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Life Cycle Economics & Full Service Leasing

April 02, 2014, 07:00 AM

In the world of equipment financing, if you ask ten people to define the term “Life Cycle Economics (LCE)”, you’re likely to get ten different answers. For the purposes of this discussion, we’re going to use a simple definition: The total cost of ownership of new equipment to the original owner during the equipment’s operating life.

I became aware of this concept over twenty years ago when I worked for one of the leading OEM’s of heavy duty trucks. I worked as a finance guy with the truck sales group and was impressed by how well our vehicles sold despite the fact that our product line was 10% - 15% more expensive than many competitors' trucks. Even back then, a fully spec’d 6X4 truck tractor with a sleeper cab was selling for $90,000 or more, so that price difference was no small matter!

As I dug into our value proposition more closely however, I found that our sales force could show the customer that not only was our truck less expensive to operate and more reliable, but that it was worth 15% - 20% more than a competitor’s truck when it came time for trade-in or sale.

The key to delivering this value proposition to the customer is being able to bring all of the component costs and key metrics together to refocus the customer’s thinking away from the upfront purchase price of the truck, and to start focusing on the life cycle economics as a solution to lower costs, reduce risks and simplifying the business model – leading to increased profitability & return on equity:

Chart showing Depreciation - Blog by Cramer Owen

The above chart is not intended to suggest that each of the categories carry the same importance, rather, it graphically outlines key expense and asset/liability categories that help construct the equation to determine the life cycle economics for a truck transport operator.

Full Service Leases

It is worth noting that there is no unified legal, accounting or tax definition of a Full Service Equipment Lease. It is generally accepted that a Full Service Lease includes providing the equipment, service, maintenance and may include other ancillary services (such as telematics, fuel services, cost tracking, etc.) for a fixed term. It does not include vehicle operations including drivers. The tax, accounting and legal focus is on the truck lease portion of the contract and whether it would be characterized as an Operating Lease (or True Lease). Depending on the size of the operation, geographic coverage, tax position, operating practices, maintenance facilities, etc., a full service lessor may be able to offer a value proposition that has substantial benefits to a lessee such as:

  • Using scale to obtain the best equipment (access to performance data that the lessee may not have) for the application at the best prices (using the aggregate purchasing power of the lessor)
  • Having the ability to provide full maintenance service efficiently and with minimal down time during the life of the lease (of course the lessor must have the capabilities to provide services throughout the lessee’s service area)
  • It may provide an Operating Lease structure that (at least currently) takes the transaction off-balance sheet with tax advantaged pricing to the lessee
  • Reduce  the end-of-lease truck risk (trade value), also using an Operating Lease structured as a FMV (Fair Market Value) or FPPO (fixed purchase price option) or alternatively include a ‘Like Kind Exchange’ provision (as allowed under the Internal Revenue Code section 1031) that would enable trading out certain trucks at optimal times and replacing with new trucks
  • Provide ancillary services such as fuel management services, roadside assistance, driver training, insurance equipment tracking, other vehicle performance analytics and cost tracking services

Full Service Leases for automobiles started in the late 1930’s (see Automotive Fleet, January 2013 publication, History of Fleet Leasing). However, Full Service Leasing of commercial trucks really did not become widespread until the late 1970’s and early 1980’s. These enterprises are non-bank equipment leasing companies and manufacturer’s captive finance companies. Some of the notable companies (among many others) in the business are PHH, Donlen, ARI, Penske, PacLease, Ryder, Volvo, etc. In the last decade the segment has grown significantly, with an estimated one third of the heavy duty commercial vehicles on the road today operating on a full service lease.

Challenges for Banks

There are two primary challenges faced by bank-owned leasing companies to enter this market:

  1. Most do not have the capability to offer full service maintenance throughout the lessee’s operating area, and
  2. The Federal banking rule, known as Reg. Y, restricts bank holding companies from engaging in a non-banking activity, either directly or through a subsidiary. Banks may apply for approval to enter in to non-banking activities, but generally the activities required to provide equipment servicing and repairs have fallen far enough outside traditional banking guidelines, that except under rare circumstances, banks have elected not to pursue creating leasing subsidiaries and seek such regulatory approvals. 

