THE EEEECTIVEMEss OF ALTERNATWES TO PURCHASE IN THE MARKETING GE CONSTRUCTION EQUIPMENT THROUGH DISTRIBUTORS ' find; for thoDegm ofPh. D i :1 MICHJGAN STATE UNIVERSITY Alen Jay Byfwork ‘ 19:61? * THESIS This is to certify that the thesis entitled THE EFFECTIVENESS OF ALTERNATIVES TO PURCHASE IN THE MARKETING OF CONSTRUCTION EQU IPMEN T THROU GH DIS TRI BU TO RS presented by Alvin Jay Bytwork has been accepted towards fulfillment of the requirements for Bu51ness Pho Do degree in Iltglulillistration 9 161a: MOE/7 fl Datew 0-189 LIBRARY Michigan State University ABSTRACT THE EFFECTIVENESS OF ALTERNATIVES TO PURCHASE IN THE MARKETING OF CONSTRUCTION EQUIPMENT THROUGH DISTRIBUTORS by Alvin Jay Bytwork Rentals, rental-purchases, and straight leases are the principal alternatives to purchase in the conStruction equip- ment industry. Rentals are primarily of used equipment for needs of less than a year where there is no intent to pur- chase. A rental-purchase contract is for a longer period with a purchase option attached to facilitate possible sale. Straight leases have no option to purchase, although aggregate payments must equal the purchase price over an average period of three years. A selective study was designed to investigate: 1. Whether the alternatives to purchase were as profit- able as sales, and 2. Whether marketing effort influences the volume and profits of rental-leasing. A In addition, the study was aimed at describing some marketing implications and adjustments for the alternatives to purchase. The rental-leasing literature relevant to construction equipment was examined. Facets of the major problems which appeared were consolidated into a questionnaire. Subsequent interviews and a pretest guided the reformulation of a final questionnaire which was sent to a national random sample of the AED (Associated Equipment Distributors). Cost and Alvin Jay Bytwork operating data were available from the AED. A cross-check of these data with those received from the respondents indicated that the respondents were typical distributors. Answers to the questions revealed both attitudes and practices. A comparison of this information with that obtained in a similar survey of contractors, the primary distributor cus- tomers, indicated that while distributors clearly perceived the reasons why contractors rent, they did not correctly evaluate the reasons why contractors lease. Major findings on the central problem include: 1. The alternatives to purchase have profit margins comparable to those of sales. 2. These alternatives can increase (or retard the decrease) of total income and profits; however, a rental is often in lieu of an outright sale. 3. There is no consistent ranking of the alternatives to purchase according to highest profit margins. A. Most distributors do not expand marketing efforts according to the profits they earn from each alternative. Attitudes toward rental-leasing sometimes divert their efforts. 5. When distributors directed their marketing efforts according to the profit margins, they earned profits above the median of all distributors. 6. About one-fourth of the total marketing effort is for rental-leasing, which accounts for a similar proportion of total income. Alvin Jay Bytwork On the additional issues, the findings are: (1) Credit requirements and tax considerations make it advisable to evaluate the market segments for each alternative prior to conducting marketing efforts. (2) There are different primary advantages and disadvantages for each alternative to purchase. (3) Distributors often grant free maintenance; therefore, they should arrange plans and rates to include some maintenance. (4) Independent professional lessors can often provide valuable marketing aids for the distributor who does not possess the necessary operational facilities. Copyright by ALVIN JAY BYTWORK 1962 THE EFFECTIVENESS OF ALTERNATIVES TO PURCHASE IN THE MARKETING OF CONSTRUCTION EQUIPMENT THROUGH DISTRIBUTORS BY Alvin Jay Bytwork A THESIS Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Marketing and Transportation Administration 1961 I, f? 2’". Ln flit S967 . - I I; 3:. if)- //{-5,7 ACKNOWLEDGMENTS The writer is deeply grateful for the guidance, direction, and encouragement of the thesis Chairman, Dr. W. J. E. Crissy. His readings of the manuscript and subsequent suggestions made the dissertation more succinct. Sincere thanks are given to the professors of the Graduate School of Business Administration who have been stimulating, the members of the construction equipment industry who provided valuable advice and returned the survey questionnaires, the members of the Department of Statistics who checked the methods of measurement, and fellow graduate students who made critical evaluations. I appreciate the efforts of my wife in the typing of the drafts while caring for increased duties. Finally, I stand in humble reverence before Almighty God for providing the opportunity, clear mind, and good health necessary for accomplishing this task. ii _...___‘.__—_ m... _...~ ~.-——— r... TABLE OF CONTENTS ACKNOWLEDGMENTS LIST OF TABLES Chapter I. II. III. IV. HISTORICAL CONCEPTS, PROBLEMS, AND PRACTICES THE IMPLICATIONS OF CONSTRUCTION EQUIPMENT LEASING Introduction Problems of Rental—Leasing Practices in Construction Equipment Marketing The Scope of the Study DESIGN OF THE STUDY The Problem Defined and Its Significance Hypotheses of the Study Methods and Techniques of Analysis Practical Questions for Examination Variations of Rental and Leasing Plans Financial Requirements of Leasing Tax Aspects of Leasing Legislative and Judicial Impacts on Leasing SURVEY ANALYSIS OF RENTAL-LEASING Significance of the Questionnaire and Sample Changes in the Market and Profit Evaluation of the Hypotheses MARKETING ADJUSTMENTS FOR RENTAL-LEASING PROGRAMS Evaluation of Reasons for RentalmLeasing by the Contractor Advantages and Disadvantages of Rental- Leasing to the Distributor Present Conditions Influencing Rental~ Leasing Potential Changes in Marketing Strategy A Leasing Program and Possible Pitfalls iii Page ii 22 33 101 Chapter VI. SUMMARY AND CONCLUSIONS OF THE RESEARCH Results Conclusions BIBLIOGRAPHY APPENDIX iv Page 183 192 197 Table 10. 11. 12. 13. 14. 15. LIST OF TABLES Comparison of Major Variations of Rental- Leasing Some Major Problems Faced During the Growth of Rental-Leasing Marketing Conditions and Practices Prevalent in the Construction Equipment Industry Contractors With Fewer Than 50 Employees Do Almost Two—Thirds of the Equipment Buying . . . . . . . . . Rental Activity by Construction Equipment Distributors . . . . . . . . . Variations of Distributor Rental-Leasing and the Percent Financed with Distributor Funds Total Construction Equipment Sales by the Major Producers, 1956 Profitability Comparison Model for Leasing and Buying Construction Equipment Comparison of the Geographic Area of the AED Survey with this Study Contractors' Use of the Purchase Option The Use of Purchase Options by Contractors and Distributors . Contractors' Plans to Lease (Rent) Rental—Lease Portion of Construction Equipment Acquisition Contractors' Reasons for Leasing (Renting) Distributors' Perception of Contractors' Reasons for Rental—Leasing V Page 11 78 103 106 106 108 109 111 112 Table 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. Reasons Why Contractors Rent and/or Lease as Viewed by the Contractor and Distributor Effect of Rental-Leasing on Sales and Profits Rank Correlations of Profits, as a Percentage of Sales and the Marketing Efforts Relation of Proper Marketing Direction and Net Profits, as a Percentage of Sales Relationship of Firm Profits and Profits as a Percent of Sales Comparative Credit Restrictions on Rental— Leasing Distributor Desires for Rental—Leasing Compared with the Percent They Are Now Doing . Rental—Leasing Activity as a Part of Equipment Distribution Forecast of Total Construction Equipment Sales and Rental-Leasing . The Main Reasons to Start Renting and Leasing Conditions that Aid Rental-Leasing Growth Main Uses of Finance Leasing Serious Problems of Finance Leasing Through an Independent Leasing Company Serious Sales Problems with Rental—Leasing Disadvantages to the Distributor with Rental- Leasing . . . . . Number of Firms Engaged in Renting Each Type of Construction Equipment vi Page 115 118 121 123 125 126 127 128 129 130 131 132 133 134 135 136 Table 32. 33. 34. 35. 36. 37. 38. Stipulations and Benefits of Rental-Leasing From Distributors Responsiveness of Distribution Methods to Marketing Effort Effectiveness of Marketing Effort for Rental— Leasing Volume Advantages of Rental-Leasing to the Lessee— Contractor Disadvantages of Rental-Leasing to the Lessee Advantages of Rental-Leasing to Lessor- Distributor Disadvantages of Being a Lessor vii Page 137 140 140 158 169 CHAPTER I HISTORICAL CONCEPTS, PROBLEMS, AND PRACTICES Introduction Rental-leasing in the construction equipment industry exists in three principal variations: rental, rental-purchase, and straight (or true) leasing. The last is the newest and least known so it will be defined first. A true equipment lease is a marketing method to distribute madhinery to a user for a long-term (usually a period of three years or more), without purchase option, while title remains with the seller or is transferred to a third-party. This definition has found acceptance in the literature and in common usage. The true lease plan does not include an option to purchase within the contract.1 Mr. Bruce McNab, in his thesis, recognizes this definition although his leasing dis- cussion is very general and does not single out true leasing. The true lease plans and arrangements can be quite varied. Jones and Lamson Machine Company have four true lease plans. g Bruce McNab, "The Lease as a Device to Market Equipment" (“Rpublished Master's thesis, Department of Business Organization, Ohio State University, 1959), p. 125- "Leasing . . . New Twist in Marketing Grows as it gets Older," EQGUStrial Marketing, February, 1956, p. 57. l