| www.rfgonline.com | Tuesday, May 11, 2004 |
PC Leasing vs. Buying Revisited
RFG believes shifts in the IT and economic climates during the last few years justify reconsidering PC leasing for desktop and laptop refresh cycles. In many cases, leasing can offer attractive financing rates and lower total costs of ownership (TCO) than purchasing. Leasing can also be an effective cost mitigation tool, even for enterprises ultimately planning to own the leased hardware. IT executives should examine CFO financial strategies, enterprise budget plans and assumptions, infrastructure requirements and growth strategies, and PC life cycle management capabilities to prepare for the lease-vs.-purchase analysis. Furthermore, IT executives should collaborate and strategize with appropriate line of business (LOB) and financial executives, to raise awareness of the merits and negatives of each acquisition method.
Business Imperatives:
When IT spending began to slow after Y2K, the dot-com bust, and September 11, 2001, IT and business executives were forced to make difficult decisions about technology and personnel directions and expense reductions. Further, many enterprises have delayed upgrades as data computing requirements have increasingly shifted to the back end and the rate of perceived tangible desktop computing advancements has slowed. (See the RFG Research Note "Client Hardware Acquisition Strategies for 2003.")
A large number of corporate PC refresh cycles have been extended to four years or more. This trend has been bolstered further by IT and legal executives concerned with data cleansing and confidential data privacy concerns, e-waste disposal, and regulatory records compliance. However, the costs of managing an aging PC hardware base are rapidly escalating for IT departments. are rapidly escalating for IT departments. Specific challenges include break/fix issues, patch testing and deployment, problems with incompatible software, support for inconsistent and numerous system images, system re-imaging, and other PC TCO elements. As a result, many enterprises are facing unacceptable levels of user service dissatisfaction, and outdated equipment that they would like to update.
Additionally, decreasing costs of PCs and the speed of technology advancements are wreaking havoc on residual values of incumbent systems. IT and business executives should seriously consider incorporating this fact into refresh cycles. Under current market conditions, systems retain very little residual value after 48 months, and almost none after 60 months.(See the RFG Research Notes "Client Hardware Acquisition Strategies: Curbing Technology Refresh Costs" and "Switching PC Hardware Vendors: Understanding the Costs.")
Typical lease periods are 36 to 48 months, although both longer and shorter terms are available. Nonetheless, many corporations are dissuaded by PC leasing options, as total acquisition costs over typical lease periods have traditionally been higher in leasing scenarios. Moreover, many enterprise executives have required useful lives for PCs beyond the lease periods. The additional expenditure of lease buyouts makes leasing even less attractive.
Recent financing trends, however, have reversed this pattern. So-called "fair market value" (FMV) leasing is now typically less expensive than purchasing over a 36-month lease. FMV leasing may even be less expensive if IT executives choose to exercise the lease-purchase option. IT executives should, at the very least, ask PC vendors to provide multiple leasing quotes for detailed comparison, and be prepared to perform present value (PV) comparisons of all scenarios.
The concept of present value is critical to understanding the different lease and purchase options available. Present value attempts to recognize the future value of money as it is paid out over the lease or financing term, in current dollars. PV does this by applying a discount rate, usually the interest rate, to payments over the period of the lease or finance term. PV is calculated using the formula PV=C/(1+r)t, where:
C = total dollar amount;
r = discount rate per unit of time period; and
t = time period.
Although budgetary pressures are still a large factor for funding projects and acquiring assets, IT executives should not automatically assume that raw hardware costs are the most important criteria for selection. Leasing is attractive for companies favoring attributes such as consistent and controlled system images, effective and guaranteed disposal strategies, and the ability to expense rather than capitalize and depreciate system payments. Additionally, with leasing, enterprises can enjoy fixed and financed payouts and scheduled technology refresh periods. These can help to guarantee compatibility with the latest software and security updates. (See the RFG Research Notes "Reducing PC Acquisition Costs" and "Patch Deployment Best Practices in the Enterprise.")
While raw dollar costs are generally the most persuasive component of the lease-vs.-purchase decision to IT executives, CFO and legal compliance teams may have different priorities now than in prior years. Today, many companies will select leasing to take advantage of one or more of the aforementioned available benefits. For example, FMV leases can be treated as operating expenses for up to 36 months – a fact that may be reason enough for CFO teams to select leasing over purchasing.
FMV leases therefore tend to be the most attractive and flexible for enterprises because they can be expensed rather than capitalized. This is because the lessee does not assume ownership of the equipment at any time during the lease's lifespan, which is not true of other lease types. To be considered an operating lease (sometimes called a true lease), a lease must meet the standards set by the Financial Accounting Standards Board (FASB) in its Statement of Financial Accounting Standards No. 13 (FAS-13). These are listed below.
The first and third requirements of an operating or true lease become increasingly difficult to fulfill as the lease term gets longer and as the rapidity of technology change erodes end-of-term FMV. Although vendors can and do offer operating leases for 36 months, they are technically in violation of the first operating lease requirement, as equipment FMV after three years is generally quoted in the 15-percent range. Vendors often use residual value insurance and other tools to deal with this problem and achieve compliance. IT and financial executives should work with vendors to understand how lease terms are structured, and ensure that vendor and enterprise accounting practices meet FASB and internal accounting practices.
