Dealers Striving to Thrive Need Size

Sept. 28, 2010
Dealers' service contracts are not only profitable revenue generators, they can also offer a competitive advantage to contractors who have not been able to hire enough qualified service technicians.
It's not surprising that more than 40 percent of dealers report a significant increase in rental revenue last year. About 65 percent of all contractors use short-term rentals. About a third of firms with fleets valued at $10 million or more have reported significant increases in rental hours purchased each year for the past five.
Equipment dealers are more likely than traditional rental companies to offer heavier equipment for rent, such as this Cat 938G in Hawthorne Machiney's Cat Rental Store fleet.
Some rental firms have offered their capabilities to manufacturers hungry for more distribution and became authorized distributors. But manufacturers require typical rental firms to keep new machines in their fleets for at least a year before selling them, according to the AED Rental 2006 study.
Equipment rental companies' inventories and rental rates for backhoe-loaders have thoroughly challenged many contractors' traditional ownership arithmetic and introduced firms to rental.
Dealer service can be more important than product or price in an equipment purchase decision.

With competition from rental firms, demands by manufacturers to improve customer service, and customers' expanding expectations, construction-equipment dealers have had the choice to either grow or wither in the 21st Century. It has been difficult for dealers to maintain business as usual, and distinctions between rental companies and equipment dealers have blurred.

More customers expect to rent equipment: Dealers add notoriously cash-hungry rental fleets.

Diesel emissions regulations bring computer controls and other innovations on construction equipment: Dealers multiply their spending on technician training and retention.

Manufacturers push to refine the customer experience: Dealers invest in parts inventory, facilities, and retailing systems.

A dealer needs size to generate the capital necessary for these improvements. Dealers who survive can develop better capabilities to serve their customers. These entrepreneurs' challenge is to grow without losing touch with the smaller businesses they have served so well.

"The construction equipment business is very much a local business, a people business, a personal business," says Toby Mack, president and CEO of the Associated Equipment Distributors. "Having the entrepreneur interacting in the market with the customers is what makes these businesses so successful."

Rental consolidators have pushed the equipment-retail size race. Unrealistically low rental rates contrived to service monumental debt, and to compete with deluded competitors, made renters out of a lot of equipment users. Several rental consolidators' shareholders and creditors are footing the bill for this self-destructive market pioneering, but it seems to be working.

For the past five years, even as the post-bankruptcy rental industry has been raising rates toward a sustainable level, Construction Equipment's Annual Report & Forecast research consistently measured about 65 percent of contractors using short-term rentals. Short-term rental use has been consistent with about 83 percent of firms with fleet values of $10 million or more. Moreover, about 25 percent of contractors say the number of machine hours they rented increased in each of the past five years. About 33 percent of firms with $10 million and larger fleets say they have increased rental spending.

An unsettling number of rental outlets ultimately define success based on attracting investors to buy their company rather than on luring equipment users. United Rentals, Hertz, RSC, Neff and NES are owned by private-equity firms — groups of investors who pool cash and borrowing power to invest in companies that can be resold for a profit. On a smaller scale, private-equity firms have purchased Coast Crane in Seattle, Old Country Rentals on British Columbia's Vancouver Island, and Toronto's Stephenson's Rental Services.

All of the vendors in your rolodex have one goal: to make money for their owners. Some of them have figured out that the best way to do that is to make sure you make money. Firms owned by private equity groups plan, ultimately, to make money by selling the company. They have to operate the business to do that, so renting equipment from them may not feel significantly different than renting from anybody else. For now.

"When a company is owned by a group of investors, it's for sale," says the fleet manager at one of the private-equity rental companies. "It affects how they're managed.

"They have a very short-term outlook," he continues. "You don't have to make decisions that will improve the fleet or the company 10 years from now. You just have to look good in three years or five years.

"So it's not about staffing up service departments or training technicians. It's too hard to keep skilled employees from jumping ship, and the payoff doesn't come quickly enough to improve the selling price of your company."