Clark Equipment Company recognizes the lease without a purchase option an; a straight lease. Others do likewise. Following general practice in this paper, true and straight leasing will be used interchangeably. Straight leasing is narrower in definition than the following one of a general lease. Legally, a lease is a contractual arrangement under which the use of an asset is transferred by its owner for a certain period of time to another party for a consideration.1 The definition used in this paper denotes a more precise area of leasing. The straight lease, as used in about 45% of this paper, can also be prefaced with the adjectives--non—cancellable and finance. Together, these adjectives mean that the lessee (user) must pay, over a period of time, for the total cost of the equipment. These are terms that can be applied to the lease although they are not used in every instance. Short— term leasing has been distinguished from long—term leasing as being for a period of less than three years.2 While no legal distinction exists, rental is generally designated as having a time span of less than one year. Leasing of equipment started in the United States in x 1 D. Maynard Phelps and J. Howard Westing, Marketing EEEESEEEQE (Homewood, Illinois: R. D. Irwin, 1960), p. 321. Richard Vancil and Robert Anthony, "The Financial Community Looks at Leasing," Harvard Business Review (November—December, 1959) I p. 127. pre—Civil War days when Mr. G. McKay could not sell his sole— stitching shoe machine, so he decided to lease it.1 The general leasing trend then had its start. Part of the stigma attached to leasing as a subaltern method of marketing may also have had its conception from this beginning circumstance. "The attitudes of the sales staff toward leasing as a 'last resort' can adversely affect the success of the leasing operation."2 A segment of the rental-leasing movement, the straight lease, came into prominent recognition about a decade ago. "A major food corporation's need for equipment in 1952 marked the beginning of diversified equipment leasing." Ten million dollars worth of equipment was marketed by the true lease in 1952 and in 1959 this type of plan accounted for two billion dollars of sales. Most companies that have used this type of plan, as reported in the literature, are satisfied with the results. Many more concerns are planning for the use of leasing. It may be a marketing trend that has important future significance. Francis A. Babione, "Marketing Equipment by Leasing" (unpublished Ph.D. dissertation, Department of Business Organization, Ohio State university, 1949), p. 87. Personal interview with Mr. Ben Williams of the Wood Office Furniture Institute, Kellogg Center, April, 1961. He 13 owner of Office Lessors, Elkhart, Indiana. J. Kane, "Coming of Age of Equipment Leasing,’ Burroughs SEEEEEEELJHZEEEI Vol. 44 (March, 1960), p. 12. 4 Significance of the Problem Area This study, though limited to construction equipment distributors, will hopefully add to the knowledge of the marketing ingredients present in rental-leasing, to enable leasing as a marketing method, to be utilized in the most profitable manner. The study does not purport to analyze the marketing mix of the outright sale, but it will differentiate between the marketing approach needed for selling and the one utilized in rental-leasing. Historically, leasing has been defined as a financing and selling device. In mid-1944, however, it was put into the framework of marketing and called a marketing tool. To see the true significance of rental—leasing, one should review the connotations assigned to it. In its conception, rental-leasing was thought to be a manipulation tool used to make a "sale" by a different approach. Now that its use is becoming more prevalent, many consider that it is in the category of another marketing plan——such as a time payment Plan. Not everyone accords that significance to it. Although leasing has grown in importance, in a recent book it was referred to as just a "pricing device."l Others View it as a PrOmOtional device or a sales closing tool. Whatever \ D- Phelps and J. Westing, loc. cit. 5 nomenclature is assigned to rental—leasing, it is an important part of many marketing programs. We have proceeded a long way from the industrial revolution. Mass production is a possibility with almost every type of manufactured good that is produced in our economy. Yet in spite of all of the finished products, we have difficulty in distributing adequate portions at various times. We have inventory build-ups in some areas far in excess of those needed or desired. In a time of concentrated effort on mass production, mass distribution was neglected. Now with major attention being placed on product distribution, rental—leasing must be examined for development of its full potential as a distri— bution tool. Leasing contracts and arrangements are a complicated phase of marketing effort. In coping with these complications, we must examine basic business concepts. Practical Importance of this Study In this paper an attempt is made to differentiate the variations of renting and leasing. The word "leasing" is applied to so many different types of distribution plans that the advantages of one are often confused with the advantages 0f anOther. When the advantages of all of the plans are COmbined, it seems as though everything that is marketed should 6 be leased. It is then wrongly advanced as the panacea for marketing ills. No systematic recording of the extent and growth of leasing has been made. This paper makes a prognosis of growth on the basis of some trends and business conditions that affect leasing. When practical, the full details concerning the approach of rental—leasing are given. In the construction equipment industry, there is renting being done by the distributors and contractors to other contractors; and leasing being done by the manufacturers, distributors, specialized construction lessors,and bank lessors. Each approach may have a different effect upon the future of leasing and when this is true, the different approaches of rental—leasing will be discussed. There are many questions that must be resolved for leasing to make its most profitable contribution. Jones and Lamson Machinery Company studied leasing programs and compared alternatives for six months. Then, after beginning the program, they had to make major changes during the first month of leasing operations. If many practices and effects were made clearer, more companies might find leasing to be to their benefit. If l . . "Selling Now Means LeaSing, Too, Sales Management, March 18, 1960, p. 18. 7 companies can use methodological tools to analyze the financial arrangements of leasing, the changes in marketing strategy and policy that must be implemented, the added risks, and the altered market structure; then they might find leasing a more manageable and important tool. The finance studies of leasing have fostered important progress lately in comparing costs for the lessees; marketing studies have been less successful, thus far, in revealing the market considerations for the lessors. Distinctions in Rental—Leasing Operations To summarize some of the characteristics already mentioned and to facilitate the examination of rental—leasing, a comparison can be made of some elements of the contract and practices. TABLE 1 Comparison of Major Variations of Rental—Leasing Straight Rental- Characteristics Lease Purchase Rental Contract for 3 years or more Usually Seldom No Purchase option in contract No Yes No Payments equal the price Yes Sometimes No Cancellable No Yes Yes "Sales" aid by financier Usually No No Year Practice began 1952a 1887(approx.) 1861 Relaxed credit minimums No Seldom Possibly a . . . . . Diver51fied leaSing of many companies through an independent lessor. 8 The characteristics noted above apply to many industries although practices vary. For example, the lease by International Business Machines provides for a replacement of a machine when a superseding type is marketed, but a straight lease through an independent company requires the full contract period. Problems of Rental-Leasing Some firms, at best, tolerate rental—leasing as an unavoid— able hurdle in carrying out their marketing program. The reasons for their feelings cover a wide range. Some of the reasons are unfounded while others show a realistic attitude. Companies find that they may be relinquishing their used product market to professional lessors who resell the equipment after the lease period. The analytical tools of investigating the effect of leasing on their market position have been absent, resulting in considerable uncertainty regarding profitability determinants. To locate the specific problems of rental-leasing in the construction equipment industry for intensive study, a questionnaire pretest was given to selected distributors. The pretest questionnaire responses show inferentially that The questionnaire pretest was given to 30 members of the .Associated Equipment Distributors, Sales Managers Conference, iKellogg Center, March 15, 1961. The pretest questionnaire and results are in Appendix I. 9 many diversified fears are latent in the minds of those who may start the long-term leasing of construction equipment. Therefore, part of this study is used to shed light on these obscurities and thereby give direction to the action of those who are in a position of influence. After the problems of the distributors were probed, a final analysis for possible marketing adjustments was made using pertinent literature and some marketing theories for guidance. Some problems are not recognized by lessors: some are over-emphasized. The tables of advantages and disadvantages for the lessor-distributor, found in Chapter Five, illustrate areas of information for a new distributor philosophy. Objectives of the Study In this paper,some of the underlying marketing adjustments for rental-leasing are examined. In addition, the study will reveal the effectiveness of marketing by rental—leasing as applied in the construction equipment industry. These goals were decided at the provocation of one of the major writers on leasing—-"possibly effects of a wider use of leasing on a Single industry . . . are also worthy of consideration."1 \ Francis Babione, "Marketing Equipment by Leasing,' Journal W, Vol. xv, No. 2 (October, 1950), p. 209. 