"Lease Vs Buy Template"
MACQUARIE EQUIPMENT FINANCE Strategic Advisory Factoring Risk into Lease vs. Buy Decisions for IT MAY 2008 Leasing of IT (Information Technology) A more recent innovation in usage practice able to get out of a technology footprint assets has a history as long as that was developed in the PC/networking quickly), and became the standard of IT itself, and this history reveals era, as IT investment shifted away from vehicle for managing technology refresh innovations in how leasing has been large systems only (e.g., mainframes and cycles. Various types of leases -– used. At first, due to the investment enterprise-class servers) and began to created specifically for the challenges intensity required for early computers, include distributed assets (e.g., PCs) as a of distributed assets—were developed, leasing was used only as a financial significant portion of the IT budget. These with features such as ‘serial number vehicle. It was, essentially, a way to pay distributed assets were characterized by substitution’ and ‘partial returns’ (e.g., for productive assets over time. And, (a) low cost, (b) shorter life spans, and Macquarie Equipment Finance Flex as the relative amount of IT used by a (c) high unit counts. Even though they Lease offering) geared to the real world firm increased (measured as a % of all were less expensive on a per-unit cost of small, geographically dispersed capital equipment), leasing began to basis, they quickly became essential to units. be used as a way to keep assets/debt modern business productivity. Leasing of off of the Balance Sheet (via operating these assets became a way to maintain leases). technological flexibility (i.e., the need to be STRATEGIC ADVISORY SERVICES Thus, leasing benefits for smaller/ (from large installed bases) to create shorter-life assets became focused on competitive cost pressures, large labor flexibility, while benefits for larger/longer- pools at reasonable prices, vendor life assets remained centered around alternatives, and a stream of upgrades, finance/costs (see Figure 1). add-ons, plug-ins, and peripherals to extend the range/reach of feature sets of any technology we invest in. This factor includes TCO-type costs associated with increasing maintenance expense, repairs, downtime due to failure rates, spare parts availability/ pricing, service contract increases, dwindling skill sets, and other legacy- support issues. If the technology industry goes in a different direction than our selection, or develops alternative standards which become widely popular, we may find ourselves in the unenviable position of having to negotiate service, support, and upgrades with a smaller set of suppliers than are available for the competing Figure 1: Leasing: Flexibility versus Cost technology which we didn’t buy. In such a scenario, at some point it becomes The newest innovation has developed requirements, technical capabilities, infeasible to stay with that technology out of this flexibility feature, and or operational realities are flawed just choice. concerns using leasing for managing enough to render the implementation various forms of risk. In most of these infeasible, and one which has to be Product Life-cycle Risk. This risk can cases, the issue is on risk management: abandoned mid-stream. In such a be articulated with the question “What loss containment under unfavorable case, equipment that cannot be used is the probability that important new developments. In other cases, the elsewhere in the business must be technology options will emerge which issue is on cost avoidance or business replaced with a solution that will work. will NOT run on our technology?” This disruption costs. Three specific vectors The results can be financially disastrous, relates to how fast the technology is of risk are targeted: (1) technology risks, if we have no way to recover some changing and in what direction the (2) business risks, and (3) usage pattern of the investment in the first batch of industry is going. This is the basic risks. Most of these risks involve the equipment. If we have to ‘eat the whole issue of platform currency, relative to possible scenario of having to abandon thing’, then even early-termination fees technology industry offerings, and has a technology footprint, or of having to on leases will result in lower loss than to do with the ability to exploit current/ bear higher downstream costs. that incurred in a ‘purchase’ scenario. future market products on top of the Accordingly, leasing of such business- technology platform in question. critical equipment is being used to Platform changes generally are ‘linear’ Technology Risks manage this risk, and lease structures in nature, but every so often, non- can be negotiated to allow favorable linear changes occur: Processors go Suitability Risk. This risk can be asset transfer/acquisition later, should multi-core, addressing mechanisms articulated with the question “What is the implementation end up successful. become 64-bit, and bus architectures the probability that the technology will radically change. The technology not meet our specific business need?” Ecosystem Risk. This risk can be industry as a whole loves platform Although it does not occur too often, articulated with the question “What is changes, for this allows the creation of there is some probability that even the probability that this technology will the ‘next generation’ of capability (for the most carefully designed technical not engender adequate after-markets sale, obviously), which only runs on solution will simply not work for us. and inexpensive labor pools?” We are the new platform. New features, higher Either our understanding of the business generally dependent on market forces performance, increased manageability, 2 STRATEGIC ADVISORY SERVICES more consistent availability, and but the environment changed in such a Usage Pattern Risks sometimes greater cost economies way as to render the project unattractive accompany platform changes. (or even, ‘prohibitive’). Again, we are “Goodness of Fit” Risk. This risk can faced with what to do with the asset be articulated with the questions “What Industry Risk. This risk can be (and those costs). is the probability that the technology