As businesses ditch asset ownership for pay-per-use models, lessors must shift their focus from residual value to real-time returns and learn to price consumption risk as carefully as they once priced equipment.
As businesses shift from asset ownership to pay-per-use models, equipment vendors and financiers must rethink traditional underwriting. Managing consumption risk — not just asset risk — is now critical to sustainable profitability.
WHY DEMAND FOR CONSUMPTION MODELS IS RISING
Several factors fuel the rising demand for consumption-based models. Companies now favor predictable, scalable operating expenses over large upfront capital investments, preserving cash for strategic growth initiatives instead of locking it into depreciating assets. Consumption models also allow businesses to scale usage based on actual need, reducing waste from overprovisioning.
A desired accounting outcome often drives customer demand for consumption-based models. Where a fixed-payment lease is generally categorized as a capital expenditure, consumption-based deals are a hybrid: The fixed portion may be treated as Capex, but the uncommitted variable portion may be treated as an operating expense. This dual classification appeals to CFOs aiming to optimize balance sheet presentation and improve financial ratios.
Furthermore, consumption models shift technology obsolescence risk back to vendors, ensuring customers stay current. Vendors are incentivized to maintain performance standards and upgrade cycles, fostering deeper partnerships. The agility offered by these models enables faster deployment of resources and simplifies budgeting by removing the need for complex procurement processes.
WHY VENDORS AND LESSORS SHOULD EMBRACE CONSUMPTION MODELS
Consumption models drive predictable, recurring revenue streams. Although the upfront revenue per transaction may be smaller, the total customer lifetime value often increases substantially. Customers integrated into consumption models are less likely to switch vendors, creating stronger, more durable relationships. Real-time usage data enables vendors to refine product development, optimize pricing strategies and enhance customer success programs.
For lessors, experience managing residual value risk translates well to underwriting consumption models. In many cases, the risk profile is comparable to traditional FMV leases, offering new revenue opportunities without a significant increase in risk exposure.
UNDERSTANDING CONSUMPTION-BASED FINANCING
Examples of consumption pricing are increasingly prevalent. A simple car rental may include a fixed daily fee plus a variable charge based on miles driven. Similarly, in technology financing, usage-based pricing structures are becoming increasingly common:
• Networking equipment may be priced based on port usage.
• Servers may be metered by memory consumption (e.g., virtual machines) or server node utilization.
• Software solutions may employ per-user, per-transaction or per-processing-cycle billing models.
Ultimately, any asset where usage can be accurately measured can be structured as a consumption-based financing deal.
In contrast, managed services involve outsourcing operational management under service-level agreements, focusing on performance and service quality. Equipment-as-a-service (EaaS) bundles products and services into a subscription model, delivering outcomes rather than ownership. While these models overlap, consumption financing centers on financial structuring, while managed services and EaaS emphasize operational responsibility and business outcomes.
REFRAMING RISK: FROM RESIDUAL VALUE TO REAL-TIME RETURNS
If a lessor is comfortable assuming 20–25% residual risk on an FMV lease, why not take on a comparable level of consumption risk? The capital at risk remains the same. However, there are key differences in how returns are realized:
• In a traditional FMV lease, the lessor earns zero return on the residual value (RV) investment until the end-of-term (EOT) phase.
• In a consumption-based structure, any variable usage during the firm term provides an immediate return on the capital at risk.
Additionally, consumption-based deals often command a pricing premium to compensate for variability. Properly priced, consumption models offer a risk premium that can significantly enhance portfolio profitability.
FRAMEWORK FOR UNDERWRITING CONSUMPTIONBASED DEALS
Consumption-based financing is new territory for many equipment finance firms. Because of the number of variables in play, this is an area where having sound advice can be essential to a successful new product offering. Putting in the work up-front to fully understand the expected usage case is critical in determining pricing and structuring the deal.
Pricing strategy is another area that can make or break success for consumption-based models. Two common approaches include:
• Flat Rate: A consistent unit price for both fixed and variable usage components. This approach allows for premium rents on the fixed cash flows, essentially subsidizing the variable risk.
• Tiered Pricing: A lower (or zero) premium on the fixed portion, with a higher premium on variable usage. Differentiated pricing increases the risk as it may discourage the use of variable units.
Market conditions and customer preferences often influence the choice between these strategies.
Additionally, it’s important to assess and articulate potential risks that could cause actual usage to deviate from the expected case. Common risks include:
• Competitive Pressure: A retailer may lose market share, reducing their need for variable capacity.
• Slower Growth: A service provider may experience delayed subscriber adoption, impacting projected usage.
Understanding these risks allows for proactive structuring and risk mitigation strategies. Other areas that should be well-vetted are determining the cushion for variability from the expected use case and identifying opportunities to leverage end-of-term activities to realize additional revenue.
CONCLUSION
Underwriting consumption-based financing does not need to be more complex than underwriting FMV leases, but as it is new to many EF firms, having an experienced advisor on board can make a difference. By applying structured pricing, building cushions for variability and leveraging end-of-term revenue strategies, lessors can confidently extend flexible financing to meet the evolving needs of modern enterprises. In an economy increasingly driven by pay-per-use models, those who adapt their underwriting frameworks will secure a decisive strategic advantage. •
John Sullivan is a Director at The Alta Group, serving clients within the firm’s Strategy & Competitive Alignment practice. He spent more than 25 years as a global leader at Cisco Systems Capital, where he led the launch of Open Pay, the company’s first consumption-based financing model.
