RERMAG

Outlook 2005

How to manage in an up cycle? How to determine fleet expenditures? Why rental is vital for distributors. What's driving the used equipment market? These are just a few of the issues tackled by consultants Dan Kaplan of Daniel Kaplan Associates and Mike Marks of the Indian River Consulting Group.

Encouraged by Quality

RER: Whenever the industry goes through a down cycle, much attention is paid to how to manage a company through the lean times. What are the keys to managing through an up cycle?

Kaplan: My advice for managing on an up cycle can be summarized in the following points:

A. Raise rental rates.

B. Add additional fleet. Incremental equipment into a fixed cost operation equals significantly greater profit than the core fleet, as fixed costs are already covered.

C. Consider opening additional rental branches.

Going by the principle that more fleet can bring about more profit, how can a rental company determine how much capital to spend on fleet?

When a rental company adds fleet in a fixed-cost operation, the profit on the incremental fleet is double the core fleet as I indicated above. To determine how much capital to spend on fleet, I recommend the rental company develop a fleet plan and three-year pro forma operating statement. The fleet plan, if done well, will determine the amount of fleet required or desired. The pro forma operating statement will allow a rental company to review future operating results, without actually spending money.

The pro forma operating statement will indicate if the incremental fleet is profitable, and if the profits are adequate to cover the incremental finance costs.

What percentage of a rental company's gross volume should be spent on maintenance and repair?

Repair and maintenance for a typical rental company should range in the 8 percent to 12 percent of rental revenue, on a fleet with an average age of 30 months to 34 months.

As you visit rental companies, do you see enough attention being given to maintenance and repair?

The answer in short is yes, I do think rental companies put a great deal of attention to maintenance and repair. For some reason I have increasingly been asked this question. I don't consider maintenance a problem today or that it will be a problem tomorrow. Think about it, if the fleet is not maintained, a rental company will be out of business. A long time ago, the industry figured out how to properly maintain equipment.

Do you see the market for small independent rental companies as being very different from the market for national rental companies? How do you view these markets over the next year or so?

There is a vast difference between the markets for the small independent versus the national rental company. The small independent generally serves a customer in a small geographic area. The small independent usually has smaller equipment with the largest equipment having a value of maybe $40,000. Their total fleet has a value of less than $1 million. Independents do not have a complete fleet offering, and often cannot serve or do not serve the large industrial and commercial customers. Independents' fleets are typically focused on the do-it-yourselfers and the smaller contractors.

The national rental companies have an average fleet level at each of their hundreds of branches in the $6 million to $8 million range with rental revenues at each branch in the $3 million range. The large national rental companies have fleets in the billions of dollars and transfer equipment between branches to drive utilization and serve the customer. The national rental companies offer a complete fleet offering and total geographic coverage.

Today the overlap of the independents to the major rental companies is very small. In time the large rental companies will become even larger. The small independents will stay small and service the local customer. The small independents will never go away; they provide a basic need at the local level.

What kind of changes do you expect to see in the rental industry over the next few years?

In the next five years I expect to see the size of the large rental companies significantly increase. They will operate globally and have rental revenue on the $5 billion to $8 billion range. There will be more than one of these global rental giants. Within five years I expect the manufacturers to own one or more than one of these large rental entities.

In terms of internal operation, what are the most encouraging strengths you have seen over the past few years and what are the areas that most require improvement in your view?

I am encouraged by the sophistication and impact on software to the rental industry. Software is revolutionizing our industry. In order to be competitive rental companies will have to become masters of software. All the major rental companies today are operating at a level of sophistication in software that is essentially making obsolete the less sophisticated companies.

I am encouraged by the quality of the rental product being offered by the industry. I can remember the day when you had to hold your breath and hope the equipment did not break down while on rent.

As far as the future; look at remote wireless equipment tracking systems to bring the rental industry to the next level. These systems today can tell a rental company where their equipment is at all times and when the equipment is being operated, for instance on evenings and weekends. Additionally these systems can communicate back to the rental company important operating data such as the hours on a machine.

Do you anticipate an additional wave of consolidation and what form do you expect it to take?

I expect there to be further consolidation of the top 10. This may begin to occur in 2005. Look for the equipment manufacturers to take a larger role; maybe not acquiring a rental company in 2005, but taking a much greater role. In particular watch Volvo and Komatsu.

What new investment do you expect to see in the rental market in the foreseeable future?

The capex spending for the larger rental companies increased 43 percent in 2004 versus 2003. In 2005 I expect the larger rental companies to further increase their fleet investments by 20 percent over 2004.

