The Keys to Profitability

June 1, 2005
If everyone agreed on the key to profitability for an equipment rental company, there would be no failed start-ups, no Chapter 11 filings and no disappointments

If everyone agreed on the key to profitability for an equipment rental company, there would be no failed start-ups, no Chapter 11 filings and no disappointments in the rental business. Everyone would get it right the first time, never lose money and revel in profits. But that's fantasyland; we're dealing in reality.

RER recently conducted its second in a series of reader surveys, this time to determine how they define their profitability and how annual revenue is broken down by expense in their businesses. Industry consultants also offered their opinions about what it takes to be profitable and provided some guidelines to help rental businesses measure their progress.

How do you measure?

Readers were asked, of the following: time utilization, dollar utilization, return on sale of used equipment compared to original cost, or other, which is the most important measurement of profitability in your business. By a wide margin of 58.5 percent, respondents said dollar utilization. Trailing far behind with the second most common response was time utilization with 14.6 percent. Only 6.1 percent of respondents said return on sale of used equipment compared to original cost; 9.8 percent cited other; and 11 percent had no answer.

In a much closer race, visitors to a recent RER Web site poll responded similarly to the same question, but with a narrower gap between time and dollar utilization. There, respondents revealed the most important measurement of profitability is still dollar utilization, but by only 50 percent, while 36 percent of respondents found time utilization to be a better measure. Only 8 percent of respondents said return on the sale of used equipment compared to original cost, and 4 percent answered other.

Gary Stansberry, partner, in Arlington, Texas, and Cameron Park, Calif.-based consulting firm Hageman, Stansberry & Associates, cited dollar utilization as the most important measure of profitability of the choices given, but said that a more accurate answer would be EBITDA — Earnings Before Interest Taxes Depreciation and Amortization — because it gives everybody a level playing field.

“An all-encompassing measure, EBITDA takes into account revenues and expenses,” Stansberry explains. “The amount of debt a company has generates the amount of interest the company makes. EBITDA levels the playing field for all companies.”

Dan Kaplan, owner, Morristown, N.J.-based Daniel Kaplan Associates, believes that time utilization is truly the key measure of a rental business' profitability. As he explains it, “Time utilization is a determining factor in defining dollar utilization, but without strong time utilization, you don't have anything.

“Time utilization, on its own, doesn't tell you if you're profitable,” Kaplan says. “But time utilization is an important factor in how well a company does.”

Stay focused

As rental continues to grow and prosper, more and more rental companies are focusing on peripheral offerings, such as selling equipment, parts and accessories. RER's survey indicates that 28 percent earn 16 to 20 percent of their annual income from these offerings, while 15.9 percent earn less than 5 percent of annual revenue from the sale of these items. Overall, however, the survey shows that the majority of rental companies are relying on services other than rental in at least some capacity for a portion of annual earnings.

Not surprisingly, our survey showed that the majority of respondents earned most of their annual income from equipment rentals. A considerable 57.3 percent said that more than 75 percent of their annual revenue comes from rental, and 29.3 percent said 61 to 75 percent of revenue comes from rental.

In contrast, the survey reveals the exact opposite finding for equipment service performed as a measurement of annual revenue. Nearly 55 percent earn 5 percent or less from service offerings, while 29.3 percent earn between 6 to 10 percent of annual revenue from service.

In line with these findings, industry consultants recommend maintaining rental as your primary focus.

“If you look at the gross margin, the biggest profit maker is always going to be rental,” says Stansberry. “You've got to focus on offering rental and then generate a complementary revenue stream by having point-of-sale merchandise in your store as well as service. Seventy percent or greater needs to be generated from rental, which includes ancillary charges such as damage waivers, environmental, and pick-up and delivery.”

Fred Dupy, owner of A to Z Rental, American Party Rental, American Rental North and American Rental South, all in the Austin, Texas, metropolitan area, also calls rental a key component of profitability and equates the balance of offerings by his business to a three-legged stool. “In most areas we do two legs really well, but the third leg not so well,” Dupy says. “I don't think you can achieve a perfect balance.”

Circumstances may strengthen your business in areas you don't expect. Dupy, for example, considered parts and equipment sales an area of weakness for his businesses until the economic downturn caused rental to decline beginning three years ago. To make up for the income discrepancy from rental, Dupy began to focus more carefully on parts and equipment sales. And with the recent rebound of rental he has kept sales a paramount focus, strengthening the business as a result.