10 Attention will center on construction equipment distributors and their use of rental-leasing. Concern will be centered primarily on the marketing and sales use of rental—leasing to increase the sales within the United States, since exporting was as low as $50 million out of $1.8 billion of construction equipment shipped in 1959.1 Of the 1200, 900 independently owned and operated distributors of construction equipment are joined voluntarily in the Associated Equipment Distributors (AED),:2 with head- quarters in Chicago. All of the 1200 distributors account for 95% of the industry's products in the United States.3 The 900 AED members account for about 80% of United States construction equipment distribution. Specifically, this study focuses on how rental—leasing is used by the distributors within the construction equipment industry, how important it is to them, and the future of this type of marketing plan for them. Some of their attitudes toward it come to the surface. It is presumed by some, that one of the biggest drawbacks to leasing is not the loss of ‘ 1 Ehe U.S. Industrial Outlook for 1960 (Washington: U.S. Department of Commerce, 1959), p. 177. . This Association is referred to frequently and the initials AED will be used in future references. 3 .Ihe U.S. Industrial Outlook for 1960, op. cit., p. 176. ll ownership pride on the part of the buyer, but the loss of pride in salesmanship when "only a lease" is transacted. The model on the following page shows the focus and interrelationship of the leasing problem. Summary of the Problems A search of the literature revealed many problems attendant to marketing goods through some variation of rental—leasing. Those problems that are most recurrent to enterprises that rent and lease are summarized in the following table. TABLE 2 Some Major Problems Faced During the Growth of Rental-Leasing By the Dealer By the Customer *1. Lessors may buy direct. l. Uncertainty of tax, *2. Lose control of part treatment. of used-market. *2. Lease requires payments *3. Prospective customer may equal to full price. go direct to lessors. *3. Less recourse for service 4. Contract and tax mis- than with rental or rental— understandings. purchase. 5. Restrictions of capital *4. If manufacturer plays financing. greater role and dealer 6- High inventory investment. plays smaller role, the customer may lose his service facility. 5. Competition from dealer renting. 6. Increased competition from financially unsound lessees. \- *Problems particularly acute in straight leasing. 12 Vflify'l (tr/1: \ \‘Ix : ‘Consumer ( CE ,Pj hr“- r. Market \\ i Industrial Market / I ./ I - ,/ ;’/A- .f——*—— Total Market “emu”— for goods and services CE is the construction equipment market Does leasing expand the market (sales)? a-—-, b--- Note: It would be extremely difficult to differentiate between the expansion results of area a and area b. -——————Area of investigation for this study. Figure 1 Relation of Construction Equipment to the Total U.S. Market and the Area of this Leasing Study 13 Practices in Construction Equipment Marketing Rental—leasing plays a large role in total "sales" of construction equipment. The bulk of it was brought about through competitive action for short-period equipment use. Rental activity began at about the same time as the distributor organization came into existence. Previously, the factories sold direct to contractors and serviced these accounts, but this proved to be cumbersome and unsuccessful. Auction sales of construction equipment were not generally practiced prior to 1957. Since that time, they have been used to sell the excess equipment resulting from the completion of large projects, and that could not be sold profitably through the normal ' used equipment channels. "Auction sales by distributors and large contracting firms are indications of depressed market conditions and may establish a trend for the disposal of used machines in the future." Comparison of Distribution Methods Concern here is for the variations of rental-leasing vis a vis the outright or financed sale. The following table will help distinguish some characteristics of the construction equipment distribution methods. 1 Ibid. 14 TABLE 3 Marketing Conditions and Practices Prevalent in the Construction Equipment Industry Straight Rental- Characteristics Lease Purchase Rental Sale Maintenance in— cluded in payments No Seldom Sometimes No Open for inspection by seller Yes Yes Yes No Seller controls hours of use No Yes Yes No Easy repossession Yes Yes Yes No Close distributor- contractor relations No Yes Yes No Seller replaces obsolete equip- ment No No Yes No Average life of contract, in years 3 1.3 .5 3 Seller is sure of receiving payments Yes Usually Usually Yes Rate of interest on contract 6% 5% 7% 5% add-on compound simple compound Date of significant beginning 1954 1922 1920 ____ Importance of Construction Equipment Marketing Construction equipment marketing represents an important segment of the total industrial marketing effort with a type 0f durable good in a price range that would make some of the deriVed results applicable to other industries. In relation to the total industrial market of an estimated 15 $250 billion in 1959, construction equipment accounted for slightly less than one-hundredth of the total market. The price range of the equipment sold may be from a hose clamp selling for a few dollars to a dragline excavator valued at over $100,000. Some of the results of this study may be applicable to other industrial marketing areas for some of the same products and conditions are found in other industries. For example, the construction equipment industry uses fork- lift trucks as does the materials handling equipment industry, which was one of the first industries to use true leasing. The construction equipment industry was picked because it has been mentioned by many authors as being one of the most prominent in leasing. "The construction industry (including road-building) was among the 10 leading industries using leased equipment in 1958."1 It is active in rental—lease marketing and will thus be a source of facts and opinions about the features, advantages, and disadvantages of this type of Program. All types of leasing and rental activity are found to some degree in construction equipment marketing. Any comparison between the true lease, the short-term rental, and the rental- Purohase plan (where the customer may buy the item depending l . . Robert Sheridan, "Questions I'm Asked about Equipment Leasing," Contractors and Engineers (April, 1959), p. 2. 16 on favorable contracts, service, and use he may receive from the machine), will make a valuable contribution. The writer will also examine the effects of the variations of renting and leasing, and the extent to which each is found within this industry. Thus, while this paper is concerned in part with the finance lease, this study of the construction equip- ment industry will quantify some of the effects of all rental- 1easing. ' Construction equipment marketing utilizes channels of distribution similar to those found in other heavy goods industries. Most of the equipment passes through the following channel: Manufacturer-—-distributor---user, but some companies such as John Deere, have their own channel: Manufacturer---branch warehouse---dealer--—user. By using this industry, many of the specific findings will have appli- cation to other heavy goods industries with more validity than if a specialized industry, such as farm implements or office equipment, was used since the channels are more representative and the contracts do not have as many atypical clauses. In addition, the construction equipment industry was used because: 1. Many different types of the straight leasing plans are practiced: a. Yale and Towne, and Clark have their own leasing subsidiaries, ”.41 17 b. John Deere has a direct contract with the D. P. Boothe Leasing Company, c. Some distributors have their own leasing sub- sidiaries. An extensive survey of the industry could be made through the Associated Equipment Distributors so that complete coverage of a large portion of total industry I sales was possible. Conditions for the Growth of Rental-Leasing Two factors contributed materially to the growth of the rental and rental-purchase business in the construction equip— ment industry. These factors are: 1. The cyclical and seasonal use of machines by the contractors-—new construction starts are at the mercy of appropriation cuts by the government and curtailed plans for expansion by private industry. Uncertain future work reflects in the limited purchase plans by the contractor. Not needing equipment continuously, the contractor rents during the short period of use. The practice of contractor-to-contractor rental—- distributors overcame this disadvantage in part by engaging in this business themselves. They have been partially successful in turning this into a profitable 18 alternative to sale. Other factors contributing to the growth of rental-leasing but relegated to a secondary level of importance are: 1. Dealer dependency on rentals when equipment could not be sold during the depression era of the l930's-- equipment could not be sold even on the most liberal credit terms. 