Rental Strategies Aid Compliance, Costs

May 1, 2012

Fourth in a series, this installment of The Management Challenge explores machine rental as it affects the “acquisition and disposal” segment of the management hexagon. Read other installments in The Management Challenge series:

Housing permits are on track to reach almost 900,000 this year, multifamily construction is already up 21 percent over last year, and energy-related construction is up 24 percent. Cautious optimism is in the air, but construction equipment fleet managers are still concerned about capital preservation, rising owning and operating costs, predicted usage, and financial flexibility. Capital expenditures for equipment are still seen as a major financial risk, especially during an uncertain growth period. To manage those concerns, an increasing number of construction firms are using rental equipment as part of their fleet-management strategy.

Fourth in a series, this installment of The Management Challenge looks at machine rental. Others in the series:

Equipment Profession Facing Management Reset
In-House vs. Outsourced Maintenance
Why Managers are Running the Rental Option
The Complexities of Compliance
Meet the New Boss, Not the Same as the Old Boss
Outsourcing Cuts Shop Costs

“Visibility is keeping contractors from buying new equipment,” says Steven Settlemayer, Neff Rental’s vice president of sales. “We are all using the same forecasting sources and seeing the same uncertain outlook. The vast majority of our rental customers are subcontractors, but even the big general contractors don’t have much better visibility more than a year out.

“When the market crashed, virtually everybody auctioned off equipment,” Settlemayer says. “Some needed to raise capital, others had older equipment that didn’t meet EPA regulations or cost more than they produced. But as the markets begin to build up again, contractors are making plans to acquire additional equipment to bid new jobs, or find specialized equipment that will position them for new markets.”

Yet contractors don’t want to make any long-term investments because they don’t know what is going to happen even six to twelve months from now, Settlemayer says. Estimating predicted usage is the hurdle. Predicted usage, the measurement that ultimately justifies equipment acquisitions, is usually based on an analysis of current projects and jobs waiting in the inventory pipeline.

But funding cuts and delays spurred by the recession continue to keep the pipeline’s project flow to a trickle, and inventory is not being refilled. Remaining funds are being directed to shorter-duration and less-expensive projects. Large road- and bridge-building has been the major segment of the U.S. heavy construction industry since the Eisenhower era, and those projects are ending, says Andy Agoos, transitioning to smaller maintenance and restoration jobs that are much shorter in duration. Agoos has managed both construction and rental fleets, and is a Construction Equipment contributing editor.

This transition from years-long projects to shorter jobs is aggravating the issue for equipment professionals. Contractors are losing the benefit of planning around lengthy projects and are instead trying to schedule months of shorter jobs. Inherent to trying to mosaic short jobs together is the possibility of profitless gaps between jobs that skew the familiar usage formula. Settlemayer says rental allows contractors to add equipment on an as-needed, piece-by-piece basis for each job and not lose money on idle time between projects.

John McClelland, economist and vice president of government affairs with the American Rental Association, credits an anticipated rental increase of 20 percent this year to contractors rethinking ownership affordability. He says that before the economic downturn, the simple calculation to determine financial efficiency for a piece of equipment included weighing original equipment purchase costs with operating costs, divided by predicted usage.

“When the recession hit, contractors who owned equipment were finding that, besides the purchase cost of the equipment, when they considered the additional costs associated with owning, they had to ask themselves if ownership was really affordable,” McClelland says. “All of a sudden, some of that efficiency equation changed. Rental as a primary channel for acquisition is making more sense.”

Settlemayer says contractors and fleet managers are now looking past the equipment’s initial acquisition cost and analyzing how they will manage the equipment’s support and operating expenses such as maintenance, repairs, inspections and environmental compliance, and even storage. Besides the base cost of a yard, storage expenses can include security systems, structures, taxes, insurance, area maintenance, yard employees, and associated administrative overhead. Rental, on the other hand, eliminates the contractor’s storage responsibilities and passes on just a fraction of storage expenses to the contractor in the overall rental rates. The costs don’t disappear, but because they are bundled and shared by other renters, they are vastly more affordable.

When budgets are tight, affordability is easier to measure in fixed costs instead of indeterminate add-ons, another reason rental is popular in the current recovery economy. Whereas ownership costs escalate over the life of the machine and add to operating costs, rental equipment has a fixed, predetermined rate for the length of the contract that includes scheduled and unforeseen expenditures. Fixed rates give the contractor greater financial flexibility because a large part of the equipment’s operating costs are settled and locked in when the contract begins. Surprises are rarely affordable.

