Rental equipment – return on investment

Few things are more exciting than when UPS or FedEx arrives with a load of new equipment at your warehouse. I remember everyone from management down to warehouse guys would run down to the dock and help unload the truck and begin setting it up to play with and admire the new equipment. As software specialists in the production business, we share the pride with you and your team. All that new equipment means the company is doing well, right?

Of course, our next questions would be: how much did you order and on what metrics did you base your purchasing decisions? Most of the time when we pose that question, we get a blank look and sometimes owners will get extremely defensive. Usually the response is something to the effect of: “Well… I have been doing this a long time and I know what people want. Plus, this moving light company was offering a special on some back stock, so I got a good deal.”

As an owner, your rental inventory is your single largest capital investment and realistically your job is much like a stock portfolio manager, with your rental inventory serving as the various stock investments within your portfolio. Managing that portfolio is vital to ensuring your business delivers the necessary return to keep your operations profitable. A big part of our business at Navigator Systems is that we try to listen to and consult with production companies on how to maximise asset utilization. However we find even some of the highest performing rental businesses aren’t making truly informed decisions when it comes to what to purchase and when. Instead, many owners assess their inventory based on “what their gut feels” and end up making expensive purchasing and divestiture decisions based on what they think they know or what has always seemed to work in the past.

The reality is, the days of “gut feel” are gone. The 1980’s and early 90’s Production “Wild West” are a thing of the past. When pioneers like Jere Harris convinced a group of venture capitalists to invest in a lighting company, it opened a floodgate of outside money that began investing in lighting, sound & AV equipment like PRG. Did you know that the largest AV company in the world is Goldman Sachs? But what would their investors do if told that purchasing decisions were made solely based on gut feel and unsupported by hard data? Let’s just say some heads would roll and their stock prices would suffer. To be frank, they really don’t care that this new lighting board has all those “cool features that lighting designers want”, they want to know “how much does it cost, and how quickly will it pay for itself and make me some money”.

Admittedly, gut feel can get an experienced rental operator pretty far but eventually you will hit the growth ceiling. The only way to really break through is making educated decisions based on consistent, constant management of your rental “portfolio.”

Developing a successful inventory management strategy is actually simpler than it seems when we apply consistent and constant management advice. Let’s start by reviewing some general industry guidelines as they relate to inventory management. First, appearance matters; equipment in good condition and packaged well  is more likely to be treated well by your customers and employees, cutting down on repairs and maintenance expenses as well as boosting your company reputation. Next, your most high profile equipment should remain at a maximum acceptable average age of 3-4 years at total original cost; this means half your equipment is 3-4 years old or newer and half is likely four to five years or older.

As a general rule of thumb, a rental business can maintain its current inventory condition, level and average age by reinvesting 10 percent of the equipment’s original equipment cost (OEC) in new equipment purchases on an annual basis, while at the same time divesting 10 percent of that same OEC each year. This “10 percent in: 10 percent out” rule is referred to as maintenance capex; any investment above that maintenance level is considered growth capex, which will, in turn, expand your inventory and your revenue capacity.

Utilize your rental software

Maximizing the use of your rental software is vital; utilize the available features in your software package to record and track data for each individual rental unit. Having good equipment records will allow you to analyze and calculate important metrics within your business that will not only allow you to strategize on an operational level, but also on “portfolio management” level. Furthermore, this data is essential if you are dealing with lenders or investors or, if you want to explore a potential sale of your business.

If you are properly utilizing your software system and keeping reliable records, tracking these important benchmarks can be done quickly, automating much of the process with just a few clicks of the mouse. As we develop a fundamental strategy for consistently and constantly evaluating the inventory, we will be applying a function of these metrics, which should be easy to calculate if you are recording the following essential data points per rental unit within your software system:

Management by exception: when to divest equipment

When it comes time to retire or sell equipment in your inventory, the decision shouldn’t be made based solely on equipment age. It should be based on a variety of multiple metrics and performance benchmarks. Likely, you have several high return units that are six or seven years old, and that is ok as long as that equipment is not costing you money.  The easiest way to determine which units must go is managing by exception, or “cutting the tail” (reducing the amount of under-performing assets). Cutting the tail involves drilling down on rental equipment data, first category-by-category, and then unit-by-unit, red-flagging problematic or underperforming units and disposing of such. The first red-flag is excessive repairs and maintenance expense, while the second red-flag is low financial (dollar) utilization; a single red-flag is a warning sign a unit may need to be expunged, while two red-flags on a particular unit means it’s got to go.

Overall repairs and maintenance expense should generally be in the range of 6 percent to 8 percent of total rental revenues (excluding revenues from re-rents), and no individual unit should exceed repairs and maintenance expense of 10% of the rental revenue it generated. Repairs and maintenance includes routine, preventative and major repairs, the cost of which should be recorded at every service.  Any machine exceeding 10 percent maintenance expense to rental revenue should be immediately red flagged for further review.