2. Attention given to renting during World War II--there were many Office of Price Administration hearings. The Office of Price Administration asked the AED and the Associated General Contractors (AGC) to calculate and publish a recommended procedure for establishing rental rates. Rental activity increased because dealers could not get the equipment to sell. It was a sellers' market so they elected to rent their inventory instead. This gave them a source of income. One interviewee said specifically, "We wanted to rent for we Couldn't get replacement inventory." The conception of finance leasing took place in 1934. The 1 F. Babione, op. cit., p. 116. OPA, Opinions and Decisions, Vol. I (Washington, D.C.: U°S- Government Printing Office, 1943), PP- 193 ff‘ F“ Interview with a non-replier to the AED mail survey. 'lnanCial information and personal attitudes were asked of the resPondents. Anonymity was promised them for obvious reasons. 11 erefore, all further quotes and references to them will be ~ 1.07 19,250,000 9.8 176,400,000 98 a"Range of Common Experience" figures represent the range reported by the middle 50% of responding distributors. The reader is cautioned that these values are estimates based on a projection of a single percentage base. A small change in the percentage will radically change the estimate of the industry volume. To elaborate further on the value of rented equipment, it can be noted that the middle "50% range of common experience" 50 as cited in the Cost of Doing Business, indicates an upper distributor rental income as high as 7.1% of sales. Cal— culating this activity by the previous method shows that 41% of the equipment distributed by this'firmewas rental equipment. Distributors are classified along product and volume lines (small, medium, and large). A dealer is either a tractor or non-tractor distributor. The non-tractor distri— butors are usually smaller operators in terms of volume ($1,446,713 average), but usually have a higher percent of their sales in rental activity (3.17% compared with .32% for tractor distributors in 1959). The higher percent of rental income may be due to two major considerations: (1) They may desire more rental business,for their products require less "free" maintenance. For example, a diesel engine powered electric plant might not require as much Inaintenance cost as a Caterpillar D—8 tractor. (2) The Price range on the equipment is lower, and with a lower volume Of sales to make their profit, they resort to rental activity txa produce income at the lesser risk per unit rented. This jJiference cannot be accepted without noting that the medium ‘R31ume, non—tractor distributors (sales of $1.1 to $2.1 Inillion annually) do the largest percent (10.26%) of the rental 1 . . . . Volume. However, this is more understandable when it is x 1 . . . . Cost of DOing BuSiness, op, c1t., p. 50. Rental income on "used" equipment. 51 realized that it requires a substantial inventory to: (1) become known as a "rental house,‘ and (2) be able to spread the risks of loss or damage to the equipment among several units so that losing a unit will not produce calamity for the business. One J. I. Case dealer, no longer in the rental business, reported that he rented a Terratrac to a contractor Who later stopped making rental payments. When the dealer went to the site to repossess the crawler, it had disappeared. Sometime later in his search, he noticed a patch of fresh earth on the north side of the lot. Taking one of his other tractors, he dug into the spot. There was his Terratrac! The contractor had covered the evidence. The tenuous nature of the contracting business precludes them from being classified as the best financial risks. Their rate of business failures is about 6% annually. The distributor plays a different part in the financing of rental-leasing depending on the variation of it. An approximate division of his financing role is shown below. TABLE 6 Variations of Distributor Rental-Leasing and the Percent Financed with Distributor Funds Rental 85% Rental—purchase 40% Finance lease 05% 52 About 30%1 of the distributors have started their own rental-leasing subsidiaries to finance a portion of this activity. The W. W. Williams Company of Columbus, Ohio, is one of those companies. This company is, however, an exception in that they fund a large portion of finance leasing (one—fourth of their total sales). Most other distributors use the subsidiary for only their rental and rental-purchase activity. A subsidiary can be incorporated to reduce the liability of the owners should they suffer heavy losses in the rental business. If the company then becomes bankrupt, the courts cannot attach the debts to the distributorship or the owner. As most distributorships are individual or family affairs, they wish to protect themselves against unlimited liability inherent in partnerships. When distributors do finance rentals, they "raise their prices to cover the cost of financing, operation in a secondary market, and increased selling costs."2 Distributor leasing requires either an abundance of dollars or an extensive line of credit. Of course, a dealer could be funding conditional sales contracts, in which case he could "factor? these to release monies for lease contracts. Distributor lEstimate by Mr. Clarence Griese, Assistant Director of AED Industry Relations, in an interview, March, 1961. 2 McNab, op. cit., p. 129. 53 financing provides for the greatest amount of control over and cooperation with the lessee, but it can be the most troublesome if the equipment is not operating properly. In the absence of a third-party, professional lessor as a buffer, when any equipment stops—-1ease payments may stop. "The distributor may require the lessee to agree to purchase the equipment for stated option prices at some time during the term of the lease, or at the end of the term."1 This allows the distributor to be sure that the price will be recovered in full. Should the distributor feel that he does not need this protection, the contractor will buy anyway, or that his bargaining position is not strong enough to demand this provision, an option to purchase may be included. Most construction equipment rentals are written on the typical AED contract and have a purchase option, with the rents applicable toward the sale price on a diminishing scale. If purchased within 3 0 days, 90% of the paid rental to apply on full value or purchase price set out above. If purchased within 720 days, 80% of the paid rental to apply on full value or purchase price set out above. If purchased after 900 days, none of the rental provided for in the attached contract is to apply on the purchase price set out above. If and when this Privilege of Purchase Option is exercised the lessee agrees to either pay the balance in cash, in which event the lessor will execute a bill of sale, or enter into a conditional sales contract or 1 . . . C. W. Steadman, "Chattel LeaSing — a Vehicle for Capital EXpansion," Business Lawyer (American Bar Association, Jan., 1959)I p0 5230 54 chattel mortgage as lessor may require and upon such terms as may at that time be agreed. Leasing Company D. P. Boothe, Jr. was the first to start a diversified leasing company, May, 1952. Deere and Company started their lease plan with the Boothe Leasing Corporation with an announce- ment on January 26, 1960. "Four thousand John Deere dealers from coast to coast will have this lease program available as an added sales tool. A substantial volume of profitable lease business from this source is anticipated."2 Leasing through lessor companies in the United States grew to $197 million in 1960, one-third of the total amount of long-term finance leasing ($530 million).3 These long-term finance leasing figures do not include railroad rolling stock, cars, trucks, or equipment from International Business Machines Corporation and other companies with "operational rental plans." Reasons for excluding the last group are: (1) company 1This is a portion of the typical Associated Equipment Distributors Contract. The AED will send samples of the contract to their members who request them. They mention in the cover letter that, "if your attorney should advise you that these forms are acceptable for your purposes in the states Where you sell or lease equipment they may be ordered from Von Hoffman Press, Inc., in St. Louis, Missouri." 2 . . 1959 Annual Report, Boothe LeaSing Corporation. 3Arnold W. Rodin, "No Slowdown in Leasing Industry; Volume Jumps to $530 Million in 1960" (Chicago: Imberman and DeForest, Public Relations Firm for Nationwide Leasing, Dec. 15, 1960), p. l. 55 financial reports do not separate satisfactorily the rentals from the payments for services, and (2) the merchandise can be traded in for new equipment when it is superseded. There are two primary types of leasing operations carried on by leasing companies. The first is direct leasing. A business wishes to obtain some equipment, so instead of purchasing it, it investigates leasing benefits and arranges to see one of the 50 or more leasing companies. The other type of leasing through professional lessors is merchandise— 1easing. These are the pre—arranged programs between the professional leasing companies and manufacturers or distributor organizations. To indicate the importance of the latter type of leasing, the merchandise—lease plans account for about 60% of the volume of Nationwide Leasing Corporation.l Deere and Company has this plan with Boothe Leasing Company. It is described below in detail. Merchandise-Leasing A manufacturer arranges a leasing program with the leasing company, that will be uniformly used by all of its distributors. The leasing company sets up a complete sales training program so that his leasing program will have maximum impact. In merchandising—leasing plans, W. Freeman, "Leasing is Found to Expand Sales," Qflgy York Times, November 29, 1959, p. 3. 