The costs of keeping current with environmental compliance mandates are also fueling equipment rental. As more states and local governments add clean diesel mandates to their bid contracts, contractors must use EPA-compliant equipment if they want to compete for jobs. Managing compliance not only strains capital equipment budgets, but it also increases back-office record keeping. David Schmid, president of ECCO Equipment in Santa Ana, Calif., says that keeping equipment up to date and in compliance with EPA and other agency regulations is time-consuming and expensive. For example, as of March 1, 2012, the California Air Resources Board (CARB) requires equipment owners to:

  • submit annual initial reporting forms for each off-road vehicle,
  • document subfleets and multiple fleets details,
  • account for vehicles with two or more engines,
  • complete responsible official affirmation reports,
  • verify and correct duplicate serial numbers,
  • submit hour meter reading logs for low-use vehicles,
  • present written idling policies,
  • provide retired or sold vehicle documentation,
  • list old vehicles used for parts,
  • provide proof of retrofit devices verification, and
  • pay for and file various permits, certifications, exemptions and registrations.

That’s for one state. For one year. For each piece of equipment.

Although environmental regulations are not necessarily designed to generate income, policy makers are not blind to the revenue-producing opportunities and will probably continue to add directives in the future.

Instead, contractors are relying on their rental house to handle the paperwork and are finding that besides freeing them from administrative tasks, the detailed rental reports for each machine help track usage and figure customer costs.

“Depending on the number of machines in the fleet and the areas in which they will be operating, breaking out compliance expenses on a per-machine basis to recover costs can be an administrative nightmare,” Schmid says. “Rental companies are better prepared to track each machine’s compliance fees and maintenance schedules. There is no premium on our rental rates that reflects compliance costs because our company has always had a green culture. When a contractor is renting one of our pieces of equipment, he can be sure that the machine meets environmental and site regulations.”

The subset of expenses that make up scheduled maintenance and repairs is also part of the equipment’s rental rate and is far less than what each service would cost individually. Warranty-mandated maintenance tasks on rental equipment are performed using manufacturer-approved products and to the maker’s specifications by trained technicians. This is especially important for newer equipment with Tier 4 engines.

“These aren’t your father’s machines anymore,” ARA’s McClelland says. “The new technologies incorporated into EPA-compliant vehicles require new diagnostic equipment and diesel technicians trained to work on the new engines.” This means rental equipment from a reputable rental company is ready to work at the capacity the manufacturer intended. Contractors who rent also don’t have to tie up cash for inventory and storage of consumables such as filters, batteries and tires. Nor does the contractor have to oversee hazardous materials disposal and ground contamination issues, or carry overhead costs for a large maintenance facility and staff.

Productive uptime, service and reliability are what contractors really buy when they rent equipment. Agoos says equipment rental companies’ fleets are usually within the two most recent model series, and they replace or auction aging equipment. Additionally, rental companies put an average of only 800 hours on each machine annually. Low hours combined with high-quality maintenance scheduling are a good predictor of onsite reliability. By comparison, equipment-owning contractors average around 1,500 hours annually and tend to keep their equipment longer. Although a paid-for machine may eliminate the stress of a monthly loan payment, equipment that is run longer hours for more years becomes less reliable and creates greater stress with increased maintenance costs, more breakdowns requiring transport and shop time, and more money lost to downtime.

Large rental firms with multiple locations will write contracts that promise fast field service and replacement equipment anywhere in their operating region. This is an advantage for contractors doing work in several different areas because equipment can be repaired or delivered from the nearest rental location. A rental contract with a quickly delivered, onsite equipment repair or replacement agreement will keep a project on track.

Rental equipment can also save money by giving the contractor the opportunity to test the latest technology in real work applications, and to gauge actual usage and productivity, before making a purchasing decision, Agoos says. Discovering that a machine offers too much power and increases fuel costs, or isn’t matched to work well with existing units in the fleet, or just won’t suit specific applications, is much less expensive when found before the machine drives off the lot.

Rental equipment is the norm for contractors in Europe, where approximately 70 percent of all equipment used is rented. The reasons that make renting the preferred acquisition track there—more smaller and shorter-duration projects due in part to a mature infrastructure and economic instability—are becoming a fact of life in the United States. Perhaps the advantages of renting equipment during the economic recovery will convince stateside contractors that rental can be the new norm for America, too.

Rental is also a strategy to rebuild fleets. Contractors who offloaded equipment during the downturn and haven’t recovered their purchasing power are finding rental companies are open to negotiation. Randy Coffey, general manager of rentals for Kirby-Smith Machinery headquartered in Oklahoma City, says he is seeing more rental customers who are negotiating future purchasing agreements as part of their rental contract.

“Primarily, we do rent-to-rent,” Coffey says, “but if a customer tells me he’s got six months of work for an excavator but won’t know if he’ll have more work for that machine until the end of the initial six months, we can offer him a rent-to-own contract.” Kirby-Smith will write into the contract the buy option that spells out terms that begin the first day of rental. As long as the account is in good standing during the rental portion of the contract, the contractor knows exactly what his purchase terms are if he should decide to buy the equipment later. Unlike a lease that commits the contractor to a specific contract length, Kirby-Smith treats the agreement as a rental. If the contractor finds there is not enough work to justify the purchase, he simply turns in the machine. Coffey says he has customers who are building up their fleets by combining short-term rent-to-rent and longer-term rent-to buy options.