After that sweet expansion in construction a decade ago, the bursting of bubbles, c. 2008, halted work with incredible abruptness. For a couple of years there, it was hard to imagine how contractors would ever see a “recovery,” at least for quite some time.
And yet, 2011 brought one, according to several authoritative studies. Last year held steady, too, with a slight pullback, the Rouse Construction Rental Report found in mid-2012. An ensuing revival in demand for construction equipment has now lasted about three years, according to the US Census Bureau, raising machine sales to $49.9 billion in 2011, for example. That was a big 38.2% leap over 2010 levels. The Equipment Leasing & Finance Foundation reports similarly that for eight straight quarters during that period, investment in construction equipment grew an annual rate of 20% or more. Eventually, though, the demand peaked in 2012 and began declining just a bit.
So, fleets of digging equipment are growing. Both contractors and rental sources alike are buying. About half the latter beefed-up total inventory in 2013; only 6% decreased it, according to the construction division of Wells Fargo Equipment Finance Inc.
As for construction contractors, in 2013 81% purchased new earthmoving hardware. About the same percentage bought used. Those figures were nearly as high as 2012, when about 87% acquired new or used equipment, notes a report issued under the direction of John Crum, WFECD national sales manager.
All in all, this three-year rally reflects a big rebound in optimism regarding future construction work. According to WFECD’s Optimism Quotient, the last two years reflected two of the most confident periods in 13 years.
The Case for Renting, Stronger than Ever
The following discussion might also be subtitled, How rental equipment keeps reshaping digging contracting. As the equipment distribution business continuously evolves, it keeps defining the contours of earthmoving contracting itself.
A bit of historical perspective here: When rental executive David Bourdon first got into that business about 25 years ago, he recalls, “There weren’t a lot of rental companies-certainly no national ones that had a footprint. And you didn’t have the availability of rental equipment that you do today.” Bourdon now manages a Houston district branch for United Rentals. Thanks largely to a couple of decades’ worth of shifting in market contracting economics over time, UR has grown from a modest operation into the largest rental firm in the world. Bourdon has witnessed an explosion in demand for digging machinery throughout this period-more or less in good times and bad, in fact. As market hunger for machines has grown, he explains, “Companies like United have grown with it.” The relatively easy availability and expansion of rental choices has transformed contractors’ bidding dynamics and dictated their business strategies along the way.
Today, he says, “Contractors now have a lot more options than they ever did, and they’re generally having a more and more positive experience with renting.” It’s a feedback loop that in turn feeds ever more demand.
Bourdon continues: “On a macro scale contractors have a long list of reasons why they so often prefer to rent equipment rather than buy it.” What drives the decision are these three key factors.
First, much equipment is needed for only occasional use. Hence, “It’s extremely hard to justify buying machines to fit all applications,” he points out. Perhaps your currently owned excavators “are large enough to do the job just awarded very efficiently,” he says. Or vice-versa: “The one you have is too big.” Renting is thus called for in such cases, “so you always get the right-size tool for the job,” he says.
The second big driver is capital preservation and the accounting advantage. Most small businesses these days, Bourdon notes, “are constrained” by lack of cash to invest. Renting overcomes this shortcoming. And accounting-wise, by renting, “You don’t have the assets on the balance sheet, and, when you’re through with the job, your expense is over,” he notes. If you buy, conversely, you incur an extended commitment to keep making payments, buying insurance, and often servicing the debt.
The third reason Bourdon cites is that “Growing and dynamic digging businesses are always scaling,” meaning they’re nimble enough to resize operations continuously for peak efficiency. Companies that survived the nasty downturn typically cut back on staff and equipment purchases ahead of the collapse. Compared with the flexibility of rental, buying of equipment reduces the your room to shrink easily. “You may have five jobs now, then three next month,” he says. “It’s difficult to own just the right-size fleet to service the variable work you have. It’s far easier and makes more sense to own a small core that will be kept busy-then rent additional pieces as needed,” he says.