56 leasing is used as a primary sales tool, giving the manufacturer's salesmen an important new way to move goods. Not only does this normally enable a manufacturer to increase his sales by the added leasing volume, but the interest generated around the leasing plan results in opening new markets for the product and inevitably results in increased direct sales, often greater than the leasing volume. The sales assistance received from the lessors is often substantial. They will print brochures for the manufacturer with the equipment and leasing details pictured in an attractive setting. These promotion pieces, usable as either sales aids or mailing stuffers, are generally free to the dealers. Boothe Leasing Corporation sent leasing representatives to most of Deere and Company's distributors, who then explained the program to the sales staff and made some joint calls with Deere salesmen. A merchandise-leasing plan can be arranged through a number of leasing companies. Programs do, however, vary considerably. KSM Leasing Corporation does not include an option-to-purchase in any of the contracts. KSM will include maintenance, but prefers not to do so. "If we are to include it, the maintenance cost per year would be included in the original invoice cost when figuring the monthly charge." lR. Sheridan, "Questions I'm Asked about Equipment Leasing," Contractors and Engineers (April, 1959), p. 2. 2KSM Leasing Manual and a personal letter from L. S. Clark, Vice-President of KSM, July 13, 1960. 57 Direct Leasing Direct leasing (the occasional lease arrangement) still accounts for the greatest volume of business with leasing companies. Manufacturers want to be free to choose the lessor that best fits a particular transaction. In some instances, they could not install a uniform plan for all distributors, for it would meet too much opposition from those who count leasing as an "unnecessary evil." Even without a national plan, distributors can take advantage of this financing method. They can contact the lessor directly when one of their customers is interested in leasing. KSM guarantees not to interfere with normal selling arrangements. "We will contact your customer on a specific lease proposal only at your request or suggestion." There may be some danger of competitive interference from leasing companies,although there has been no strong evidence of it as yet. James Talcott Leasing Corporation, a company that specializes in financing construction equipment, advertises: "Are you planning to buy more Income Producing Equipment?, 'Talk to Talcott First' . . . About Leasing."2 These lessors may later, with their large volume of business, lIbid. Wall Street Journal, repeated advertisements. 58 be able to influence both the seller and the lessee. Nationwide Leasing Corporation, Chicago, intends to buy l5% of Remington Rand's output, excluding the Univac. This purchasing power has the potential of price and bargaining leverage. Automobiles are now purchased by car lessors at $100 more than the dealer”s cost.l Some distributors hope that similar arrangements will not be made with construction equipment manufacturers. Manufacturer Leasing It is worth noting that manufacturers were the originators of the practice of leasing. It was first used only after attempts to sell resulted in failure. This was the last resorti United Shoe Machinery Company found other uses for it quickly. It was found successful for controlling the use of the equipment and the patents. It was a means of controlling the market and then adjusting the effort to it. Another of its advantages was stability of income. In one of the earliest articles treating the marketing aspect of leasing,2 the stabilized rate of growth and profit for the International Business Machines Corporation and United Shoe Machinery was _l lLee Fleet, Dealer Franchise Plan, Lee Fleet System, Inc., 1958. 2R. McNeill, "The Lease as a Marketing Tool,” Harvard Eusiness Review (Summer, 1944), p. 419. w.__‘ 59 traced from 1928 through 1940. During that period, the former derived about one-half of its income from leasing and enjoyed double the annual profits at the end of the analyzed period. United Shoe's profits remained at about the same yearly amount during the 12 years. The writer inspected the gross and net income of these two companies from 1940 to 1959. Most of United Shoe's income during both periods was the result of the leasing program. Gross income grew from $45 million in 1940 to $90 million in 1959. While profits fluctuated during some years, profits averaged about $9 million annually. Many other manufacturers lease a portion of their output. Pitney—Bowes receives 50% of its income from rent and services, and American Machine and Foundry, 20%. There are some significant differences between the classic "operational" leasing examples and finance leasing. Most of the above companies have relied heavily upon leasing, almost to the point of not wishing to sell any of their products. Finance leasing is just another means of marketing and financing. IBM allows equipment to be "traded in" when the equipment is superseded. Finance leasing requires payment during the whole period: the equipment cannot be returned. In common with the examples given, Caterpillar Tractor, Yale and Towne Manufacturing, and the Clark Equipment Company have experienced 60 growth with leasing revenues.l As an example of one type of plan in the construction equipment industry, we can look at the Clark Equipment Company for the effects of leasing on distribution. Dealer Arranged The distinction that is being made in the manufacturer leasing plans is one of degree of cooperation and involvement by the distributor, rather than control. The Clark distributors have a financial interest other than receiving the commission checks (which amount to the same as if the sale was cash). The commission comes directly from the Clark Leasing Company, a subsidiary of Clark Equipment. The title is given to the Clark Leasing Company, but the dealer must agree to buy the used Michigan unit (Clark‘s line of construction equipment machinery) for 5% of the selling price if the contractor does not wish to buy the equipment after the lease.2 Of course, the contractor is also given the right to renew his lease at reduced percentages of the initial rental fees. 1 . . . . H. Edelstein, "GrOWing Trend to Renting vs. Owning Capital Equipment," Magazine of Wall Street (July 6, 1957), p. 454. 2 . . . . . "LeaSing . . . New TW1st in Marketing Grows as it gets Older," Industrial Marketing (February, 1956), p. 57. 61 About 25% of C1ark°s business is related to leasing. This does not say that 25% of their "sales" are leases. Many times a contractor can be approached with this idea, and there- by,he may become interested in the product. He may later find that buying outright would be the best in his particular case. Sales are stimulated that otherwise might not have been con- summated. Clark estimates that over half of its leasing business comes from customers who have never purchased Clark equipment before. Some of the switching from a lease to a sale might come about because of the high credit standing necessary for leasing. Without a down payment or lease payments in advance, more is owed to the company; therefore, a higher credit rating is demanded. C. E. Killebrew, Vice President of the construction madhinery division of Clark said, "We do not . . . and will not . . . take credit risks that are unwise. In a good many instances we have had to deny their requests because even as good as our plan is, it does not provide a man with more credit backing." The financial considerations of Clark‘s plans have concerned a few of its distributors. .Some of the complaints have been unusual. One Midwest dealer remarked, "I sell other lines of 1Ibid., p. 56. 62 equipment. Sometimes when a contractor really needs a larger unit than what Clark offers, he will buy the Clark from me just because the finance rates are so low. This prevents me from selling the type of equipment they should have. I wish Clark would get out of the banking business."1 The tone of his voice emphasized his intense dissatisfaction with leasing. The interest rates charged are most reasonable for the straight lease without the option to purchase—— slightly over 5% simple interest. The interest rate with the option to buy is 5% higher. Like many construction equipment leasing plans, at least 50% of the price of the equipment must be paid in equal installments during the first year of the lease.2 Sitting behind his desk, one Clark dealer remarked, with a grumble, "There are no misunderstandings with Clark. We just finance many of the leases of Clark machinery through the bank. The details stay closer to home that way." Clark Equipment also has a rental subsidiary, the Clark Rental Corporation. The Sales Training Manager in New York said the main distinction between rental and leasing is that "leasing is without maintenance, rental is with maintenance. We rent very little construction equipment mainly because we lPersonal interview, January 20, 1961. Name withheld for obvious reasons. 2Bulletin on the Michigan Lease Plan, Clark Equipment. 63 . ..1 haven t tapped the market yet. A sales manual has been designed for a one—hour course to be given to the Clark dealers. Guides to the sales approach are also given. The approach will depend of course on the customer and the situation at hand. To a qualified customer Who is known to finance most of his equipment, a direct approach could be used. "We can put this machine on your job for $66 a month—~no money down." Such an approach would create immediate interest to this class of customer. The direct approach would be unwise in other instances. If the customer is unknown to you and his place of business does not look particularly prosperous, it would be better not to lead directly into financing . . . In areas where seasonal changes create down time, a (skip payment) contract is actually encouraged. Customers may make as many as four token payments per year (minimum payment is 1.25% of the sales price per month). The manual further points out to the distributor the advantage of manufacturer leasing: l. One—stop shopping. 2. Immediate financing. 3. Feeling of continued manufacturer interest. Clark's construction equipment leasing program has enjoyed success since its conception in 1953. Mr. Kennedy, the' Marketing Research Manager at Benton Harbor, said his construction equipment division enjoyed a rise in sales as a result of the leasing program. To get some idea of their increase, the l . . . Personal interView, Mr. Ted Werner, New York City, May 15, 1961. 