The Customer Takes the Wheel

March 1, 1999
At January's Associated Equipment Distributors convention in San Diego, the increased importance of rentals to traditional equipment distributors was

At January's Associated Equipment Distributors convention in San Diego, the increased importance of rentals to traditional equipment distributors was demonstrated by the theme of its opening business session - Consolidation in the Rental Industry. The panel, chaired by Mike Marks of the Indian River Consulting Group, included the following:

* Fred Whaley, vice president of corporate development, NationsRent, Fort Lauderdale, Fla.

* Rich Knopke, regional operations manager, Hertz Contractors Supply, Kansas City, Mo.

* Jim McCullough, vice president of construction equipment sales for Case Corp., Racine, Wis.

* Charlie Leis, president of Bramco, parent of Brandeis Machinery & Supply, Louisville, Ky.

The participants discussed questions posed by Marks as well as from the audience. Here are some excerpts from their discussion:

Marks: The rental industry has a structural growth rate that is higher than the traditional distribution business. This is the beginning of what most people would look at academically as the creation of a new channel. Part of this is the shift in power of the old traditional model of manufacturers controlling distributors down through to a movement of power to the customer base. A lot has to do with the flexibility of capital. I've had contractors say to me, "Why should I buy something if I can get [rental companies] to carry all the load and just get the equipment when I need it."

We're looking at, in a lot of cases, hard numbers of 20 percent growth. Even taking it down to 15 percent, we're looking at huge numbers. This is more than a blip on a radar screen. We're looking at growth rates comparable to the semi-conductor industry.

Knopke: I've been in the business for 33 years. My brothers and I sold our business in August 1998. If we look at the biggest changes in the industry, on the rental side in particular, it really is a new channel. Up until about 10 years ago, the manufacturers had all the influence; now, clearly, the customer does.

The customer has a big appetite. But he's not demanding a lot - he wants a good piece of equipment that he can buy or rent, he wants it to work, he wants it on time and he wants a good price. But he's become ever more demanding and will continue to be that way, in my judgment.

I think the customer is getting the best value he's ever gotten for the products. For distribution, the question is, it is AED? Is it ARA? What's it going to be? It's blurring, there's almost no difference any more. It's clearly the customer [who is in control].

Marks: There is a sense that the power has been shifting. Is this a good thing, a bad thing? Is it just starting, is it over? Where is the power in the channel going, and do you really believe the customer is right?

McCullough: The customer is driving what's going on, although I'm not sure that the customer wasn't always driving what's going on. North America now has a lot more competition - that customer has many choices - and people are going to have to earn the customer's business. It's not going to come automatically; it's not going to come necessarily as brand power as maybe it once did. It's going to come from those companies, and those distributors or channels, that best provide the most amount of value back to the customer.

Leis: The customer has always been in control, but the rental industry itself really experienced significant growth through the '80s and early '90s because traditional equipment distributors were not tending to customer needs. Large national organizations want one source to go to, and with the lack of savings that occurred and lack of capital throughout the '60s and '70s, [rental] became a form of financing your business. The rental companies stepped in to do that, whereas traditional distribution did not.

Knopke: The customer is going to be more demanding. One of the major issues is that the way they come to market has changed. The customer is doing things quicker than ever before, whether it's because of the cell phone, the fax, the computer, whatever. There are more demands on the customer from his client. The customer is going to seek out the best value, and I don't think we've seen anything yet.

Contractors have to do that to be more competitive in the industries that they serve. There is no doubt that finance sources have driven a need for more liquidity and less assets on the balance sheet. All of us are going to have to provide a variety of solutions to satisfy that customer, and if you can't, you'll be eliminated.

Audience question: How will companies adjust if there's an economic downturn, and why did Leis and Knopke sell their rental companies if the market was, in fact, expanding so strongly?

Leis: We chose to stay with the traditional distribution business instead of the rental center. We could have done the reverse, but our particular market area is fairly sparsely populated, but there is a lot of mineral extraction and that type of business. Brandeis Machinery has been successful in that market for 90 years.

