Equipment Type

Why Managers are Running the Rental Option

Fleet quarterbacks are watching costs, capital and schedules and calling audibles in the acquisition game; it’s not all about Tier 4 performance or maintenance concerns

December 20, 2013

It is being talked about and it’s in the statistics: Equipment rental is up, and fleets are making rental a larger part of their overall acquisition strategies.

Seventh in a series, this installment of The Management Challenge examines the increasing use of rental as an acquisition option. Others in the series:

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

The reasons and advantages vary depending on who’s talking, with capital preservation, cash flow and scheduling playing a large part, as well as uncertainty over an economy that still struggles to maintain traction. Tier 4 is a factor, but to a lesser extent than you might think.

The American Rental Association forecast that 2013 would see rental revenue reach $38 billion for North America, a 6.2 percent increase over 2012. Looking forward, its Rental Market Monitor’s North American Economic Analysis (provided by IHS Global Insight) projects revenue growth to accelerate for two more years before leveling off in 2016 and 2017.

Removing the tents, tables and party favors, and examining equipment, the general tool segment will show the highest compound annual growth rate (CAGR) at 10.1 percent over a five-year forecast, while revenue for the construction and industrial equipment segments is projected to see a CAGR of 7.8 percent between 2013 and 2017.

The construction and industrial segment is forecast to grow 9.1 percent in 2014 and 10.5 percent in 2015. In all, total U.S. equipment rental revenue is expected to grow at a CAGR of 8.6 percent between 2013 and 2017, exceeding pre-recession totals in 2015 and reaching $46.3 billion in 2017.

When was the last time you heard anything even remotely related to the construction industry reaching “pre-recession” levels?

These numbers haven’t escaped the attention of the equipment dealers you work with, as dealers’ investments in rental fleets are up, too.

“What we’re seeing is that a large portion of the data that reports where machines go does show up as dealer-owned rental fleet as opposed to independent rental companies,” says Joe Mastanduno, rental accounts manager for John Deere Construction & Forestry. “There is an opportunity there for dealers; it gets customers to come in and try machines. On the big equipment, that’s been successful for several of our dealers located in pipeline areas.”

Mastanduno says that current pipeline work is driving a lot of rental activity, and future fracking will drive even more. “For companies in remote areas like North Dakota or Montana, it’s much easier to get equipment on the ground by renting equipment. And fracking is everywhere. What hasn’t already been tapped is going to be the next location people move to. Just about every state has some fracking potential. It just so happens that a lot of those areas that were first were in remote areas where customers may not have had fleet before, so renting was a great way to get people on the ground quicker,” Mastanduno says.

Another school of thought attributes the uptick in rental to costs and cash flow.

“Dealers are now in the rental business and will continue to be in the rental business if they hope to maintain their customer base,” says Garry Bartecki, staff VP of Finance for the Association of Equipment Dealers, in a recent Construction Equipment Distribution column. “Contractors are not buying and probably won’t buy as much going forward now that they have figured out how much it costs to own equipment.”

Cash is precious

“I really think we are in for a major shift toward the lease/rental options to preserve capital,” says Bob Merritt, CEM, director of equipment, Energy and Construction, at URS. “I see this as a big move in our work going forward.”

With margins still not reaching pre-recession (there’s that term again) levels, and equipment costs rising as OEMs factor increases in health care (labor) costs and Tier 4 technology costs into the price of new iron, it will take more and more to make owning new equipment “pay.”

“As much as we’d like to own everything that we would run, it just doesn’t make economic sense,” says Warren Schmidt, CEM, corporate equipment manager for Flatiron.

“If I rent a piece for three or six months, then at the end of six months, I send it back and can move on—I’m not paying the ownership costs for that piece of equipment, or trying to sell it,” Schmidt says.

Flatiron currently has 1,100 pieces of equipment, ranging from air compressors to barge cranes, with the largest “dirt” equipment being off-highway rock trucks and big excavators. The company’s involved in heavy infrastructure with an emphasis on bridges, but also works in road building, concrete paving, and utilities.

“We’ve got operations in New York, the Carolinas, Colorado, California, Washington State and three provinces up in Canada,” Schmidt says. “We’ve always rented a lot of equipment here at Flatiron just because of our needs and how spread out we are.”

In addition to costs and the geographic stretch of operations, scheduling plays a major part.

“I may need 20 excavators on a job, but I may only need them there for three months,” Schmidt says. “Then I’ll be back down to two or three. So it doesn’t make sense to buy 20 excavators if I can get by with three in my fleet. If there’s an issue with scheduling, or you don’t have good schedules, the rental market is a quick fix. We’d rather own the stuff, but if somebody blows their schedule and says ‘I need this loader or excavator,’ and it wasn’t really in the long-term plan, then you could maybe do a rent-to-own option at some point to take it over. It’s a stop-gap measure if nothing else.”

According to Schmidt, Flatiron rents “equally as much as we charge ourselves in internal rent.”

Other factors, Tier 4 hesitations

A somewhat fragile economy is still giving many contractors pause in making purchases and leading to more rentals, as is the broken record that is highway bill uncertainty. Current funding expires again in September, and after a series of short-term extensions that were largely Band-Aids, the current atmosphere of intense partisanship doesn’t bode well for a long-term deal and the stability contractors would like.

“Because we’re more of a support mechanism to Operations, it’s something we kind of keep an eye on but it’s at a second-tier level for us,” Schmidt says. “Obviously they’d [Operations] still have to bid the work and get it before it becomes pertinent to what we want to do.