Financial utilization is the ratio of rental revenue (excluding damage waiver, delivery, environmental fees or re-rents) generated as compared to OEC (in other words… Financial Utilization = Rental Revenue ÷ OEC). Financial utilization targets should be set for the overall inventory and for overall Master categories and (sub)categories, such as Lighting – Consoles, Lighting – Truss, Video – Projectors, Video – Switchers or Audio – Speakers.  Any category or individual unit not achieving the targeted financial utilization rate should be “red flagged,” and cause for such underperformance analyzed. Low financial utilization rates will either be a result of chronically problematic, older or underperforming units or low rental rates.  We often find that low financial utilization goes hand-in-hand with high maintenance expense (a two red flag scenario).

Once you’re done identifying low financial and high maintenance units, check physical (time) utilization by category for any particular category with excessive quantities. Physical utilization is the amount of time a unit is out on rent versus non-rental ready or rental-ready status.  One issue we often see by ordering from “gut feel” is quantity issues: Maybe your “gut feel” ordering resulted in 4 consoles in the rental inventory, yet the hard data indicates you should only have 2 or 3.

At any given time, roughly 68 percent of your inventory should be out on rent, while 20 percent should be in the warehouse in rental-ready status and no more than 8 percent of your equipment should be in non-rental ready status (either in-transit, in need of preventive/routine maintenance or hard down). Check your metrics on physical utilization by category; if your physical utilization is less than 68 percent you probably have too many units.  If more than 68 percent, maybe you should buy more.

The 8 percent benchmark for non-rental ready units is an often overlooked asset management standard. Non-rental ready units should be treated as “hot potatoes.”  Rent it, fix it or sell it. No unit should ever be on hard-down for more than 2 weeks!! I see people all the time asking us to make HireTrack NX put something into repair “FOREVER!!” NO!! Bad Dog!! No!!

Most people don’t realize that selling off your equipment is your final opportunity to maximize the return on your investment. Let me say that again… “selling off your equipment is your final opportunity to maximize the return on your investment”. Taking the time to explore all the avenues for equipment disposal (i.e. CraigsList, Thousands of FaceBook groups, Google, etc) and evaluating current fair market value rates is your best bet to achieving the best sale price. Never set your sales price based on book value,  simply educate yourself on the current value for a piece based on condition, hours and features of the unit. In a perfect world, a typical return on disposal between 44 percent and 47 percent of the original cost. Keep that target in mind while determining sale prices and try to obtain the highest resale return possible to apply towards your new equipment purchases.

Making informed purchases

Making purchasing decisions should also involve many of the same benchmarks we have already reviewed when making divestiture decisions. First, concentrate on your highest financial utilization categories, as these equipment items will always bring the highest returns and therefore increase your return on investment. Next, just as physical utilization will identify excess equipment in any one category; it will also identify insufficient quantities in any category. If a category has an excess of 72 percent physical utilization on rent, additional units are probably in demand. Remember our friend from the opening story. Experienced rental operators may make good decisions on the majority of their “gut feel” purchases, but you probably have made a few poor decisions too; did you really need 60 more speakers, or was it actually 40 more and some smaller consoles.

Another great data point to track is “missed rental” opportunities. You should always be evaluating all your jobs for which you bid and lost, and include the reason you lost as part of the autopsy.  Train your employees to input this information on a regular basis and review the “lost job” log frequently. You may find the company receives multiple requests for a particular unit not in your inventory, or the company often substitutes a larger unit for a requested smaller unit, which means it’s time to consider implementing additional equipment in a specific category.

When purchasing new equipment, don’t just “place the order” for the same units at the same pricing as you have in the past. Consider different unit configuration or staggered deliveries, ask for and press for special pricing and terms. Consider checking alternative suppliers and brands, if for no other reason than to use as leverage with your current supplier.  However, purchasing new is not always the best approach. You certainly recognize that equipment costs have continued to rise, but, unfortunately, we have seen rental rates remain stagnant. The ratio of equipment acquisition cost to rental revenue affects your financial utilization. One way to improve financial utilization is to buy late model, low hour used equipment on high ticket units. Used equipment availability and pricing has been favorable to buyers in the last 12 to 24 months, making it a viable option for some rental companies in smaller markets. Keep an eye on that PRG or PSAV website for used equipment.

Continuously monitor to maximize ROI

As mentioned, benchmarks like physical and financial utilization are also affected by other factors such as rental rates and repairs and maintenance practices. Monitor your rental rates, track your sales team results by individual and implement new service procedures to improve shop productivity.

When developing or adjusting your inventory management strategy, remember consistent, constant management is key to maximizing the return on your equipment investment. Evaluating your inventory portfolio is much like doing laundry: that chore is really never done!  We recommend reviewing the key benchmarks discussed today at least on a monthly basis, always utilizing a 12-month average to account for any seasonality in your business. Your rental software package can automate these reports and deliver them to your desktop with little or no additional effort.  Review, rinse, repeat and watch your returns gradually increase from your hard work!

[subscribe]