Moving Beyond Elephant Hunters

RER: You are well known as an expert on distribution. Can you outline the primary problems distributors in the construction equipment industry are facing today?

Marks: There are several. First, distributors are facing rising management challenges, and they are facing a generation succession issue. There has also been a fair amount of consolidation, turning companies into multi-location operations, and I'm not just talking about national players, but companies picking up locations here and there. They can run a single location distributorship like a candy store, and really provide personal service. They want to always have a senior guy on site. But with multiple locations, computer systems and operating disciplines become more important.

So one of the biggest challenges they face is they don't know how to transition from entrepreneurial to professional management. The top guy likes to make all the decisions. And along with that is a fundamental lack of understanding of product support. Most dealerships don't know how much money they are making in parts and services. You run a bigger business differently than you run a smaller business.

Another problem I see is the amount of money they spend on elephant hunter sales reps, guys who are trained to go out and sell new equipment. If the customer is seeking any other services, they say, “I don't handle that.”

AED studies have categorically demonstrated that if a dealership took dollars away from new equipment sales reps and re-distributed them to rental or service reps, it will make more money, whether it's with big or small equipment.

There are also changes in channel pressure. I expect that we will still see consolidation among big iron producers. We will see consolidation because there is pressure to sell more iron but margins are shrinking. If I was the only guy in a market area, I could give bad service because I was the only guy in town. Now there is an explosion of will-fit parts and customers don't really care any more who provides it.

Do you find interest in renting growing?

In the AEM Doing Business Report the preference of customers to rent has gone up three years in a row. It used to be the case among contractors that only little guys who couldn't afford to buy were into rental, but now more and more construction guys use rental to handle a major component of their fleet requirements.

Customers are looking for value. If you look at what Caterpillar, Deere, Volvo and so many other manufacturers do, it's provide great equipment. So a 3- or 5-year old 220 is a great value. Buying used is more acceptable for today's contractor. So if Volvo makes good stuff and the used market is viable, it cannibalizes the sale of new equipment, so they are essentially victims of their own success. There is a big problem if elephant hunters want only to sell new, and the customer says, “Why buy when I can rent? Why buy a cow if I can get milk for free?” So rental is more acceptable than it was, and used is going up in market acceptability. That puts a lot of pressure on the market and distributors end up with overcapacity in new sales resources.

What do you think is going on in the used equipment market today?

We had a really bad year after 9/11, and what happened was manufacturers took capacity off line, we also had a glut of late model used equipment and the price of excavators and other categories collapsed. The economy was bad, there was a huge bubble from the rental company rollups. But now that inventory is gone and the economy is back. So now you can take the price of a D-8 and it's higher at the end of 2004 than at the beginning of 2004. So, and this happens once every decade, you could buy used equipment at the beginning of '04, use it all year and it's worth more at the end of the year than when you bought it.

Now manufacturers are adding big steel surcharges, and a lot of companies have growth in work-in-process inventories that are sitting around waiting for small components, so because of that the lead time on new construction equipment is going out. So that's driving the price of used equipment.

There were huge changes between 2001 and 2004 and now the genie won't go back in the bottle. Take a company like NationsRent, it once was purely rental and now it is selling new, used, rental, service, basically doing whatever the customer wants.

It seems the distinction between rental company and distributor is blurring even more?

Absolutely. Ten years from now, the distinction between rental houses and distributors will be gone. Everybody will be in the sale of new and used, parts support and rental. Many distributors are already involved in true rent-to-rent, and I'm not talking about people whose idea of short-term rental is 90 days. There are two things distributors have to do to be in the game. They have to have a dedicated rental inventory, and most don't. They need a separate inventory for sale and for rent. Second test is real short-term rental. I don't expect them to rent a huge excavator for an hour, but they should be prepared to rent it for a day if the customer wants it.

How does the decision to go into rental conflict with their relationship with the manufacturers they represent?

If I'm a Deere construction dealer, with a rent-to-rent fleet, I'm going to give my Deere sales rep a big purchase order and put $1 million into the rental fleet. If I'm a dealer and I go into rent-to-rent, there's a big spike of sales to buy rental fleet, but that purchase level decreases during the next year. Then I go into the used equipment business, and that often cannibalizes new sales. If I'm in the rent-to-rent business and I need a high-rear-wheel dozer for a customer and can only get that from Caterpillar, I'm going to buy it used and then my manufacturer gets upset!

