March 1, 2002
Time Utilization is Key RER: Many manufacturers that supply the rental industry have clearly struggled in 2001. Sales are down, production is down, profits

Time Utilization is Key

RER: Many manufacturers that supply the rental industry have clearly struggled in 2001. Sales are down, production is down, profits are down and layoffs are many. What kind of trends do you expect to see in 2002?

Veneris: Today, companies react so quickly to downturns in the economy that I believe the cycle of layoffs and cutbacks has probably already reached its peak. Soon vendors to the rental industry will be ramping up production as the economy bounces back.

What are the upcoming trends in rental software that will have an impact on the rental industry in the coming year or so?

For the tool industry, I believe there will be a major shift toward measuring equipment inventories using time utilization ratios versus more traditional return-on-investment metrics. Because labor costs are often a limiting factor for party/event businesses, I expect rental software to more accurately track labor costs to help party/event stores manage the labor aspect of their business and thereby increase profits.

Because competitive pressures will only grow stronger in the coming years, rental businesses will increasingly look to their software vendors for additional training to learn how to better use their management information systems to uncover crucial business information that will in turn lead them to focus on the aspects of their business that have the greatest potential to impact their bottom line.

Are Internet-based programs leading to more electronic commerce the dominant direction in the foreseeable future?

I have been surprised at how quickly the rental industry has adopted use of the Internet to handle many back office tasks such as ordering parts and doing their banking. On the other hand, the rental industry as a whole has been much more conservative in adopting Web-based rental transaction processing.

Up until this point, the primary e-commerce solution that has interested distributors and rental companies the most has been parts information and accessibility over the Internet.

What other areas might interest rental companies? The emergence of Web-based banking has revolutionized a business' ability to manage cash flow. Online banking tools will continue to have a positive impact on how businesses manage their cash.

In terms of operations systems for the rental industry, what areas seem most interesting and important to rental companies at the moment, i.e., inventory control, accounting, parts management, point-of-sale efficiency and service department management?

While there are some general commonalities in terms of the kinds of business problems rental stores are addressing through the use of management information systems, we find that each store has a unique set of problems that must be addressed. For one store, the focus may be tuning their rental inventory to better match actual demand. For another store, the focus may be on identifying core customer accounts and developing ways to strengthen key business relationships. The beauty of software systems is that they can be used to dissect any aspect of your business — to provide insight into why a problem is occurring or to uncover potential business that may have otherwise been overlooked.

The key to using your management information system successfully is education. Consistently, our most successful clients are those who avail themselves of every opportunity to learn more about how to use their computer system to be more profitable. We have also had great success in providing application consulting services to our clients. This service provides an objective evaluation of system usage and encourages the implementation of new software systems to address unique business problems and take advantage of potential opportunities to grow their business.

What kind of changes do you expect to see in relationships between rental companies, manufacturers and dealer/distributors over the coming years?

We are working with PartSmart, RentTrain, and other vendors serving the rental industry to integrate new functionality into our computer systems. This trend will continue as rental store owners demand that the applications they need to run their businesses work seamlessly together.

During the current economic downturn, what are the most important lessons rental companies should keep in mind to survive and prosper through this period?

During the past 25 years, I have observed that every time an economic downturn occurs, rental companies tend to react by cutting costs and freezing equipment purchases. I don't believe this is necessarily the most intelligent response. Instead, rental owners should take advantage of the lull in business activity to refocus their energies even more on analyzing their inventory mix so they can emerge from a downturn with an inventory better tuned to maximize on the eventual upswing in business.

Rental companies should also aggressively market their businesses during this time, since customer loyalties become more fluid during a downturn and a good marketing push could result in a gain in market share.

How should rental companies maximize their computer software to improve performance, especially during this period?

Rental stores should learn more about how their rental software can maximize efficiencies during this period. For instance, if a store hasn't had a chance to learn how to use a more advanced feature such as setting up preventive maintenance schedules or multi-tiered pricing for resale items, they should implement these additional modules now. But even more importantly, rental stores should use the time to analyze the virtual gold mine of data stored in their computer systems to identify business opportunities for cutting costs and increasing revenues.