Knopke: We were concerned about our ability to satisfy the customers' appetite, and also the risk involved if he loses his appetite. The dollars that we have to invest are so great that we didn't feel the returns were commensurate with that. In the marketplace, margins had come down, but the value of the business had gone up. And it was a good time to take a look at that adjustment.

From the standpoint of what we're going to do now to manage our company, we're going to have to do a lot of work on utilization of the equipment, anticipating what's going to happen. And I think we're going to have to get a lot of cash. The value of the equipment will come down quite a bit when the blip hits.

Whaley: The research that we did on the recessionary period in the '80s and early '90s [showed that] the growth in the rental segment was about 20 percent for that period, [which was] greater than it was in other times. We did an extensive study of Japan, which has had a very recessionary period for the last six years, and rental had some gains in market share during that period. I do think that, like all businesses and all opportunities, we're going to make sure that we do things to shore up our business during a recessionary period.

One of the differences between the rental companies and pure distributors [is that], if [distributors] get equipment and sell it and turn it over and it goes off the balance sheet, you grow your business by incremental increase to the balance sheet. Where in the rental industry, as many people have learned, it's a very capital-intensive business - you buy the piece of equipment, you're going to own it for three or four years, you got to find a way to pay for that every single day. If it doesn't turn over, when you grow your business, you got another piece of equipment there and the balance sheet grows quite large. So the service and price of capital is one of the significant differences in the growth of the two businesses.

In a downturn, [rental] probably becomes the more risky part of the two businesses. But we did see growth, in both the Japanese situations and in the downturns of the late '80s and early '90s.

Audience question: The customers have driven the trend toward rental and consolidation has been driven as much by Wall Street and the capital markets as anything else. Wall Street has a very short attention span. >From Fred Whaley's perspective, how long will Wall Street look at this trend favorably?

Whaley: I agree with your comment about Wall Street; they seem to have a sheep's mentality. They'll run off a cliff together and they'll all try to climb back up together. If you are a public company dealing in the public market place, you have to take opportunities to utilize the capital that is available and you have to slow down your growth when it's not available. Currently capital is available, so consolidation will continuesomewhat. But it is a skittish market.

Although Wall Street has many things about it to keep you up at night, it does provide capital at the right time that allows you to grow your business. It's what the American capitalist system is built out of. With all the people pouring money into 401(k)'s and into all the investment funds that are available today, the system is feeding itself. And as long as we all continue to believe the system is working, it will continue to work and we'll have good growth in the future.

Marks: What is the traditional full-service dealer going to look like in a couple of years?

McCullough: I believe most of the entrepreneurs are going to understand that it's probably going to cost more to be in the business, the capital levels will change and you're going to have to find ways to service the needs of the customer. If the customer says, I don't want to be buying equipment, then somebody's got to carry the asset. Perhaps manufacturers and dealers will arrive at some risk sharing and some reward sharing that way. I'm not sure we have a clear picture of how that all works at the moment, but if you're going to keep the customer and you're going to compete, you're going to have to service all the elements of the demands that are out there.

Leis: I think new discussions will take place among traditional distributors [on questions such as] the value of territory. It's being attacked everywhere from the Internet to rental companies where manufacturers have used them as alternative channels of distribution. In four or five years, the traditional distributor is going to be looking at softer things like maintenance contracts and rebuilding machines. I think residual values of machines will just plummet.

Marks: In closing, what should distributors be thinking about?

Knopke: We have to focus on that customer like a laser. We have to ensure we secure good people and that's becoming ever more difficult. We have to increase our intensity, our sense of urgency and our sense of speed.

Leis: You need to take the time to analyze the strengths of your company and where you think you can take the company.

McCullough: Two things - listen to the customer and, unless you're a fish, don't try to swim upstream.

Whaley: We think it's about relationships. We think companies are built by people. Whether you're a national company or an equipment dealer building a sound business in your community, we think it's about people. And as long as you treat your people right, treat your customers right, you'll have a good business and meet the challenge.