In addition to FMV leasing, two other types are common in PC leasing – both of which are capital leases. Fixed Purchase Option (FPO) leasing allows the lessee to purchase the hardware at the end of the lease period for a fixed price, usually 10 percent of the original cost. A Dollar Buyout Lease allows the lessee to avoid getting a bank loan and allows a corporation to purchase the hardware at the end of the lease period for one dollar.
Beyond accounting advantages, having guaranteed strategies for asset disposition and privacy concern elimination via hard disk cleansing are significant motivators for risk mitigation and assembling legal teams to provide oversight. (See the RFG Research Note "PC Disposal Strategies.") IT executives should review assumptions about business, financial, and regulatory priorities with the appropriate executives, and collaboratively work to develop a set of criteria and weighting factors to assist with the decision making process.
In cases where leasing is attractive to executives, IT executives should be aware of the numerous hidden costs associated with leasing, and prepare to erect the proper contract management processes to oversee the process. The most common area where enterprises get caught is the end of the lease. Vendors require enterprise clients to declare their intention either to return the leased equipment or purchase the hardware by a predetermined date, usually three to six months before the lease ends. The vendor may further require this notification to be delivered in writing. Failure to comply with the process specified in the lease contract typically results in the lease automatically renewing, usually at the same rate. Although many hardware vendors will simply allow month-to-month extensions, third-party leasing companies may force longer terms.
Many enterprises forget about this contract clause and end up keeping systems beyond their intended return date. Moreover, the process for managing both the contract and the leased systems may determine whether or not the enterprise is even able to surrender the PCs at the lease's end. To transition systems effectively, IT executives need to ensure that notification is delivered properly and that systems can be effectively switched. Effective transition requires the negotiation of another lease or purchase, enough lead time to get the new systems delivered, then installed and tested at users' desks. Next steps include software installation, then data and personality migration. Each new lease agreement also requires a grace period to cover overlap or time delays after new systems are installed, and provisions for securely wiping enterprise data from the outgoing PCs.
IT executives should also pay close attention to how "dead on arrival" (DOA) PCs and insurance are handled, the number of free spare systems to which the vendor is willing to commit, and shrinkage toleration. DOAs should be the responsibility of the vendor, and IT executives should assess a penalty on vendors who deliver an unacceptably high number of DOAs. Furthermore, DOAs should be replaced within 10 days, with spares available immediately.
Most vendors only insure each system until it is relinquished to a preferred shipping carrier. Enterprises must pursue carriers for reimbursement for systems damaged during shipping. Enterprise must therefore frequently endure long sorting and waiting periods as each carrier investigates each claim and processes remuneration. Ideally, IT executives should push vendors to insure the systems until they are received and confirmed undamaged at their final destination points. Where enterprises use vendors' installation and setup services, IT executives should ask those vendors to assume responsibility for each system through its installation and for a fair period of time thereafter.
IT executives should also negotiate the proper number of "hot standby" systems provided to the enterprise based on past experiences with hardware failures and the size of the PC lease. Most vendors are willing to tolerate a certain percentage of shrinkage upon lease completion without requiring the enterprise to pay any fines. Additionally, IT executives should request the ability to return other similarly equipped PCs from any vendor, to further attempt to reduce potential liabilities. The best defense for these issues will be a strong asset management strategy, with which vendors can often help either with software and/or services. IT executives should review lessor capabilities to provide electronic lease management tools and processes to reduce costs and simplify end of lease.
RFG believes PC leasing can offer compelling potential cost savings to enterprises able to manage the lease process carefully, and to understand that PC TCO extends far beyond acquisition costs. FMV leasing can offer very attractive cost savings, even when lease-vs.-purchase comparisons are based on acquisition costs alone. To evaluate lease-vs.-purchase scenarios effectively, IT executives must understand budget planning, business and financial executive drivers, desktop and server infrastructure requirements, and PC TCO components. IT executives must also understand how PCs are used in the organization, and how lease pricing is constructed. IT executives should also bring their understanding of both financing options and business and technical requirements to financial executives as early in the process as possible, to garner their support for the final lease-vs.-purchase decision.
RFG Research Notes provide concise, high-level analysis and recommendations on specific topics of interest to enterprise IT executives. The Notes also provide a framework for further detailed Inquiries by RFG clients, and for follow-up presentations and workshops by RFG research staff available to all interested IT decision-makers. For more information, contact Client Services by telephone at (US) +203/291-6900 or by e-mail at clientservices@rfgonline.com.
Copyright © 2004 Robert Frances Group, Inc. All rights reserved. Agenda products are published by Robert Frances Group, Inc., 22 Crescent Road, Westport, CT 06880. Telephone 203/291-6900. Facsimile 203/291-6906. http://www.rfgonline.com. This publication and all Agenda publications may not be reproduced in any form or by any electronic or mechanical means without prior written permission. The information and materials presented herein represent to the best of our knowledge true and accurate information as of date of publication. It nevertheless is being provided on an "as is" basis. Reprints are available.