“It’s kind of like in California, where you heard three years ago it was going broke, but we were still bidding work and getting it, and they pay their bills there,” he says. “Until they stop paying, we’ll keep bidding. So from the equipment side, it’s something to watch, but more so if you have a materials operation and you’re a supplier versus a builder.”

Mastanduno says that a longer-term highway bill would boost ownership rather than rental, but cautions that “long term” must be clearly defined.

“If it was a long-term highway bill, five-plus years, then people would say they’re going to get work more long term and they would shift toward buying the equipment, or at least a long-term lease,” he says. “But if it’s a short-term bill, supplemental funding for two years or less, that leads people to say ‘Why would I buy equipment? I’ll just rent or lease for now.’” Mastanduno adds that an infrastructure bill would benefit not just highways, but also pipeline work. “Those are the two things that Deere watches very closely as the two big opportunities.”

The rental decision is also being driven by certain types of equipment, as it always has. “There’s so much miscellaneous stuff that we rent that we wouldn’t want to own anyway, like rammers or trench rollers,” Schmidt says.

“I’d almost rather rent that equipment—it’s self-destructive, it’s hard to track, and it’s kind of a maintenance headache,” he continues. “By renting it through a rental company, if we have a problem, we can basically get it replaced. That’s another advantange; with a rental, if you have a machine go down and they can’t fix it in an hour or so, they’ll replace it. I don’t have that kind of backup in the fleet, typically. You’re paying for that, there’s no doubt, but by the same token it’s a convenience factor.”

Schmidt also described his timeline between renting and owning.“We’ve got a couple jobs coming up that are one-year-long jobs, so if it’s not something like a loader or a screwdriver that you’re going to use all the time, chances are I’m going to rent it for the year rather than go out and buy something.”

The longest he likes to go on a rental is one year. “I would like to keep it to that; if I go longer than that we have to take a hard look at it and try to make it work where we could own it,” Schmidt says.

In 2013, Construction Equipment’s exclusive research revealed that 22 percent of fleets are not going to buy Tier 4 machines, but will rent them instead. Respondents cited performance and maintenance concerns with new systems, many requiring a new fluid (DEF) and new components under the hood.

Of course, manufacturers will tell you they’re sure Tier 4 will not be a problem, meaning there’s at least a little bit of a disconnect. It could be a hangover from on-highway experiences, according to Mastanduno.

“When we first started talking about Tier 4, back in 2007, three or four years ahead of time, people were just experiencing the on-highway equipment and there were some issues when the technology came out,” Mastanduno says. “And when it was said we’re going to have the same technology in off-highway, people said, ‘Whoa, I’m probably not going to have a good experience with it, either.’”

Tier 4 has not entered into Flatiron’s fleet decisions, because the company’s been proactive in the past and its average fleet age is relatively young.

“It’s not currently a factor, because our fleet in California is compliant through 2018, and obviously the people who rent to us in California know about the requirements and they’re all providing Tier 4-Interim or Tier 4-Final as needed to make their fleets compliant,” Schmidt says.

 Schmidt thinks companies are not so much avoiding Tier 4 because of worries about the technology or maintenance as they are avoiding it until they have no choice. Indeed, “whistling past the graveyard” may play a part.

“I think a lot of people aren’t buying newer equipment,” he says. “And it’s been the same story with the emissions thing for the last 10 years, where a lot of companies kind of look the other way, and they’re not worried about it until EPA regulations or local agencies mandate Tier 4.

“We’ve had to live with it in New York and California; having Tier 4 in our fleet has just been part of our way of life. We’ve been involved for a while, sometimes kicking and screaming, but we’ve had to do it,” Schmidt says. “We’ve had Tier 4 in our fleet as soon as the gear was available. We haven’t seen big issues with it.”

Smaller fleets and contractors, perhaps without multistate operations that include traditional hotbeds for emissions compliance such as California and New York, are wary. There are tighter tolerances for fluid performance, diesel fuel has to remain cleaner, and DEF has to be stored and dispensed properly for all the new hardware to work. And new components can be sensitive.

Construction Equipment recently saw an “engine de-rate” sensor light, which indicated an obstruction or irregularity in a piece of equipment’s DEF line, derail an entire day’s operation in the field.

But Flatiron’s Schmidt points out that equipment makers are responding to wariness.

“I don’t know of anybody that’s renting Tier 4 just to see what the bases are or what kind of experience they’re going to have,” Schmidt says. “Some OEMs, like Komatsu, are providing a lot of the maintenance on the new machines you buy anyway, for the first couple of years. So it makes it less risky, if you will.”

Before entering the rental game, Deere’s Mastanduno made his living readying dealers, rental houses and owners for Tier 4. He’s noticed over several years that rental companies have not so much been ramping up to offer Tier 4 due to user demand, but rather due to the economy.

“Late 2009, through 2010 and into 2011, when IT4 first came out, people didn’t expect the economy to come back as quickly, so it was really a catch-up there for the rental companies,” he says. “That seemed to be the biggest driver, catching up with market needs. The Tier 4 kind of took a back seat. In 2012, people were still catching up, and then in 2013, as the cost impact is much greater on smaller machines (as >75 horsepower was the target), people started paying attention a lot more.

“They had already ramped up for the economy, but more importantly, the cost impact of Tier 4 is much heavier as you go down in product to items like compressors, pumps and other compact equipment. I’ve heard as much as 50 to 100 percent, so almost a doubling in some cases,” Mastanduno says.

“That’s a large amount. So the rental companies and OEMs have been talking about these kinds of things, and it’s made a lot of movement take place among those products.”

And that may be just enough to cement a consistent rental decision for managers.

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