2 . . . . . . . J. Tiedge, "A DiscuSSion of Credit and Equipment FinanCing," Manual for Sales Training School, Construction Machinery Division, Clark Leasing Company. 64 whole industry should be brought into perspective. Of the $1,866 million construction and mining shipments in 1956, 54%.were accounted for by five major producers. TABLE 7 Total Construction Equipment Sales by the Major Producers, 1956 Caterpillar Tractor Company $ 585 million International Harvester 189 Allis-Chalmers Manufacturing 129 Euclid, Division of General Motors 71 Clark Equipment, CE Division 37 $ 1,011 million Source: Marketing Research, Clark Equipment, CE Division. Some companies do not report their sales by division, so some figures are estimates. The above figures were chosen so that some comparison can be made with Clark's activity. In 1958, when total construction equipment sales dropped to $1,400 million (-25% 1 . . from 1956) and International Harvester“s construction . . . 2 equipment sales dropped to $173 million (-8%), Clark construction equipment sales rose to $47 million (+13%). Of Clark's $47 million in sales, $6.7 million was leased, or 1Construction and Mining Shipments, Statistical Abstract of the United States (1960), p. 320. Company report, Standard and Poor“s. 65 12.5% of sales. We cannot attribute this forging ahead in the market to leasing alone for promotional factors also play a part. We can, however, see the effects of favorable marketing plans. At the end of 1958, Clark Equipment had over $8 million of construction equipment on the lease plan. This represented about 19% of the total construction equipmentqgnflease in the United States, which in 1958 was about $42 million.1 It should be noted that figures on national leasing of construction equipment are not recorded by the government. Figures recorded by private businesses are not standardized. The writer quantified leasing volume, risking the possibility of diverse estimates, so that the relative importance of leasing in this industry can be more clearly visualized. Clark has an industrious management-—from the presidency to the dealer level. "Forbes ranked Clark management highest among 13 major companies in capital goods . . . . When the new Construction Machinery Division found dealers sewed up by rivals, Spatta [the president] would persuade the best salesmen . . . 2 to set up on their own, With Clark‘s backing." H 1"Equipment Leasing Rose During 1959, Michigan Roads and Construction (January 14, 1960), p. 7. 2L. Hughes, "George Spatta, Dynamarketer-—Clark Pushes up in Four Fields at $208—Million Sales Clip," Sales Management (June 3, 1960), p. 62 66 Manufacturer Subsidiary Yale and Towne Manufacturing Company, as Clark Equipment, views the leasing business as an important outlet for new products. Starting out in 1953 on a joint venture with CIT Corporation, the industrial financing subsidiary of CIT Financial Corporation, it gained enough experience to form a leasing subsidiary. The difference between this organization and Clark Equipment is only slight; therefore, this discussion will be brief. The difference was explained as this. "You can set up a subsidiary, as Yale and Towne has . . . or you can handle it through local representatives, as Clark Equipment Company, Buchanan, Michigan, does."l Clark Equipment requires its dealers to arrange the financing details. Yale and Towne has the more centralized operation. When Yale and Towne first began to lease, CIT men explained the plan to the branches. They,too, were new at this. As a result of the plan, the manufacturer arranged for additional dealers. Because of an extended market, it invested more in sales promotion. l"Leasing--Its Pros and Cons," Steel (May 29, 1954)! P' 6' 2 . . . . "LeaSing of Y & T Lift Trucks Hints at New Marketing Trend," Industrial Marketing (March, 1953), p. 166. 67 In Yale and Towne's leasing guide, the lease is stressed as a "highly valuable merchandising tool." Although the guide states that it is for "companies needing equipment and who are either unable to purchase outright or are simply unwilling to purchase in order to obtain use of the equipment,‘ leases are usually restricted to a three year period. They have lenient financial arrangements and if a favorable Dun and Bradstreet rating is given, "no financial statement or other credit information is necessary."1 Payments during the lease are sent directly to the subsidiary and other used equipment may also be included in the lease payments. At the end of a lease, the distributor is asked by the manufacturer to sell the equipment if the renewal option has not been exercised. The sales receipt is then shared with this dealer on a 50—50 basis. Bank Leasing Banks provide much of the money needed by leasing companies. The Bank of America supplied funds that enabled D° P. Boothe to start the United States Leasing Corporation. Why not lease directly from banks? Many restrictions make it inadvisable for some banks to be lessors. Regulations may prevent them from 1"Terms of Standard Lease Plan," Yale and Towne Manufacturing Company (June, 1960), p. 7. 68 sharing in the rebate at the end of the lease, which other lenders may receive.1 Funds may be limited for distribution within a given territory. They may not have the bookkeeping organization to depreciate equipment. They also may not have enough "marketing orientation" to sell lease benefits. How— ever, despite these limitations banks do handle a significant portion of the total volume of leasing. Banks are often used in leasing because they are convenient to the transaction. They are concerned, however, about owning the equipment with the possible responsibility for maintenance. For this reason, the credit emphasis is placed on the lessee rather than on the manufacturer or on the value of the equipment.2 Banks wish to be certain that the lessee will not withhold the paymentsdue on faulty equipment. There are two good reasons for the distributor to use his own bank: (1) the rate of interest is likely to be lower, and (2) he is better known there and so may succeed in having the note processed "without recourse." If the lessor's credit line is fully utilized, it is desirable to try the lessee's bank. Many banks will finance only up to 85% of the value, with 1Gordon Brown, "Role of the Lender in Equipment Leasing," Commercial and Financial Chronicle, Vol. 191 (January 28, 1960), p. 449. 2Gant, op. cit., p. 123. 69 the manufacturer or dealer financing the remaining 15%. "Compensating balance requirements" may lower the actual loan percent of the value to about 65%. Some lenders may require of the lessor, a chattel mortgage or an assignment of the rent or lease. A recorded mortgage would be valid against "a defaulting lessor."l Under such an arrangement the lessee might still retain possession of the leased equipment and pay only the normal rent. An important detail to be remembered about the bank arrangement is this. When safety of the loan is paramount to the bank, bank action similar to "recording the lease,‘ may make the lease a conditional sale, and then related tax advantages are lost. Finance Company It was noted previously that a finance company assisted Yale and Towne Manufacturing Company in the conception and initiation of its lease program. Finance companies have supplied funds for most of the straight lease plans. Banks tend to be more conservative about putting money into the relatively new process. Insurance companies are prohibited by many state laws from investing in industrial equipment other than transportation equipment.2 1 . C. W. Steadman, op. c1t., p. 547. Council for Technological Advancement, op. cit., No. 21, p. 17. 70 Although finance company interest charges average about one percent higher than interest charges of banks, the money is usually more readily available. The process is generally quicker and smoother which is important when a contractor is taking out his first lease. The treatment he receives on his first encounter with leasing is likely to affect his reaction from then on. Distributors or manufacturers can approach the finance companies for special plans. One manufacturer has only his out—of—pocket costs financed and he holds the paper for the balance (profit markup). This way, the interest is only 6%, simple, on the monthly balance.1 The largest financers of construction equipment leases are CIT Corporation, James Talcott, Incorporated, and Walter E. Heller. The last two firms have associated leasing companies: James Talcott Leasing and Nationwide Leasing, respectively. The combination of the financing and leasing operations makes the process more integrated and allows a greater concentration of time and effort on the marketing aspects of the plan. The companies have only to obtain the lease business; they have the funds for financing. 1"Machine Tools: Lease or Buy," Business Week, July 24, 1954, p. 88. 71 Financial Requirements of Leasing Balance Sheet Changes One of the strongest appeals made by equipment lessors is . . l "Conserve your Working Capital." If the lessee does conserve working capital, then someone must be putting up sufficient money to finance the cost. The distributor may choose to finance his own "paper." The money may come from internally generated funds. "For the industry as a whole, about 80% of the total 1960 investment will come from such funds."2 The dealer may supply the funds or he may obtain a general loan against the business. The current assets of the dealer in the former case are depleted and if the contractor's practice is to eliminate the lease as a long-term liability, how may the distributor call it a long-term asset? The accounting profession has only inferred the correct recording of a rental—lease. When lease payments owed are "material," the footnote should be used to disclose the obligation rather than a formal recording in the body of the balance sheet.3 Individual contractors and distributors may l O 0 O I A preliminary content analySis was made of equipment advertisements appearing in five major construction magazines. D. Keezer, “New Financial Factor Brightens Marketing Outlook," Industrial Marketing (February, 1960), p. 39. 