Relevance in Today’s Market

What makes this segment even more relevant today than at any time in the recent past, are the following industry changes?

  • Technology is improving truck performance - lowering operating costs and lengthening the useful life of trucks.
  • Technology (telematics, etc.) now enables operators, lessors, and other service providers to track operating costs and vehicle performance much more accurately in real time.
  • OEM’s product quality and durability is converging, so quality differences are much smaller – leading to price convergence (and perhaps commoditization).
  • New government emission regulations have created significant disruptions to engine technology - creating major questions about operating costs and the future values of these trucks during their operating life.
  • The industry remains extremely cyclical with substantial peaks and troughs in demand compounded by ‘the Great Recession’ of 2007-2009, resulting in:
  1. As of mid-2013, Transport Topics reported that the average age of the nation’s class 8 operating fleet was 11 years. This historical average has been 5.8 years!
  2. Recently, used truck values have been highly volatile and will continue to be as the industry continues the replacement process
  • Other uncontrolled variables - energy price volatility, changes and new government policies/regulations and driver availability create pressure on operating margins, capacity issues and truck trade cycle decisions.

The net effect is that operating in this very challenging environment requires measuring and controlling costs, minimizing risks and optimizing asset management. These factors and the success of existing full service leasing enterprises, has created a very dynamic and growing share of one of the largest equipment segments in the U.S. economy.

With a value proposition this compelling and a market this dynamic, is there a way that bank leasing subsidiaries can participate and still not violate Reg. Y? I think the answer is probably yes, but will it will require a partnership approach between the banks and third-party service providers that can provide the service coverage, logistics support, cost tracking and other services needed by the lessees.

This is a complicated and challenging business strategy as both parties will have significant reliance on each other’s capabilities and to be competitive with existing full servicing leasing enterprises, will need to make pricing, terms and conditions and payment arrangements simple and easy to execute -- no small challenge considering the differences between the cultural and business backgrounds of the fleet logistics and servicing enterprises, and bank leasing subsidiaries.

The good news is that where there is demand, supply will follow. So, if the bank leasing subsidiaries can’t find a way to offer this product, more opportunities for non-bank leasing enterprises and captive finance companies will continue to grow and prosper with their existing capabilities. Given the complexity of the product being offered, the sales people that can understand and grasp this solutions focused value proposition, will have a huge advantage in the battle for control over this exciting and growing market segment!

Managing Partner | CH2 Capital Advisors, LLC
Cramer Owen has spent over 35 years managing, advising and leading manufacturers and financial services enterprises on ways to grow and profit by expanding product sales throughout the world. A subject matter expert on equipment financing, Owen has successfully represented and assisted multinational manufacturers, their finance subsidiaries and independent global finance enterprises in achieving growth and profit objectives. Cramer is comfortable operating in complex, ambiguous environments in both domestic and international settings. In October of 2015, Owen established an advisory enterprise, CH2 Capital Advisors, LLC. CH2 Capital is focused on leveraging Owen’s distinct skill sets and professional experience to support the strategic growth objectives of industrial and financial services enterprises.

Prior to this, Owen was National Leasing Manager with Key Equipment Finance, a division of Key Bank, N.A. In this role, he was responsible for helping to expand the company’s national footprint of financing specialty transportation equipment by working with manufacturers, dealers and large operators. Owen spent over two decades in various management roles with De Lage Landen Financial Services (a wholly owned subsidiary of Rabobank), Wells Fargo, CIT Group, GE Capital, CNH Capital, Daimler A.G. and PACCAR Inc. His roles with De Lage Landen, Daimler A.G. and PACCAR involved substantial international business responsibilities including a four year ex-pat sales management assignment in Bahrain covering North Africa and the Middle East. During these assignments, Owen’s industry experience included heavy duty specialty vehicles, over-the-road transportation, aviation, marine, cranes, aerial lift, oil & gas, construction and industrial equipment.

Owen is a graduate of the University of California, Berkeley with a Bachelor of Arts degree in economics and Thunderbird, The American Graduate School of International Management with a Masters of Business Administration in finance.

View more details of Cramer Owen’s background on his LinkedIn Profile
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