Expanding business through equipment rental

There are several factors to consider before pursuing this opportunity

WHEN DO people rent? Quite often it is when they are in need of a high-cost product that is used infrequently. For instance, a shop owner may rent a crane if a job requires crane capacity in excess of what the shop's own machine can provide.

The company renting the equipment not only derives benefit from use of the equipment but avoids incurring a range of costs in doing so. Furthermore, there is opportunity cost to consider. The decision to rent equipment as opposed to outright purchase can result in freeing up funds for allocation for other purposes that may be equally or more beneficial to the enterprise as a whole.

When exploring opportunities to expand business by way of equipment rental, management within a service and repair company might benefit from these insights.

Why?

First, the potential cash flow derived from the rental market cannot be ignored. If demand for rental equipment exists, and if a company responds to this demand, its cash flow can be positively affected. Further adding to the attraction is the possibility that offering equipment for rent may not necessarily require a large outlay of cash-only customer demand for the temporary use of a piece of equipment.

The expansion of companies in the electromechanical maintenance and repair and the electrical aftermarket into the rental equipment market may come naturally for a number of reasons. A firm may already own the equipment and wish to get a better financial return on what it has invested in it. Or, a company may be able to leverage on its presence in an existing market in providing equipment rental. Or else a prospective customer may associate a particular firm with some solution to a problem. For example, during the height of hurricane season, a company's reputation for overall reliability may carry over to spur an individual to make a pump rental inquiry.

However, before firms take the plunge into the market for rental equipment, managers within these businesses must evaluate circumstances and pose several questions relating both to their objectives in the marketplace and to the competition. For instance, the local hardware store may rent generators. If this is in fact the case, why isn't demand already being met by the local hardware store? Other questions may need to be posed as well.

What kind of equipment should the company rent out? Should some equipment under consideration for rental instead be loaned out as a way to reward loyal customers who are in temporary need of a piece of equipment or machinery in order to carry out operations of their business? Could equipment rental in any way undermine existing markets? For example, a company that provides a backup generator as a value-added service does not want to risk relationships with existing customers through the sudden addition of fees or charges that may be perceived as price gouging.

These and other scenarios should be considered carefully before the company commits to equipment rental as a potential income-producing undertaking in the marketplace.

In order to answer these questions, a firm may need to conduct some market research. Prior to allocating resources for equipment rental, a firm should survey the market to determine customer demand and the overall viability of the equipment rental.

"Make sure there is a need for it," said Mo Droppers, operations manager for the Gaylord, Mich., branch of New Hudson, Mich.-based Cummins Bridgeway, a company that sells and services Cummins engines, power-generation equipment, and related products in Michigan, Ohio, and western Pennsylvania. "You don't want to buy equipment there is no market for."

Droppers urges companies exploring equipment rental to identify the appropriate market and appropriate sizes of equipment. Once leaders within a company determine the scope and commit to the market, next they should inform potential customers that it is a source-or supplier of rental equipment.

By this stage, management at a firm will have formulated the terms of the deal. In doing so, it will have examined several factors, including elasticity of demand and the frequency of use. This information, along with considerations relating to the competition, can be used in setting the price, which will need to suit customers in the market for equipment rental.

Quite often, a customer's circumstances will determine what the customer is willing to pay. Circumstances also will dictate how often a customer rents equipment.

"If somebody is only going to use it one time, they will rent," explained Michael Faulkender, an associate professor of finance and the director of the masters program in finance at the University of Maryland'sRobert H. Smith School of Business. "If they are going to use it more frequently, they can consider buying it."

Frequent use may justify the cost of outright purchase of equipment for an individual or organization. Frequency of use also may be a criterion used by companies to determine if they will provide equipment rental and. if so, how much they can command in what they charge for rentals.

If a company is to go ahead with offering rental service, it might implement a two-tiered pricing program designed in part to generate relationship or loyalty. This is necessary because if potential customers are to use a piece of equipment three times, they are more likely to make the onetime purchase.

However, if the intended objective is to get customers to rent, management will have to do otherwise. Specifically, managers might consider designing a program whereby users pay the one-time fee for first use and a relatively more inexpensive fee for each time thereafter.

For example, a customer renting equipment may be able to use the equipment for seven days while paying for what is equivalent to five days. Customers can derive benefit from the arrangement since they may enjoy the added convenience that comes with a larger window of accessibility while doing so at a relatively cheaper price.

The company providing the rental service also stands to benefit when considering the alternative is for equipment to sit on the shelf where it does not in any way contribute to the bottom line of the company offering the rental service.

"It will cost you less if they use it more days," stressed Faulkender.

The reduced cost may be the result of the fact that the firm providing the rental is able to spread the associated costs incurred (such as the costs of marketing, transportation, training, and any investment in technical expertise) over more days while commanding a relatively higher rate than it could for a shorter period of time.

In making this consideration, executives and managers will need to balance the need to make a profit with the costs built in for conducting the business.

Ultimately, a firm exploring the possibility of expanding its business by offering equipment rental must be concerned with maximizing return on its investment in equipment. Accordingly, the firm must assess not only demand but demand over the course of time.

Forecasting can be a difficult exercise rife with uncertainty since future demand can be affected by unforeseeable elements, such as evolving technology and changing customer expectations.

Assuming some demand for rental service does exist, managers next need to make sure that demand is not limited to a small group of people at one time of year. Rather, the market should be sufficiently large, though not so large as to put a company with fewer resources in direct competition with a larger enterprise.

But beyond the number of prospects in any given market or segment, the occasion for rental-or when a customer will need to rent the equipment-is of equal importance to the firm providing equipment rental.

A firm does not want a glut of demand that it is unable to meet at one time of year, nor does it want to contend with long periods of time when there is no demand for equipment rental. Rather, the firm wants to achieve a balance of finding the right customers at the right times over the course of the year.

"You want people who need it at different points in time." Faulkender noted.

Once a firm is able to identify the scope of the market and begins to serve customers in that market at different periods of time, it can stand to benefit since more steady demand will likely translate into more substantive profit.

Some firms have succeeded in integrating equipment rental into their equation for success.

Cummins Bridgeway is one such example. It has succeeded in expanding business by entering the market for equipment rental. In addition, it has demonstrated its ability to identify customers who rent generators at various times.

The circumstances under which customers rent run the range. The company sometimes rents out equipment when there is a plant shut down. It also provides rental service during power outages. During the spring and summer, concerts, festivals, and special events account for much of the demand for rentals.

The revenue derived from the undertaking ultimately must cover capital expense, maintenance, and provision. Furthermore, executives and managers must weigh the additional risks.

"You have to think about maintenance needs," said Faulkender. "People don't use rental equipment the way they use their own equipment."

Owners may take better care of property. By contrast, rental property may undergo more wear and tear. Liability also needs to be considered. If a generator causes a fire, the owner of the generator may be liable for damage to property or personal injury or fatality. As a result, insurance will be factored into the rental business.

Nonetheless, the marketplace is full of businesses that have demonstrated how to prosper as suppliers in the market for equipment rental.

By Joseph S. Hoff, EA Associate Editor