Lookin' good and runnin'

Equipment maintenance is another significant annual expense for rental businesses. The survey shows that 42.7 percent of respondents spend between 6 to 10 percent of revenue on annual equipment maintenance, 17.1 percent spend between 11 to 15 percent, and 12.2 percent spend 16 to 20 percent. On the low end of the spectrum, 11 percent spend 5 percent or less on annual equipment maintenance.

John Claflin, owner/general manager of Nokomis, Fla.-based Commercial Surroundings Rental, takes regular equipment maintenance very seriously and calls his company “service fanatics.” For example, if they have a generator out on rent for two weeks, they will send someone out at least once a week to check on it to ensure that it's running properly and to check fluids. For an extended rental they will swap out the units mid-way through the rental term to bring the first unit back for service. Claflin's philosophy is to catch the little things that need to be addressed with the equipment before they turn into big problems on the jobsite and cause a breakdown.

Claflin also spends his resources making sure that equipment goes out looking good, despite its age. “If you send something out on rent that looks like junk, then your customers are going to treat it like junk,” Claflin says. “But if you send something out with a fresh coat of paint that looks well maintained and new, then customers are going to treat it better.” Another benefit of this practice is that you can always be sure you sent the equipment out looking its best, so if it comes back looking otherwise you know the customer is at fault.

But the bottom line for Claflin is simple — staying on top of maintenance details to avoid major breakdowns that can really take a bite out of profits.

Rate rides

Rental rates across the United States are showing modest increases this year and respondents to our survey fell right in line, with the majority indicating they already had or were planning to raise rates in 2005. In total, 81.7 percent said they would increase rates in 2005, while only 18.3 percent said they would not. Of those who would increase, 47.6 percent were planning to do so by 2 to 5 percent; 20.7 percent planned to increase rates by more than 5 percent; and 13.4 percent said they would increase rates, but by less than 2 percent.

According to Kaplan, the average rate increase in 2004 was 8 percent. And with equipment demand exceeding supply in 2005, he recommends rental businesses raise their rates by 10 percent this year. Based on the amount of capital they invest, risks they incur and service they provide, 10 percent is a fair increase, he says. Kaplan estimates that rental rates can even be increased beyond 10 percent for companies that have their time utilization at the 65 to 73 percent level. For companies with time utilization between 65 to 72 percent, he says, rate increases of 8 to 10 percent are right on target. “Each rental company has to look at their own metrics to base their decision of how much to raise rates,” he concludes.

Stansberry, too, notes that rate increases are not a one-size-fits-all opportunity. He suggests targeting the dollar utilization for each type of equipment to determine the appropriate rate increase. Overall, however, he estimates increases between 5 and 7 percent to be about right.

Experienced rental operators know that the tug-of-war with rental rates is nothing new. Claflin's company delivers almost all of the equipment it rents, so to offset fuel cost increases he has raised the rate on each piece of his equipment by $3 to $5. “If we have 100 pieces of equipment out on rent in a day, then that's $300 extra, which will basically cover the fuel for that day,” Claflin says.

Dupy, a 21-year rental industry veteran, has a frequent acronym and adage he often uses in his business, which is WIP — “when it's possible.” It's a saying that goes along perfectly with the subject of rates. Though he says he'd like to raise rates by about 10 percent, he raises them incrementally when it's possible.

“In general, our pricing has not kept up with the cost of running our business,” Dupy admits. “We're not going to blanketly be able to raise rates.” Though he'd like to simply increase rental rates by 10 percent on January 2, each year and call it done, it just wouldn't be well accepted in his market.

“You have to be careful because you can price yourself right out of your niche markets if you're not careful,” Dupy says. And getting to know the niche markets in your area and the contractors and other customers associated with them can be an important key to a company's profitability.

Paying the bills

Maintaining the facility and equipment yard, and paying utilities is a significant expense for a rental business. Stansberry recommends budgeting about 5 percent of annual revenue to this area, unless you're located in a very expensive real estate market, then he suggests spending as much as 8 percent, but no more. Based on RER's profitability survey, it looks like many rental business owners are spending too much. In fact, only 29.3 percent of survey respondents are spending 5 percent or less in this area. The majority, 32.9 percent, is spending 6 to 10 percent; 17.1 percent of respondents spend 11 to 15 percent and an additional 14.6 percent spend more than 16 percent.

Including all of Dupy's four locations, spending on facilities and utilities is generally pretty high and priorities on what needs to be done to each facility changes year to year, but he recommends striving for excellence when it comes to the appearance of your store. Customers will notice and other recognition may come too. Dupy has won several Image Awards from the American Rental Association for the appearance of his four Texas locations. The awards are prominently displayed in Dupy's showrooms so that customers can see that the owners and employees take pride in the appearance of the business, and are often acknowledged by customers.