3American Institute of Certified Public Accountants, Bulletins 38 and 43 (New York: 1948; 1953), p. 126; p. 291. 72 vary on What is "material,' relevant, or morally correct. Even financial institutions do not thoroughly evaluate lease obligations. Of 512 financial businesses surveyed, intense investigation showed that only a small percent of them used a formal analysis of the lease.1 Sixty-five percent of the finandbrs in this corporate survey said that non-cancellable leases allow greater credit than debt financing. Some interesting changes that affect leasing operations have occurred in the financial picture of the average construction equipment distributor over the last five years 2 . (1955—1959). The follow1ng changes are noted about the average balance sheet. Balance Sheet Entry Percent Change Notes, leases, and Accounts Receivable- as a percent of assets have gradually fallen from - — - — 33.05 to 30.22 while Inventories — have gradually risen from 51.82 to 55.10 and Notes Payable — as a percent of Liabilities and Net Worth have gradually risen from — - — — — 24.27 to 31.83 l . . . . R. VanCil and R. Anthony, "The FinanCial Community Looks at Leasing," Harvard Business Review (November-December, 1959), p. 116. 2 . . . AED, Cost of DOing BuSiness Survey, op. c1t., pp. 24-25. 73 In addition, the ”current ratio" of distributors dropped from 1.92 in 1958 to 1.76 in 1959. This is similar to the general decline witnessed by industries. The average ratio for all industries fell from 2.4 to 1.9 in a decade.1 Close review of these balance sheet changes above and other data seem to indicate that distributors are financing a smaller percentage of the rental—leasing business while seeking money from various sources to finance a greater inventory for rental activity. The contractor must also be concerned about his capital position. The "current ratio" is one of his concerns. If the contractor has a large quantity of machinery, which for the most part is still unpaid, his "current ratio" may not be satisfactory to make large contracting "bids." If the contractor is able to rent or lease some of his machinery, the dOWn payment that he normally would pay, remains in his current assets while only the first year‘s rentals are required to be shown in the prg forma balance sheet. With less total liability recognized, the "current ratio" will be much higher. There are many misconceptions about the balance sheet being a representation of the financial strength of the con— tractor. Some misconceptions are discussed later. One noted lFreeman, loc. cit. 74 here is that bondsmen feel that a high cash position helps to insure the carrying out of a contract. However, one AED member took an opposite stand: When a contractor owns machinery, he shows a greater intent of carrying out his contract obligation. He has the equipment with which to work, and an obligation to pay for that equipment. This drives him to make the machinery productive and thus provide income for payment. The Buy or Lease Considerations Emotional factors enter the buy or lease decision. Contractors, like other businessmen, feel a pride that comes with owning their equipment. These emotions vary in intensity from time to time within each individual, as well as among individuals, making any attempt to weigh this factor very difficult. These emotions guide the philosophy of the customers. After investigation, however, one writer did state: "A very interesting change [is] taking place in our society. No longer is it distasteful to rent."1 The rational aspectscflfthe buy or lease decision are easier to quantify. The problem can be looked at from different views: 1. Cost comparison. 2. Working capital and profit analysis. lMcNab, op. cit., p. 135. 75 The Canadian Association of Equipment Distributors studied the lease-buy decision. They compared finance leasing with buying through a finance company and through a bank.1 The cumulative cash outlay was planned through a five year period with the income tax considerations included. Canadian distributors pay a 50% tax while larger United States contractors pay 52%. This would give United States contractors a 2% greater tax application advantage to leasing than enjoyed by Canadian lessees. Results of their comparison showed: 1. Finance leasing is useful as tax relief only to the larger contractors (high income tax rate). 2. "The cash outlay is less, through leasing, for a certain period."2 3. It is better for contractors to do their "own financing, but for a short term, they are better off to lease because they have less cash outlay and more cash on hand." Profitability Model A marketing aid in the form of a model to show profits 1"Comparison of Cost and Cash Outlay When Leasing and Pur- chasing using Standard Rates for Each Type of Financing,” Canadian Association of Equipment Distributors, 1961 Annual Convention, April 25, 1961. "When to Lease or Not to Lease," Panel discussion, Canadian Association of Equipment Distributors Annual Convention, April 25, 1961. 76 available through leasing to the contractors would be of assistance to the distributors. The task here is not to weigh all the decision factors that must be individually examined by each contractor. Nor is this a treatment of the rental or rental—purchase decision. It is realized, however, that factors such as expected period of use, credit position of contractors,and disposition of the dealer towards this activity play decision influencing roles. Unlike a rental or rental-purchase, the contractor can obtain a finance lease even if the distributor does not offer it. He can go directly to the leasing company, and if the application is approved, the leasing concern will pay the distributor the full amount in cash. It must be mentioned that the receipt of cash is not always so prompt. Mr. Walter Green of Rapids-Standard Conveyor Systems said, "They want the equipment operating satisfactorily before they [the leasing companies] pay out any money. oOperating satisfactorily' is a relative term. One conveyor was not approved because a box was delivered five degrees off-center. We still do not have our money from that deal." Many computations for the lease or buy decision have been made. Most of them have not been suitable for presentation in lPersonal interview, Grand Rapids, Michigan, January 10, 1961. 77 a sales interview. Therefore, the writer computed the figures for a comparison between the finance lease and term purchase. These data are on the following page. Brief comments should accompany Table 8. The lease and purchase arrangements are compared for a three year payment plan. The interest charge on the lease actually amounts to 18%.(6% X 3 years), collected in advance. The rate shown is higher than that charged by some companies. The lease is without option to purchase and meets those conditions that will allow the full lease payment to be an expense for income tax purposes. If no equipment was obtained, the money paid in the model would be profit. Assuming that this contracting firm is a corporation that makes over $25,000 profit a year, or a sole proprietorship or partnership that is in the 52% income tax payment bracket, the firm would pay $20,454 of the $39,334 profit (shown in the model as lease payments) in income tax. Thus, by putting the money in new equipment, the actual cost is only $18,880. The lease can be renewed in the fourth year at 5% of the selling price. The model figures could continue for the full ten years, but the turning point of profitability can be seen after the third Year when depreciation allowance continues on the purchased equipment. The depreciation under the purchase plan is the highest .ooflum umfla mo fim pm wow HMBmemp .usmfihmm c300 ooo.omw mmUSHUsHU 78 .00 .Q .Ammmav ummmpmpmum paw ssm .mOHumm DCMDMOQEH WA may mo mummw m>lewwcmBB .mstom .MQ .maspmfiom .H% OH .mpHmeIMOIfidmm psmfimwsqm m w poms mo m5am> W pmxume Hammflv m mma.va 1A, m M mm¢.aam m mon.oom m 04¢.H6w pmm mno.ml M mh©.ml m>©.m oam.oa W oow.m ooo.m m owm.m aao.mu 1 446.6- 4H©.o oms.ma W ooa.m 680.... a msH.HH mav.mm W mmo.ms W owo.6m mum.m Ham v amm.ma mom.m mwa.©a www.mm m omm.ma vmm.mm m mmh.m mam w mm©.ma HBH.OH oom.ma www.mm w omm.ma vmm.mm N Hhm.m hm©.om W nam.mm omm.aa 0mm.mm o>m¢.am m omm.ma amm.mmw H pflmoum, Hmuflmmo mmzfl>mm COHDMHumHQmQMWOHDMHUonmmn mpsmfimmm mmcfl>mm mpmmfihmm “mow xm.sa @ mcflxuos xme 6am tam pmmumpaH xme xmm Hmscc< namuflmmo co Hmuwm ummumpsH pmmHopsH paw _ Hmumfi umoo msflxuoz so mosfi>mm pmoo co Hmmfloaflymw Hmsuo< mmcflsumm “oz Aévlfimv Hmsuom mmsfl>mm HmDOE Adv m.nouomupaoo n on Ame xmm mommamfl map Xma H .mH» m x couppm AOVCOmHHmmEOU so #mmumpcfl .H>\Xo .ummumucfl .H>\X© Amv mEHmp do wmmfloudm Amummmmq mocmsflm Hm>03m Hm3om ooo.ooaw pcofimflsqm Goapofiupmcoo mcflhsm .m> mcflmmmq Mom Hmpoz somflnmmEOO huHHHQNUHMOHm m mqmdflu 79 that is normally allowed, without consideration for special depreciation allowances sometimes given contractors on govern— ment projects. The depreciation continues after the equipment has been paid for,thereby changing the profit picture as time .progresses. The 52% tax saved by applying the depreciation cn1 fourth year profits lessens the "actual" cost of the enquipment from the third year value. The differences in actual costs after tax considerations, sliown in comparison (C), allow more working capital to remain vvi.thin the firm. In the case of contractors, working capital is; necessary to meet bid bond requirements. It is recognized tliat profit is not made on the amount of working capital in thus firm but on the amount of profit from completed construction lCflos. The working capital ratio to profit is one useful tool fox: measuring the financial position of a firm. With more Wntractors. The model does serve, however, as a guide. erien altered for specific situations, it may be conveniently 'usyed for explanation in sales interviews with contractors. In summary, contractors find that leasing equipment is prnofitable when the need is for only about three years and WTMen they can invest the funds thus conserved at a return of 1596 or more. fikmonetary Cons iderat ions The attitudes of the contractor as well as the distributor are: not easily changed. The questionnaire analysis brings SCHnee of these distributor attitudes into the open. Attitudes 0f <2ontractors are not always easy to discover, but some have been) mentioned. Some contractors will refrain from leasing and :renting even though the cost would be less, just so the' prafirtice vflJJ.not increase and let "unworthy" contractors into the market. 