Besides these prime reasons, Bourdon points out quite a few others that quite often steer contractors to take the non-ownership route.
“By renting,” he says, “you’re getting current machines that are safe, reliable, and delivered when you want them, where you want them.”
Another: “Over the years, equipment has been evolving”-there are more varieties, sizes, special features, and improvements with every model year. Renting makes it easier to get at these improvements for a tryout.
New excavation methods also evolve, e.g., hydro- and air vacuuming and other customized digging for specific conditions. Using specialized hardware is increasingly called for.
Some newer stuff is costlier, and the resale value of owned assets is becoming less predictable.
The ever expanding availability of rentable equipment provides contractors with ever improving consistency and predictability in costing, he notes. This becomes a critical advantage. “It makes it easier to bid and win jobs and complete jobs profitably, when you have consistent cost and reliable equipment and terms,” says Bourdon.
Doing business with large rental companies enables contractors to maintain relationships with fewer suppliers (i.e., “one-stop shopping”). Rental companies sometimes give their steady customers perks and better deals; over time, renting grows ever more advantageous.
Still another driver is the current portfolio of digging work: It’s less of the big, capital-intensive stuff of a decade ago, and more of the modest clearing and site expansion. These are relatively brief, one-off projects.
Bourdon sums up: “As markets go through their various gyrations over the past decade, rental seems to grow, regardless of total construction dollars being spent… The share of contractors renting grows every year…as these operators learn that they can better control their cost and their reliability through the rental market.” Renting is also now virtually mandatory, a given. He adds: “It’s doubtful any contractor owns enough equipment to never have to rent, so even the ones that don’t mind having lots of capital tied up in their equipment end up renting at least some.”
From Renting to Leasing to Owning
Lamont Cantrell, vice president of sales and marketing for Modern Machinery (Missoula, MT), also outlines a construction market renaissance going on now, which has, if anything, made the preference for rental even more entrenched.
The apocalyptic shakeout of 2008-2011, he notes ruefully, decimated old-line construction contractors and relatively newer firms alike. Today’s survivors “are looking at better workloads than they’ve had in years, yet still stinging from the trauma of what they endured,” says Cantrell, whose employer is a multiline equipment dealer for the Pacific Northwest, handling primarily the Komatsu line. Yet, even with good activity, customers are still “in a holding pattern” on buying, until they’re more confident of the sustainability of this recovery, he adds.
Most digging contractors also “took a lot of hits financially,” meaning they damaged their creditworthiness. Bank loans have now tightened up. Bonding agencies have also become “much, much tighter,” he adds. Rental rather than purchase keeps machines off the balance sheets so as not to impair bonding capacity, he notes.
The net effect of all these dynamics “has created extremely high rental demand,” says Cantrell. Much of the buying these days seems to be done by equipment distributors “who are ramping-up our rental fleets because we’ve had to, to meet our customers’ needs,” he adds.
Nevertheless, he says emphatically, contractors “know they need to own a certain amount of equipment.”
In this rental-frenzied marketplace, the obvious bridge to such ownership is, of course, leasing-with-option-to-buy. This path has gained appeal during the upturn, as several observers agree. The essential concept here is well understood. Cantrell explains that with this deal, “You have the ability to build equity in the machinery as well as rent it, with the ability to return it. You do have that double-option. If you see a change in your business one way or another, you may have some ability to convert those options,” i.e., postpone making a decision, or even change your mind and revert to a different alternative, depending on the specific leasing contract.
Not all rental companies are offering such versatile buyout options yet, Cantrell adds. And contractual terms vary widely. On the whole, though, he says, “Rental-purchase… has really gained favor in customers’ eyes as a way to get the best of both worlds. They can avoid taking on the debt, yet gain at least some equity while they try to determine if their future is stable enough to add longer-term debt.”