Along with facility and utility expenses, employee compensation and training are the biggest cash expenses for a rental business. A notable 32.9 percent of survey respondents said they spend 21 to 30 percent of annual revenue on employee compensation, benefits and training. Close behind the majority, 29.3 percent said they spend 11 to 20 percent in this area, while 9.8 percent said they spend less than 10 percent.

On the other end of the spectrum, 14.6 percent spend 31 to 40 percent on employees, while 6.1 percent spend 41 percent or more. Claflin estimates his employee compensation and benefits spending to be about 37 percent. His philosophy is to strive for longevity with employees. Of his 20 total employees, Claflin says 15 of them have been there for a year or more, and some employees have been with him for more than 10 years.

While Dupy's employee compensation and benefits estimates fall at the lower end of this range, he does offer his 30 employees a strong 401k plan and the best medical and dental plan they can provide. He also offers them the rental benefit, which allows them to use equipment for their own personal use, with the idea that the more they use it themselves, the more knowledgeable they will be when explaining its proper use to customers.

If the rental business is heavy on contractor customers Stansberry recommends spending about 25 percent of annual revenue on compensation and benefits, including salary, overtime, health insurance and payroll taxes. If the business is more concentrated on a homeowner base, then Stansberry recommends increasing that spending to as much as 30 percent.

Profitability is often compromised in this area when business slows down and some employees need to be let go. Companies often hold on to extra help longer than they should, Stansberry says.

Dupy admits that during the 2002-2004 economic downturn he needed to cut back on employees and didn't take action as soon as he should have. Instead, he says, they just let natural attrition do most of the work for them.

“Don't get emotional about the business,” Kaplan says. “Look at the numbers and let them tell you what you have to do.”

Safety first?

One area where rental companies aren't spending much money is safety training. A wide majority of respondents, 62.2 percent, said they spend less than 5 percent of annual revenue on safety training for employees and customers. Twenty-two percent said they spend between 6 and 10 percent in this area.

Neither Kaplan nor Stansberry were surprised by these findings. Training is an area that a rental operation just has to make time and money for. Stansberry often hears business owners offer the excuse that there just wasn't time for training. Many industry experts agree, however, that dedicating a specific time each week to spend an hour on training is better than none at all.

“This time is money well spent,” Stansberry says. “Take advantage of the classes your insurance company offers. Often just having the documentation in the files that you've done this training helps when it comes to lawsuits.”

Bigger, more sophisticated rental companies also have bigger budgets to alocate among areas like safety training, Kaplan explains. These large rental players, who usually have committed, full-time training employees on staff dedicated solely to safety training, are spending more than you think, he says. The independents just don't have the financial resources to do this.

Though Dupy takes advantage of training provided by his insurance company and manufacturers, he says it's still not doing enough and calls the topic a huge issue to the industry. “We don't adequately spend our resources in this area, and it is probably the one area that can get us hurt the quickest and the soonest,” he says. “I think owners fight that question [of training] off. I think it's the last issue looked at.”

As an example, Dupy recounts a recent busy weekend when most area high school and college graduations were taking place in Austin. The company, which had every table and chair in inventory out on rent, had a delivery truck broken down at one of its branches and the issue needed to be resolved immediately. “Day-to-day business [such as this incident] often precludes doing as much training as needs to be done,” explains Dupy.

Keeping a constant eye on your business' profitability is a good idea. Stansberry recommends tracking a handful of variables regularly and watching closely for upward or downward trends. In addition, constantly monitor past due accounts as well as payroll.

“Monitor payroll expense as a percentage of revenue every pay period,” Stansberry says. “Make sure it's in the 25 to 30 percent range. If you get out of whack for two or three pay periods then you have to take action to fix it. Maybe you've been paying too much overtime and it's time to hire another full-time employee.”

Kaplan advises rental businesses to manage the business analytically, and to continuously look at time and dollar utilization, as well as maintenance as a percentage of rental revenue.

Besides knowing your business and its everyday expenses inside and out, there are a few simple tips Dupy offers to other rental business owners. First, appreciate the staff you have. Second, appreciate the customer you've developed. Third, appreciate the day you've been given. And keep in mind that, “you're given opportunities every day that, if you use them correctly, will make you very profitable.”


The RER Profitability Survey was sent via e-mail to 3,835 subscribers. Of these, 1,464 bounced, leaving 2,371 valid invitations. Subscribers returned 102 valid responses for a response rate of 4.3 percent.