Hertz and RSC both did stellar business in 2006 — the best year in terms of revenue and profit in either company's history, according to Dan Kaplan a consultant and former Hertz Rental CEO. But he adds that both firms are reducing their capital spending this year to improve cash flow. An operating company — one committed to long-term service to its customers — would likely invest more of 2006's success in the company.

Individual branch operators will work hard to remain competitive, but these companies may not be the most secure choice for firms looking to forge long-term partnerships with vendors.

Apparently some long-haul rental managers have been investing their growth in diversification. Thirty-five percent of rental firms responding to Construction Equipment's Annual Report & Forecast survey in late 2006 reported significant increases in new equipment sales and parts sales. Thirty percent reported significantly increased service sales. The AED Rental 2006 study found that 60 percent of rental companies sell equipment using rent-to-own transactions.

Dealers have long complained about rental firms selling new equipment to customers, and the typical rental firm's manufacturer suppliers require them to hold equipment in their fleets for at least 12 months before selling it. But some rental companies are making a concerted effort to become authorized dealers.

NationsRent emerged from bankruptcy protection with a private management team and the stated objective of becoming a "fully integrated" rental company. They wanted to integrate equipment sales with the rental services they offer customers. When the British rental giant, Ashtead, acquired NationsRent late last year, the company admitted it planned to export the integration objective to Ashtead's North American subsidiary, Sunbelt Rentals.

Details of what the merged Sunbelt and NationsRent operation will look like remain scarce. But Sunbelt's spokesman is willing to say that the NationsRent brand will give way to Sunbelt's, and that the company will continue to integrate new-equipment sales.

As rental companies try to look and act more like equipment dealers, it's no secret that dealers are also looking more like rental companies.

Forty-one percent of dealers responding to Construction Equipment's Annual Report & Forecast study said they'd done significantly increased short-term rental business in 2006. The Associated Equipment Distributors surveyed its members last year and found that the typical dealer gathers 13 percent of its revenue from rental.

When The Cat Rental Store concept was launched in 1997, Cat's North American dealers operated about 85 light construction rental operations. Today there are more than 450 Cat Rental Store locations operated by Cat's independent dealers on this continent, and 1,600 worldwide.

The Cat Rental Stores illustrate how strongly equipment manufacturers feel they need a cooperative rental channel. In the late 1990s, few Cat dealers were anxious to dump capital into dedicated rental operations.

But Caterpillar wanted its dealers competing head to head with the big rental companies, and negotiated purchasing agreements with allied equipment lines such as light towers, compaction tools, pumps and other non-Cat equipment. Cat offered the benefits of its buying power to dealers who would set up distinct rental operations separate from their sales organizations — a stipulation designed to make The Cat Rental Store competitive.

"We have been in the rental business for over 40 years — mostly rent-to-sell on heavy equipment," says Chris MacAllister, president and chief operating officer of MacAllister Machinery, the Cat dealer in Indianapolis. "We got into what we call the Rental Services business — light construction equipment — in about 2000 and it has grown rapidly for us.

"It has also somewhat changed the nature of our company," MacAllister adds. "We are now doing business with a lot of new customers who are not heavy-equipment buyers."

"We had to learn how to process a lot of transactions — every rental creates an invoice — and it's a lot more action that we have to figure out how to process," MacAllister says. "Rental seems to carry a greater sense of urgency. It has been good for us to learn to be more responsive — to check things out while the customer is waiting there at the counter.

"We had to learn the rental-services paradigm and fit it together with our heavy-equipment rental model," MacAllister says of what may be the greatest challenge dealers face when adding rental. "We hope customers can rent heavy and rent light and not have to talk to two different people to do it."

Dealers' traditional rental operations, what MacAllister calls "heavy-equipment rental," are typically rent-to-own operations — extensions of the sales organization. They're effective sales tools — putting machines in the hands of cash-strapped businesses that use the horsepower to earn a down payment. But they're not sustainable as stand-alone rental operations.

Equipment rental thrives on what managers call dollar utilization, annual rental revenue divided by the original rental-fleet cost. The major rental companies maintain dollar utilization around 60 percent. A dealer's heavy-equipment rentals would be hard pressed to deliver half that utilization, even if they did charge for all of the time that a machine was off the lot.