If you run a rental business like a rental business, you have to make sure they've got the right procedures. When a rental is returned, how do you inspect it quickly so you can get payment for damages? Traditional distributors might let it sit for three weeks and then argue about whose problem is it that the teeth got chewed up? So these are your issues when you go into rental: How do you manage your suppliers right, and how do you build transactional intensity and procedures like any mom and pop rental company? And third, you have to deal with your sales force; you can't just have elephant hunters. How do you work it into a pay plan, and how do you have a counter staff that's responsive immediately?

So you decide to get into rental, you spend $100 million on a rental fleet and then the manufacturer is upset because the following year you don't need to replace it all, so you only spend $20 million. So the very manufacturer who wanted you to get into rental in the first place is now upset with you for doing it the right way.

You've always advocated that distributors get into the rent-to-rent business. Do you still see rental as vital to the long-term interest of most distributors? If so, what are the primary terms of that commitment as you perceive them?

I think distributors will be forced into rental or they will die. Everybody will do it, either they do it well and make a profit, or they'll do it halfheartedly and then give up. This industry grew up around the manufacturer; they had all the power. In the old days, getting a dealership was everything. If the manufacturer said jump, I said how high, because I would do anything to get the line. The manufacturer had all the power. Now it has migrated from manufacturer to the customer; the power is all about the customer. So whoever controls the customer makes the money. I truly control the customer if the customer is coming to me for new, used, rental and product support. I can get product anywhere. I have to become a service organization for that customer. Whoever controls customer relationships will define the long-term winners in this industry.

Getting away from the distributor and looking at companies whose primary business is rent-to-rent, what do you see as the most serious issues and obstacles at this time?

It depends where you're standing. Most of your readers are mom and pop houses, and when the pendulum swung, we saw all these roll-ups, and people cried, “the sky is falling, we're going to die.” Then we had the overvalued fleet and meltdown of national rental houses. But they didn't go away because they have a viable business model. We won't see the continued Wall Street romance, but it's a viable business model, the top rental houses' share of market will grow because they offer customers more options. More and more customers are working out of state, out of their geography. If he has a relationship with a national rental house, that company has a structural advantage to set up the rental job. They aren't better or cheaper, but it's the convenience to the customer. So customers' preferences change as to how they source equipment. As an independent, the one thing I can do is tailor to the local market, and pay maximum attention to local customers.

So the challenge for small independents is that the national companies will grow, the out-of-state contractor knows United but he doesn't know Broward Rentals, which is a family-owned, good-quality house. So independents need to work Dodge reports because they are getting a smaller share of total construction dollars.

At the most recent AED Executive Forum, I was particularly impressed by something you said that stuck in my mind, and I'm paraphrasing it: Essentially that everyone looking ahead to 2005, should do something risky and “out of the box” to separate them from their competition. You said in essence that it's not enough to just float along on the economic upswing, but to try something innovative and risky. Could you elaborate on that thought?

It's the whole issue of complacency. Take some risks. Where is the power moving? It's moving toward the customer. How many senior executives of very large businesses don't spend time with major customers at all? Quite a few. They are waiting for the money to come to them.

What are the keys to managing during an up cycle? Can this be a dangerous time, with companies getting blown away with a false sense of security that this cycle is going to last forever?

When you get a lot of growth, you tend to throw expense at it, but you need to set profit standards higher, and run it as if it wasn't an up cycle. If I want to invest in something new, now is the time. Figure out who are your key customers. Lots of customers go away in a down market, but the ones who stay with you before and after the up cycle, those are your key customers. Take care of key customers. You won't gain market share in an up cycle, because everyone is growing and product availability is limited. You gain going into or coming out of a down cycle, that's when the market share changes. Make investments to improve productivity and lower recurring costs.

E-commerce came and went as a hot buzz word, but meanwhile a lot of initiatives have quietly progressed. How do you see this issue now and what are the main “e-commerce” areas that seem to matter most now, to distributors, manufacturers and rental companies?

If you look at United Rentals, they put wireless laptops in the hands of sales people because the value of technology is how fast they can get somebody an answer; it's not replacing what you're doing. It's still all about people buying from people. If a contractor goes onto a Web site and gets information about what's in a fleet and gets an answer quickly, he'll benefit. Contractors use the Internet more than rental houses or distributors. If I'm going to Tallahassee, I may look at the Internet, but I may also call up my United guy and say I need an aerial work platform in Tallahassee tomorrow. That's the structural advantage big companies have.

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