What types of rental companies do you predict are most likely to grow in the coming years?

You don't have to be big to be successful in the rental industry. Rental companies — large and small — that strive to continually improve the operation of their business, versus those who are hanging on with a “business-as-usual” attitude, will be the winners. Adapt or die is the rule of business in the 21st century, and this rule certainly applies to those doing business in the rental industry.

We know that national chains are adapting. Smaller, independent stores need to embrace this ethic or become marginalized. These adaptations aren't secret — they include providing newer equipment, closely matching inventory to demand, designing physical environments that are welcoming to customers, reaching out to customers in proactive, innovative ways, and consistently promoting their business. Every rental business with a will to compete can accomplish these objectives and be successful.

The Supply-Demand Equation Is Out of Balance

RER: What is your prognosis of the overall economy in 2002 and how do you expect it to impact the rental industry?

Shaughnessy: We think that 2002 will be, “steady as she goes” for the rental industry. While the national economy is either in, or tending towards, recession, our experience of earlier troughs in the business cycle is that rentals remain relatively strong, albeit without the top line growth that we see during the boom years. And while we expect to see the typical shifts from ownership to rental that have characterized similar down cycles, there is a different twist this time.

One of the consequences of the consolidation process is that in some markets supply grew faster than demand over the past two years. This will have an impact in several areas. The first is that pricing is likely to remain flat. The second is that the surfeit of used equipment will counteract the impulse of some owners to rent. Last but not least, we will see some companies exiting some overcrowded markets.

Assuming a fairly weak economy in 2002, what positives do you see from it and what will be your management strategy for staying profitable?

By definition, we will be focusing less on the top line and more on the bottom. We are developing our internal information systems to give managers metrics on all aspects of the performance of business units, asset management, and individual performance. We will focus on developing our employee skill base and on eliminating waste from our operations. Our first priority will be, as always, to focus on our customers and their needs. By delivering them what they need, with service that exceeds their expectations, we can minimize the impact that the “low price” suppliers have upon market dynamics.

Have TEA-21-related highway projects slowed down this past year or in recent months because of the economic slowdown and how has your traffic-safety division been affected by this economic downturn? What is your prognosis for 2002 in this area?

Overall, our traffic safety business performed close to plan in 2001. In some markets, we have walked away from work, particularly in the contracting area, because we were not prepared to work at unprofitable rates. In general, one of the strengths of this business is that the revenue streams are more predictable than they are in other areas because of the Federal Highway program.

Has the character of the current downturn been in any way different than what you expected? Some economists have characterized it as less regional and more across-the-board than past recessions. Would you agree and if so, what affect has it had on NES?

The current economic climate is not significantly different from what we forecast in the fourth quarter of 2000. While it is true that this trough is more broad-based than more recent downturns, it has certainly hit some markets harder than others. Assessing what is really going on is complicated by the fact the rental supply-demand equation is out of balance in some areas that have not been impacted as badly as others have been in terms of construction spending, job losses and manufacturing closures.

What will be NES' acquisition strategy in 2002, considering that it will be possible, presumably, to acquire companies at much lower multiples than it was a few years ago?

In general terms we are focusing on our existing operations and where we add new operations in 2002, they will be internal start-ups. If strategic acquisition opportunities should arise, we will always consider them, but it is not our priority.

How do you see the capital markets over the next couple of years? Will it be significantly more difficult to obtain capital? How about for smaller local or regional rental companies?

It is always more difficult to obtain capital when there is economic uncertainty, but we do not anticipate that lack of capital will impact our plans. From my own past experience, it will not be difficult for established small rental company owners with good balance sheets and business plans to find capital, regardless of the state of the economy. It will be more difficult for newer companies to expand or open new operations.

Will you be inclined in the coming year to continue to age your fleets, making fewer capital expenditures than in the past? And how will the rebuild facilities in Kentucky and Pennsylvania figure in NES' strategy?

We have never believed that there is any great economic or operational benefit in having a young fleet. Most of the claims made by those who used young fleet age as a positive were bogus. We were all expanding so rapidly from 1998 to 2000 that, by definition, our fleets were getting younger. By investing in our Kentucky and Pennsylvania Rebuild Centers, we have demonstrated our commitment to a strategy that assumes that our rental assets have an economic life that is greater than conventional “wisdom” might suggest.

