barrier to entry for some customers,” Rennenberg continues. “They often don’t really know how many hours they’ll be using their equipment. So this also helps fulfill the demand of the customer when they need something flexible without having to guess what their maximum annual hours are.”
Tirey calls servitization the “third big technology wave” to transform business. “We’re moving from a product-driven environment to an information-driven environment to a knowledge-driven environment. We have the ability to put sensors on everything, compute that data in the cloud at a very low cost and turn that information into knowledge. I know not only how many miles a truck went, but I know if they were stop and go miles or big long stretches of highway. This knowledge gives us the ability to dream up new and better ways of serving customers.”
Meredith says automatic reporting will become increasingly common in the future. “From a usage perspective, as we move into the future there are going to be more real-time statistics and metrics, so the customer doesn’t even have to deal with that data — it’s just automatically sent over to the lessor where they will determine the payments,” he says, adding that sending data on a more frequent basis could result in a better match for the cash flows of the end users.
According to the ELFF’s report, the industry can also expect to see higher equipment turnover rates, prompted by customer desire to upgrade, which will demand increased asset management diligence around mid-term solution experience.
Meredith says this will inevitably lead to increased need for flexibility in usage and shorter-term contracts based on monthly or yearly needs.
“Some of our customers want diversity with contracts, specifically structure and usage propositions,” Meredith says. “So what’s going to happen is we will see more individually-negotiated contacts, which is a challenge because it’s much easier if you have standardized products and services, but it’s also a tremendous opportunity for those who have the flexibility to look at it on a more individual basis.”
Meredith says the days of separate contracts for the equipment’s lease and servicing are numbered as the industry is shifting from leasing equipment to providing fleet management services.
“They’re going to be bundled even more, so there is just one payment,” he says. “You’ll see leasing companies do everything for managing the fleet, from the point of determining how much equipment a customer needs to disposing of it at the end of the contract, refurbishing it and recycling it so it’s going to shift even further away from buying equipment to buying the service.”
With technological advances coming at a dizzying rate, obsolescence is always a danger for any fleet. Frank Bussone forwards the argument that the best way for companies to avoid this problem is to lease their equipment, instead of purchasing it outright, giving them the opportunity to update as needed.
With wild swings in financial markets, the political landscape changing worldwide, oil production through the roof and the U.S. Federal Reserve increasing interest rates, how should a company adjust its asset financing structures to contend with the uncertainty? Corcentric’s Pat Gaskins suggests using a dynamic financing model that can account for unexpected change over the asset life cycle.