Vendors are usually helpful in counseling their customers about “what fits,” acquisition-wise, he adds,
Brad Stemper, who is the solutions marketing manager for Case Construction Equipment, a global distributor of equipment (US base, Racine, WI), talks about some of the tradeoffs in this lease-or-buy? decision-a dilemma that directly affects balance-sheets and determines competitive viability, he notes.
Stemper begins by pointing out that leasing arrangements with “bumper-to-bumper warranties and full maintenance over the life of the contract,” may provide a digging contractor with overall “better cash flow” dynamics than the alternatives. This is because leases that bundle warranties and maintenance make it easier for contractors to bid on large, long-term projects. Such deals “take some of the guesswork out,” and are usually more accurate, he adds.
For a recent example, in 2013 Case introduced ProCare, a three-year, 3,000-hour full-machine factory warranty, and a three-year, 3,000-hour planned maintenance contract on heavy Case machines built with SiteWatch telematics.
Stemper continues, noting that although many leases provide a purchase option at the end, many customers still opt to trade-in for new piece of equipment. This reflects the powerful appeal of tech novelty. He explains that, due to “rapidly changing technology and ongoing innovation, new equipment is often able to outperform the machine it replaces and be more fuel-efficient.” There’s also typically less maintenance expense with newer equipment. The digging contractor also avoids being stuck with obsolescence. “A good example is the equipment engineered with the latest Tier 4 emissions solution,” he notes, referring to a recent regulatory mandate.
Buying Still Makes More Sense
The foregoing would give the overwhelming impression that equipment sales must surely be dead. But, incredibly enough, quite the contrary is true: As previously noted, about 86% of contractors have bought new pieces in each of the last two years.
Pride of ownership is definitely one intangible benefit, Stemper notes. There are also these highly practical considerations:
- The possibility that used machines will retain their long-term value better, if construction demand should become sustained.
- If the purchase price includes a comprehensive warranty and maintenance program, this reduces some of the risk of ownership, Stemper notes.
- Ownership gives you complete control over equipment: how, when, and where it’s to be used. This ensures availability during very high demand periods like the end of summer.
- There are good buys out there. One outcome of the rental boom is the proliferation of used pieces for sale. Bourdon puts it wryly. “We like to say we’re world’s largest manufacturer of used equipment. We buy it new, and it’s used straightaway, so we obviously have to divest ourselves of that equipment” when its desirability for rental has peaked.
- Perhaps more than anything, there’s the powerful persuasion of tax depreciation schedules. In the hands of a good accountant, these will bump up cash flow and make a contractor more competitive: He’ll win more bids. And this, says Cantrell emphatically, is the prime goal. He explains: “Always, from a cash flow standpoint, the rental rate is much higher than a customer’s depreciation cost when he owns.”
Example: “Suppose you’re a contractor who says, “˜I’m not going to own anything. I’m going to rent everything, and I’m going to bid against contractors who own their gear and replace it and keep it modern on a depreciation basis.’
“Generally speaking,” he continues, “a $200,000 excavator will rent monthly for something in the $6,000 range,” depending on locale and season, etc. The number of working hours per month averages about 176, so the hourly rental comes to about $34, Cantrell estimates.
“Now, the same machine depreciates for 8,000 hours in five years. So, roughly, you can say 2,000 hours depreciation value per year. After five years, the $200,000 machine retains a residual value of about 30%,” i.e., $60,000 or $70,000. Thus, depreciating $130,000 in cost, divided by 2,000 hours per year for five years, nets a depreciated cost of “only $13 per hour. So that’s your profitability,” he says.
This example illustrates the relative “best case” of an owner enjoying the depreciation benefit. “He’s able to finance it for several years,” says Cantrell. “Now he’s got this nice, late-model fleet with 2,000 or 3,000 hours on it. And it’s paid for. In the pool of competitive bidders, someone like this will stand out. He has almost no cash flow to worry about.”