Because of heavy equipment's high cost and because policies that improve dollar utilization are not good sales strategy, equipment dealers who want to compete in the rental business often have two distinct types of rental to manage — the heavy-equipment sales tool, and light-equipment rental services.

"Rental Services is profitable for us, but it is very capital intensive. It generates better cash flow, but it takes about a $1 in inventory to generate every $1 in sales," MacAllister says. "I'm not sure the heavy-equipment side is that cash intensive, and with parts and service representing about 35 percent of sales, our heavy-equipment business delivers better margins."

Adding rental operations to an equipment dealership does have some distinct advantages for both dealer and customer. The dealer's service capabilities should be able to maintain a reliable fleet, and many dealers' inventories are closely matched to heavy-construction contractors' needs. The dealer can typically fill a bigger order more quickly.

Caterpillar plans to help its dealers emphasize the convenience of choice.

"We are going to apply fully the RUN model — rental, used, and new," says Paulo Fellin, Caterpillar's vice president of Europe, Africa, and Middle East marketing. "We don't want salesmen to just be selling machines — we want them to sell solutions. Customers that have a low-hour need might be best served by a used machine. If they have big peaks of work, they might want to rent. If they have high, consistent need, they probably need a new machine."

Of course, Caterpillar dealers have new machines to sell, and Rental Store inventories to rent, but Cat wants buyers to know that their dealers can also take machines out of rental fleets at many different price points to suit many different buyers' needs.

"If a customer wants to buy, he can buy a new one or a rental rollout — we can take a machine out of the rental fleet to satisfy a need," says MacAllister. "We have made and saved deals like that."

The challenge is to balance the very different sales and rental operations in a single organization and encourage everybody in the dealership to apply the best solution for the customer.

"We no longer pay salesmen on commission," says MacAllister. "They do get a bonus, a large chunk of which is based on combined heavy sales and rental service department profits. We're giving them an incentive to work together, share leads, and do whatever it takes to get each customer's business."

Most major manufacturers that build light equipment would like to see their dealers get into the rental business — Deere and Komatsu have growing programs. The Cat Rental Store has been such a dramatic success because of the amount of capital Cat dealers can sink into the project. Each of the 53 U.S. Cat dealers, on average, has access to $4.1 billion in capital, according to machinery-industry analyst John McGinty, who was managing director at Credit Suisse First Boston before he went to work with private equity group USB in 2006. His analysis of the capitalization of various manufacturers' distribution networks suggests that the average Deere dealer is capitalized at $750 million, the average Komatsu dealer at $500 million, CNH dealer at $450 million and Volvo CE dealer at the $400 million.

Volvo Construction Equipment, with a very aggressive goal of becoming the clear No. 3 construction-equipment manufacturer in the world by the end of 2009, has decided to invest its own capital in building a rental channel through VolvoRents franchises.

On the occasional Sunday, you can find an ad in the Wall Street Journal beckoning entrepreneurs with a minimum of $500,000 in cash and another $500,000 in assets to become VolvoRents franchisees. Volvo offers its brand, systems and purchasing power to the franchisee, and the manufacturer will lend qualified applicants up to $5 million to get started.

There are 76 VolvoRents rental centers in North America (66 in Europe, and one in Mexico). Supposing Volvo committed an average of $3 million to each of its North American outlets, the company would have $228 million invested in securing a rental channel for its products. It's not necessarily an uncomfortable position for Volvo. The company owns 60 percent of its distribution in Europe, and CEO Tony Helsham says it's a good working model for the Swedish company.

Manufacturers seem convinced that if their dealers build deeper levels of service, customers will pay for it. Some evidence suggests they're right. The rise of component remanufacturing and rebuilding programs suggest that customers are realizing the compelling economics behind replacing with vendor-refurbished components. Caterpillar and its dealers have done almost 3,800 certified rebuilds around the world since the company started certifying rebuilds. About 1,000 of them have been through the Powertrain Plus program, which upgrades the entire power train of a machine and its cab.