articulated with the question “What we select (as our standard) will not is the probability that my technology Opportunity Cost Risk. This risk can closely match the actual needs of a vendor will fail at business or be be articulated with the question “What specific user group?” and “What is acquired by another firm, with lowered is the probability that we will need our the probability that the technology we service levels?” This is a familiar risk, cash or favorable debt for strategic select (as our standard) will force our of course, and is not unique to IT (e.g., opportunities?” Healthy companies user populations to a ‘lowest common supplier risk), but one wrinkle in this have many investment alternatives denominator’ feature usage?” This sector is the propensity for a firm to competing for their cash and favorable risk is inherent in all standardization buy a competitor just to get their rival debt, and each should be evaluated on initiatives, and is nothing new. product off the market. Too often good/ the basis of expected rate of return. The However, in the technology space, better products are discontinued when fundamental financial task has always we have known for quite some time the vendor is bought by a competitor. been to acquire funds at the lowest cost that user populations can vary widely This can generate support challenges of capital and invest them in projects in knowledge, attitudes toward at the same level as business failure on with highest return on assets/equity. technology, learning/interests, and the part of the original vendor. In fiercely This typically means that cash and overall support for our initiatives. The competitive technology sectors, this is a favorable debt must be used to procure needs of a software engineer at a bank, very real risk. appreciating assets, in preference to creating financial platform software depreciating assets. This principle is are very different from an order entry known as the Strategic Use of Capital clerk at a parts distributor. Typically, Business Risks and is diagramed in Figure 2. it is important to hit a happy medium between ‘one size fits all’ and ‘build Project Risk (Internal). This risk can Committing cash to ‘plumbing-level’ to order’—by segmenting the user be articulated with the questions “What ROI projects reduces flexibility for populations and creating separate is the probability that the business strategic business moves. funding profiles for each. The goal is to initiative will be abandoned due to allow technology footprint to change— performance or organizational issues?” as needed—in pockets of strategically and “What is the probability that the important users. business initiative will be abandoned due to changes in strategy?” In this scenario, the technology works well, but the operating unit fails for one reason or another. The project may be abandoned for any number of internal reasons: low- performance, re-orgs, new leadership, change in market strategy, new technology options, etc. In all cases, we are faced with what to do with the (now) unused assets. Again, we are at the ‘return-or-eat’ decision (assuming we can find no better home for them). Project Risk (External). This risk can be articulated with the question “What is the probability that the business or legal environment will force abandonment Figure 2: Strategic Use of Capital of a business initiative?” This is a far too frequent situation for modern businesses—everything was going well, 3 STRATEGIC ADVISORY SERVICES An extension of the principle can also Conclusion be made from user populations to branch facilities. The needs of an urban Not all of these risks are pertinent office in a Tier 1 metro area can be quite in all cases, but all should be at different from one serving a spacious least considered in evaluating each rural geography in the Midwest. investment in IT. In situations where the Technology decisions—and the funding investment has low risk—according to approaches that support them—should these vectors—then standard Lease- recognize the possible risk associated versus-Buy models and approaches with forcing a single technology can be used. But, when one or more of template on such diverse operating these risk factors are significant (e.g., requirements. in new markets, new products, new geographies), the financial executive Utility Risk (Distributed Assets). This should carefully consider leasing— risk can be articulated with the question simply as a way to provide an ‘escape “What is the probability that the route’, created up-front in favorable technology we select will not achieve conditions, well before a situation desired utility rates?” Distributed becomes critical. IT assets are notorious for under- utilization, and this fact has created As always, we at Macquarie Equipment hundreds and hundreds of centralization Finance stand ready to work with you to and consolidation initiatives over the design financial vehicles tailored to your past 2-3 years. It is much easier to IT investments, and crafted to achieve get utility rates up in shared resource the best possible mix of financial environments, but such moves only benefits, flexibility benefits, and risk address cost avoidance (financial) management benefits. issues, and not cost recovery. We typically cannot ‘sell’ decommissioned smaller servers, and this is another case of ‘return-or-eat’. If we are currently still installing large quantities of distributed servers as a company, for example, we might be wise to analyze whether all of them should be bought or some leased. Leasing a subset of these would at least soften the blow should a centralization/consolidation project become important. For more information, contact: Macquarie Equipment Finance The information contained herein has been obtained from sources believed to be reliable. Macquarie Strategic Advisory Services Equipment Finance, LLC and Macquarie Equipment Finance Ltd (together “Macquarie”) disclaims 2285 Franklin Road all warranties as to the accuracy, completeness or adequacy of such information. Macquarie shall have no liability for errors, omissions, or inadequacies in the information contained herein or for P.O. Box 2017 interpretations thereof. 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