In contrast, “The renters are out there paying $6,000 a month for all their stuff. They’ve got $40,000 a month in cash flow to cover, and [the buyer has] got just $7,000. And markets start contracting and tightening. And everyone needs a job. Who is more apt to get that job?” Cantrell asks. Answer: “The guy with no cash flow requirement, who owns his equipment.”
This illustrates why equipment rental-despite all the compelling advantages enumerated earlier-properly applies, he says, primarily and in the best cases, only “to supplemental machinery, depending on the customer and his applications, his projects. It’s really not right for the core business,” Cantrell believes emphatically, “because, before anything else, renting puts him at competitive disadvantage.”
Cantrell concedes there are differences of opinion on the subject. “And there are times in winter and early spring when there’s an abundance of gear, and poor utilization, so you can make some extremely lucrative rental contracts,” he adds. On the other hand, though, there are times of peak rental demand when you pay exorbitantly for one modest dozer needed to finish a job. “It’s like booking a hotel room in Palm Springs in January, versus August.”
All that said, Cantrell notes he’s never seen a contractor succeed on purely a rental basis. “No one’s done it, and no one’s doing it-because they don’t get the jobs. They bid them too high. After that, none of the other stuff matters, because you didn’t get the work. There’s nothing to debate, because you’re parked and the other guy’s working.”
Finally comes the purchase itself. Here, Cantrell outlines a typical scenario that he sees all the time these days.
A contractor shows up at the rental dealer with a short-term need-“a workload of 90 days or maybe six months,” Cantrell says. “That’s all they have on their books. They’re short a couple of pieces for a project, so they say, “˜I’d like to take a small excavator and this mid-size dozer out for three months’ rental.’
“Meanwhile, he’s still constantly bidding on projects-all the work that was put off during the downturn but is now coming back.
“So,” Cantrell goes on, “during three months of rental he picks up another six months’ workload. He keeps the machine an additional three months.
“Then he says, “˜Wow, I’ve got six months of equity in this machine. I’ve got 20% of it paid for. And now, after that last three months, I’ve got a workload out to nine months. I’m feeling pretty good and I’m profitable. I’m going to keep that machine because it really integrates well with my fleet.'”
The contractor might sweeten the move by offering an old machine in trade, Cantrell adds.
All of this, he says, “is fairly typical and normal…We see it every day. We put a machine out on what we think is a pure rental basis and it never comes back.”
As a sort of benchmark, a contractor’s prospect of six solid months of work ahead “seems to be a hot button for many-though I’ve never heard a customer actually say that there’s a “˜magic number’ to it,” he adds. “There’s too much variety and complexity to boil it down to a formula. At any time, some construction sectors are hot and some are cool. But generally, a customer who has a steady workload out there of six months in advance, and having reasonable equity in the rental machine-which typically means a four-to-six-months range-those numbers work for a lot of people. All at once, that machine starts to look really attractive to a customer for adding to his fleet.”
A Middle Way?
Brian McKenna is vice president of sales in the groundworks division of Mabey, Inc. (Elkridge, MD), a rental business for shoring supplies serving both the East and West Coasts. In this discussion over renting versus buying, McKenna proposes a kind of best-of-both-worlds path. Essentially, it offers contractors much lower leasing rates, suited for somewhat longer periods-without the assumption that payments are contributing to a buyout. Because the money only counts as rent, and the lessor will retain ownership, the monthly outlay for the lessee can be lowered.
McKenna explains the logic for a contractor: Short-term jobs almost always call for renting, and the industry’s standard agreements are crafted to make sense for these brief periods of a week to three months. However, with this agreement, “The problem for a contractor comes when the work extends to six months or more,” he says. With the original weekly or monthly rate, “They end up paying way too much.”
McKenna illustrates: “Suppose a used machine might cost a half-million to buy. If it’s rented under many standard rental agreements,” a contractor could end up shelling out “$150,000 to $185,000 over the course of six months. He’s almost halfway to buying a machine that he doesn’t really want,” says McKenna.
And it isn’t uncommon for a digging job to run longer than was expected. In a worst case scenario, a contractor who badly misjudges the production period “might end up paying even more than the machine’s value,” McKenna notes.