Do you expect to see increased manufacturer consolidation over the next year? What about dealer consolidation and rental consolidation?

Manufacturer consolidation will almost certainly increase. Dealer consolidation is almost an oxymoron since the rental consolidation process has changed forever the old manufacturer-dealer structures for most equipment other than heavy equipment. Rental consolidation will not pick up pace this year.

What kind of expectations are you seeing in your customer base?

Customer perspectives are all across the board depending upon industry and region. Contractors are probably the most skittish, as backlogs, even in stronger markets have dwindled or even disappeared.

Sole Focus

RER: What are your expectations for the U.S. economy in 2002?

Fielding: The questions facing the U.S. at the moment are those that accompany any recession: how deep will it decline, what will be its duration, and how powerful a recovery can we expect? There have been many conflicting signals of economic change, which may be why no clear consensus currently exists among professional economists. For our part we prepare for the worst, hope for the best, and leave the guessing to the ‘experts.’

What are the keys to being successful in running a rental business during an economic downturn?

Cost reduction and revenue maintenance — easy to say, harder to achieve. Cash is king in times of business uncertainty. No business ever went bankrupt by being cash generative. This means tightening the lid on labor levels and other costs to achieve immediate savings. An ongoing strategic focus of any rental business should be to strive for diversification of its customer base as a means of stabilizing income levels year-over-year. If you wait for an economic downturn to address this aspect of the business, you've lost a lot of valuable ground.

What do you see as the main differences between the rental business [of the moment] in the United States and that in Europe, particularly the U.K.?

The U.K. economy is not officially in recession at this time, and although the events of September 11th had an impact, we have not experienced that same sense of entering ‘a new and more dangerous era’ that has swept America to date. Great Britain has had to acclimate itself to terrorism over a long period of time. There is some fear that recession cannot be avoided, but the overall business climate — including that of the rental industry — remains much more vigorous than in the U.S. The British construction market is deemed to be quite strong, and this is giving rental businesses cause for optimism.

What aspects of the HSS approach are likely to contribute to your success as a foreign owner operating in America?

The rental business isn't merely a core competency for HSS, it has been our company's sole focus for more than 40 years. We operate in 11 countries, and our experience has been that every new venue has strong contributions to make to our business fabric. In the U.S. we are trying to run the business in the same disciplined way that we operate in the UK, but with the full American seasoning added. There are some who point to the American market as being a graveyard for the hopes of overseas firms in any number of industries. All we can do is remain a learning business, set the bar high and strive as hard as we know how.

Do you expect to see an acceleration in the consolidation trend among manufacturers in the coming year or two and, if so, what impact will this trend have on the rental business?

The industry can expect to see suppliers consolidate at an equal or greater pace going forward. Other things being equal, the medium-term result should be that suppliers will gain in power vis-à-vis their customers and those rental businesses that have not become vertically integrated. But there is a long way to go before this becomes a really hot issue in the rental industry.

Vertical integrators have their own issues to consider, like the natural reluctance of some rental companies to buy product from a competitor. There are other risks as well: as the market becomes tougher, an integrator may start to see the manufacturing margin and the rental margin merge into one. It is likely that either the manufacturing arm or the rental arm will start to chafe at their lack of freedom and resent their status in the relationship. These animosities take a little time to develop — but they do!

How will the inauguration of the euro affect the economy in Europe and the U.K., and how will the rental industry be impacted? How will construction equipment manufacturers be affected? How will contractors be affected?

The U.K. has chosen to place itself outside the euro-zone, and this will likely hold true for some time. As for the dynamics of the euro's introduction into a mix of European economies, there has been plenty of contradictory speculation but no history, so we must wait for time to tell. In any case I would expect its impact to be slight on a service industry like the rental industry where competition is almost exclusively local, as compared to a manufacturing industry, for example.

A New Source of Distribution

RER: In this past year, national rental companies have dramatically reduced capital expenditures on equipment and are aging their fleets. Smaller rental companies have also reduced expenditures. How have these developments affected the used equipment market as a whole and the auction market in particular?