"Customers have been asking for CSAs (customer-service agreements)," says Bill Springer, Caterpillar's vice president of marketing and product support in Peoria. "A lot of customers are beginning to change the way that they want their business to be done. They're identifying their core competencies and in many cases they're saying, 'Caterpillar dealer, you have great capabilities, so figure out a way to help me.'"

It is possible, though, that demand for dealer service is localized to areas where the shortage of qualified technicians is worst, because demand for service agreements appears to be less than universal. Nineteen percent of dealer respondents to the Construction Equipment Annual Report and Forecast study said they have seen significant increases in customer service agreements. Nearly 80 percent have seen no change in service-agreement business.

"I wouldn't say a significant number of our customers use customer-service agreements, but it is growing," says MacAllister. "I expect it will continue to increase, but it has been slow coming."

Nevertheless, construction equipment is a unique kind of purchase in that the dealer who sells the product is often more important to the choice of what to buy than the product itself. Construction equipment is not so nimble as heavy trucks or cars, easy to transport long distances to reach a suitable service center. When problems arise, construction equipment usually waits for service people to come to it. Waiting is expensive, and customers value dealers who can get them up and running fast. It's a fact that preserves dealer importance in the equipment distribution chain.

Perhaps the most common distinction between traditional dealers and rental companies, or any alternate channel of distribution, is their service departments. As inconsistent as their capabilities may sometimes be, they have more experience getting machines running again for customers than virtually any other link in the distribution chain.

Dealers have a lot of experience finding, training, and retaining technicians. They haven't cornered the market on customer service, but dealers in general — not every single dealer, but manufacturers' authorized dealers as a group — set the standard for how other distribution businesses should treat customers.

Growth, as necessary as it is to marshal the necessary capital today, has not made it easier to keep an open relationship with your local equipment dealer. But the entrepreneurs who run independent dealerships are creative and motivated people. Those who haven't mastered the local touch on a larger scale will learn from those who have. They must, because it has become a very competitive world in which they make their living.

Rental companies are looking for opportunities to get between dealers and their customers. These specialists' retail rental processes — again as a group, not each and every branch — are refined to attract people long accustomed to owning machines to choose renting. Some are becoming authorized machine dealers and expanding their service capabilities, making themselves available to fill any voids left by stretched dealers with products on allocation from their suppliers.

Of course dealers and rental companies can both be excellent business partners for equipment users, if you want them to be.

"The relationship between a fleet manager and an equipment dealer or manufacturer is held together with the same glue that binds a thriving marriage — the success of either is built on trust and communication," writes Greg Kittle, equipment manager with Ryan Central in Janesville, Wis. His comments were published as president of the Association of Equipment Management Professionals in their magazine, Equipment Manager. "In many ways, the relationship among end-user, dealer and manufacturer is harder to maintain than a marriage. After all, two people who are married to each other share the same general plans, expectations, goals and dreams — or they should. In the business world, however, it sometimes takes a healthy helping of innovation and imagination to lead two or three diverse businesses in the same direction and to the same destination."

An objective appreciation for the value of your vendors' capabilities, relative to your own, can motivate some firms to enter a vendor relationship with a sense of commitment approaching that of marriage.

Some dealers and rental companies are anxious to talk about how their resources can save you money or free your people and resources to focus on winning contract awards and building projects. That's why AEMP coined the phase "equipment triangle" and has focused on how to strengthen relationships between the parties.

The AEMP encourages all parties to seek ways to transcend traditional, often adversarial, vendor/customer relationships through exchange of information and responsibilities. The intent is for users to avail themselves of dealers' equipment-management resources. Vendors should profit as equipment users become more successful.

"They won't reach that destination unless representatives of all three sides of the Equipment Triangle — manufacturers, dealers, and end-users — are sensitive to the unique needs of the others," Kittle continues. "Our relationship with dealers and manufacturers continues to evolve. We are asking more of them than we ever have, but we are also sensitive to their profitability. We realize that when we grow, our vendors grow, and we know we could not do what we do without their support. In turn, dealers are well aware that a large part of their success depends on the help they get from equipment manufacturers.

"The bottom line is that partners in a relationship who are willing to take their share of the liability will also earn their share of the profits," says Kittle. "That sounds kind of like a marriage, doesn't it?"