“So there’s a major decision to be made when he needs a piece, maybe for six or nine or 12 months, or as long as 18, and he doesn’t know the time for certain, or is unwilling to commit to a lease purchase, or the equipment supplier is inflexible,” says McKenna.
Another ruinous situation occurs when digging is unexpectedly stalled for weeks and weeks. The equipment sits idle. Meanwhile, a high weekly rate is being paid out. This scenario is also not uncommon, McKenna notes.
All in all, then, the much better alternative is to structure a flexible agreement that takes note of the great practical difference between shorter- and longer-term usage of, say, less or more than nine months. The agreement should allow a much lower cost for this longer time, because the deal lacks a buyout expectation. In such a case, the rental company could lower the net outlay to as little as a third, compared to standard weekly rate, says McKenna.
He explains, too, that “It’s critical for the rental agency to be more long-term minded for the sake of their customers’ success. They need to help contractors have the best of both worlds,” i.e., the cheapest possible monthly outlay [as when purchasing], without the burden of ownership. “The contractor pockets the savings of a lower rate, and he gives the equipment back at the end of the project,” McKenna says.
Another extremely helpful rental innovation is a “pay-when-paid” provision: The rent comes due only after the contractor has been paid.
In sum, “Rental agencies need to think more like contractors,” says McKenna. They should behave “like strategic partners.” Such a relationship will benefit both, he adds. Yet, “unfortunately, the rigidity” of certain ingrained rental agreements “[often] doesn’t allow them to do that.”
There’s also an historical backdrop in favoring such collaborative thinking, he adds. Just a couple of decades ago, there were no rental companies, McKenna recalls.
Here he echoes Bourdon’s point raised earlier. Rather, in those pre-rental days, OEMs like Cat, Deere, or Komatsu offered lease-with-option deals, effectively to only a limited number of better qualified, firmly-established contractors. Any would-be entrants to excavation contracting faced this and other capital hurdles. However, ultimately, when equipment rental houses “eventually came along, all of a sudden that allowed someone to start a construction company with just an office and pickup truck. They could rent equipment for a short term. And after they were done, just give it back. They had neatly fixed costs,” says McKenna. “If they knew how to do the job and were very proficient at executing it, they could compete against the guy who owned his own equipment.”
The ensuing expansion of rental access effectively sponsored thousands of contractors to get their start in business. So, in a sense, rental businesses and digging contractors have been partners from the beginning.
Looking ahead, this raises the question of how best to improve chances of staying in business by managing equipment dealings.
McKenna observes that although “a lot of contractors are good at performing their jobs, they are not so good” in management acumen, especially newer, inexperienced ones. Contractors should learn to do better at a number of tasks, he suggests. For one, they should sharpen their accuracy in building their costs into their job quotes. Then they need to control expenses “so that they wind up being profitable,” he says. Next, in their job-site execution, “They have to become more proficient and responsible with budgeting and production schedules and streamlining cost structures,” he believes. “Managing costs is probably the hardest thing for contractors these days. They can’t just go to suppliers and ask for help or beat them up for cheaper numbers, because that only subsidizes part of the job.”
Finally, in many small businesses of all kinds, cash flow management is often the most critical challenge. The level of competence shown in this often determines ultimate success or failure. In equipment acquisition strategies, as illustrated by the above discussions, cash flow should be a primary driver. Putting into practice the strategic insights that McKenna, Bourdon, Stemper, and Cantrell outline will be indispensable for staying afloat in the years to come.
Then, operational management becomes decisive. This starts with assessing near- and far-term construction trends so as not to be caught by surprise in the next downturn. Scale the business (staff and equipment) to maintain efficiency.
Finally, keep a sharper eye on the expense ledger.
McKenna sums up: “The most important thing for contractors is to watch the money going out, besides the money coming in.
“That’s really what separates the successful contractors from the ones that don’t survive.”