Prevost: Ritchie Bros. sells tens of millions of dollars worth of equipment for rental companies, but our overall sales total almost $1.3 billion annually. I don't mean to minimize its importance, but it's a small part of our overall business. The total used equipment market is not as affected by rental companies as you might think.

Aerial equipment sales have a big impact, however, because it is rental companies that primarily buy and sell aerial equipment. Rental companies are not selling as much used as in the past, but they're not buying as much new, so I guess it kind of balances out.

We are receiving a lot of trade-ins of all types of equipment from rental companies that come to us via manufacturers. Rental companies trade equipment back to the manufacturer, so we see more business from rental equipment trade-ins. When manufacturers see the job we do selling the trade-ins, they become more interested in what we can do to sell their new equipment. So in that sense, the rental channel opens other eyes and they see that we are a new source of distribution for unused equipment as well.

We sell millions of dollars of brand new equipment, direct from manufacturers. Some have discontinued models and are selling off that stock, or they have extra because dealers didn't place the orders they thought they'd place because of the economic situation. Some companies use us to sell new equipment straight out of their factories to our end-user buyers, who pay more than dealers, who of course get special discounts. Recently we've also seen a strengthening of pricing in many areas for late model equipment with minimal use.

How was business in 2001 for Ritchie Bros?

Very good. We ran out of catalogs at some of our auctions because there were so many people. Our auctions keep getting more equipment because dealers, and standard dealer outlets, are not getting as much play at their sites. They have paired down inventory so more large buyers are attending our auctions where they have a lot of choices.

What trends do you see in the rental industry currently?

Rental companies are extending the life of their fleet. Many of the large rental companies are extending their fleet life, looking to buy less than they bought last year, and even if they increased spending it wouldn't come close to what they bought two years ago. Then we have some companies being de-listed, and some filing for Chapter 11 protection and all of this causes a ripple effect. Investors and bondholders will look more closely at other rental companies, requiring better management and fleet management policies, so we'll see a tightening of the rental market. We'll see continued low rental rates because the market is so competitive and I expect rates will remain low for a while.

The manufacturing sector has certainly had its problems.

I expect we'll see more consolidation in the manufacturing sector. Look at Terex, increasing earnings by buying other companies, recently buying two German companies. So they're growing by acquisition, we saw that in the rental industry. Hopefully what manufacturers are buying will be strong enough to add to their revenue streams. Second and third tier manufacturers are the hardest hit right now, they've been hurt by the economic downturn, and hurt by not being chosen by national rental companies as preferred vendors. They are talking to each other and we'll see more alliances. I expect to see more private label branding where some manufacturers may not necessarily buy others, but will enter into agreements where one manufacturer will build for another and put the other manufacturer's name on the product, forming alliances if not outright purchases.

We may see some second and third tier manufacturers filing for protection from creditors. Who knows if they'll come out of it? I don't mean to paint a gloomy picture, but we're in a state of change that has not yet stabilized.

How do you expect most companies to react to the recession?

I expect we'll see a lot of cost cutting. We're already seeing it, it started about a year and half ago and it hasn't gotten better. I don't foresee it getting better in the next eight to 10 months. I see cost-cutting continuing on. It has to; the economy dictates it.

If you take all the business conducted in North America, equate that to 100 percent, all it takes is a 1 to 2 percent drop and it has an enormous ripple effect.

The past seven to nine years, it has been 1 to 2 percent on the up side, and everybody was laughing on the way to the bank. So right now the 1 to 2 percent drops are making major ripples in the system and cost cutting will continue. Companies whose houses are in order will weather the storms. Those that are over-leveraged, over-stocked with over-inflated inventories, and juggling books to stay profitable will have a very difficult time. This recession will be with us for a while. If companies have good business practices, chances are they will survive just fine.

Might this cost cutting go to extremes that will hurt customer service?

Service is king and knowing how much you can cut without hurting service is a balancing act that companies will have to work with. Some may not be able to balance correctly. If they can't balance it well, they will certainly hurt their business and customers will go where they can get the service they need.