81 It is difficult to put a "price tag" on the value of ownership pride, but each contractor, consciously or uncon- sciously, assesses this when he makes the buy or lease decision. This value has often been mentioned as the main Epurchase were twice the amount ($50,000) for which the lessee could and did purchase the premises at the end of the S‘ENEar term."1 This lease did not provide for rent to be Crediited against the purchase price. \ Rent vs. Purchase,612 Standard Federal Tax Reports “Wishington, D. C.: Commerce Clearing House, Inc., 1960). 84 If the total rental is more than "reasonable" under a purchase option contract, then to avoid giving the idea that equity might be building up, the additional amount over the normal rental could be specified separately as "“Consideration for the option,u the lease making it clear that this additional Eaayment confers no equity in the property."1 It may be that Cfilark Leasing Company"s brochure stating a 5% higher interest cliarge for leases with an option to purchase, will satisfy tlie requirement of this separate payment and make them tax 6 eductible . Development into a later sale holds little affect on rent dexductibility as an expense. "Rental deductions were allowed orx machines which [the] taxpayer later purchased."2 The Ccnicern is that the intention to buy was not present at the tinke of the lease contract. The intent is not always clearly discernable. "The tax— Paxner rented equipment for use in his contracting business, ustually at a monthly rental of 10% of the list price of the eqtuipment. He retained possession of some of the equipment GUIthg the non-working season, at the request of the lessor, Witliout paying rent. Some of the equipment he purchased, aFEXLying rental payments to the purchase price." These \ 1Ibid. 2 Western Contracting Co. 271 F. 2d 694., 1959. 85 paynents were disallowed as deductions.l As the intent is so :hnportant, the writer suggests typing on the contract form-- “flflne intent is to rent. The purchase option will be exercised cuily if the situation changes." If the equipment is to be rented at daily or weekly rates lfiased on production, use, or mileage not directly related to prtice and the purchase option would be exercised at the fair nmxrket value at the date of purchase; then it would usually be ccnasidered a lease by the government. Eggnsiderations Supporting Tax Exemption No one group of measures taken can insure that contractor lxaase payments will ultimately be classified as an expense in tflue tax courts. It is advisable to note that a Pre-clearance VWith.the Internal Revenue Bureau will save many headaches. Chlst:a brief word about this procedure. When a distributor dexzides what typescfiflease arrangements are most desired by bids contractors, he should then determine what arrangements arts most compatible with his own needs and requirements. A Stzxndard lease form can be drawn up with the aid of his lawyer, Perhaps using the AED form as a guide. This should be sub— mitted to: Lease Pre-clearance Section, Internal Revenue l Abramson v. U.S., 133 Fed. Supplement 677, 1955. 86 Bureau, Washington 25, D. C. Instructions are in Revenue Ruling 54—572. While this precaution will not guarantee that all future leases will be treated as expenses, because the courts reserve the right to interpret the rulings and code, the IRS is closest to the intent and interpretation of the law. Considerations to be included in the preparation of the contract are: 1. No purchase option. This is discussed in another section of this study. It should be here noted that the purchase option usually classifies the lease as a "sale." If it is a sale, the depreciation rates, not the lease payments, are the expense items for tax purposes. If the purchase option mpg: be used, certain precautions might help. The buying price at some future date should be the fair market value at the time the final sale takes place. This might be determined later by an average of three estimates of its value; If the intent to buy is indicated, as opposed to only showing the possibility that this may become a sale later, then the tax courts will treat it as a sale. Any indication that equity is being built up by the contractor will cause the Internal Revenue Service to disallow the expense. This is Spelled out in the Revenue Code. ¥ 1 . Section 162 (a) and (e), Internal Revenue Code, 1954. 87 2. The rentals should approximate the amount of possible deppeciation. Some use the guide of 10% either above or below the depreciation rate as permissible for the amount of the rent that can be classified as an expense. 3. The lessor should pay the insurance, maintenance, taxes,and other expenses that can be estimated properly. By doing this, the lessee does not care for the equipment as if he were the owner, and the courts get the impression that he is not buying. It is noted, however, that few finance leases are arranged in this manner. 4. Renewal rates shouldgprovide a substantial return for the lessor. If the rates are too low, it would seem that they (are only paid to have some evidence of a lease after the full price has been received. 5. The lease should not be recorded nor allude to bank- ruptcy law protection. These only strengthen the belief that a conditional sale has been made and the lessor desires to further insure his repossession rights on the "sold'' equip- ment . 6. Broker the lease through a leasing concern. This is advisable when the difference in cost is negligible. It brings third-party assistance to attest to the lease conditions. 7. Lengthen lease period. The closer it approaches the depreciation period of the equipment, the less the IRS is apt 88 to View it as an expense-padding vehicle. "Some acceleration of lease payments would seem to be quite proper because leased equipment usually depreciates faster than owned . "1 equipment. A Surface Combustion Company (furnace and air-conditioning . 2 . . . industry) spokesman VOiced this word of caution. "We have analyzed a number of lease agreements of other companies and find that two-thirds fail to be leases if placed under close scrutiny by the IRS." This can cause confusion dangerous to the good will of customers. Clark Equipment is now experiencing some of this controversy. If the lease is "titular," that is, treated as a conditional sale by the IRS, customers who leased mainly because of tax advantages will be sorely displeased. State Tax Many states have personal property and sales taxes. Usually states are not as interested in Who pays the taxes as they are in that they get paid. Some states, such as Ohio, fix an extra property tax upon items that are leased by lessors of another state. This is a penalty upon those who use the F. Griesinger, "Decisions to Lease or Buy Equipment Are Made.no Easier by New Revenue Rulings," The Journal of Taxation, Vol. 4, No. 3 (March, 1956), p. 3. 2 . . . . John E. Taylor, "LeaSing an Industrial Equipment," Toledo, Ohio, p. 26. 7Iar————————————————————————————————————————————* 89 lease method of acquiring equipment outside the state. The credit manager of the John Deere branch office feels that the holder of a rental-purchase contract is subject to double taxation in Michigan. While the payments are being made for the use of the equipment, a "use" tax is paid on the rentals. If the equipment is later purchased, a sales tax is applied on the total price of the equipment. This would make the arrangement expensive and be a strong disadvantage. The personal property tax issue is of grave concern to the lessor. The AED typical contract spells this in detail. "Nothing in this paragraph is to be construed as meaning that the lessee is to pay the personal property tax levied against the machinery rented when said machinery is delivered within the home state of the lessor,as in this case the lessor is to pay his own personal property tax."1 This seems to be the best method of handling this problem. The contractor doing business in another state should know more about the legal problems of that state because he must obtain a "permit" to be allowed to start new construction. Legislative and Judicial Impacts on Leasing The legal questions involved in leasing are different from those of sales. "Lease liabilities are not debts. They are AED, "Terms and Provisions of Lease,' printed for members. 90 not liens on the assets of the corporation because the corporation does not own the leased assets."1 The liability does not involve all of the contractors assets, but only the particular piece of equipment which could be repossessed by the distributor. While antitrust action has prevented the distributor from forcing the contractor to operate the equipment at top capacity, which he would like to do if his rate was applicable to production, he can still use the maintenance service as a source of additional income. These rate surcharges for maintenance range from an extremely reasonable amount ($8 a month on a $4,000 piece of equipment) to exorbitant amounts. If the dealer wishes to curtail the leasing practice, he raises the surcharges. The lessor faces less legal requirements than the seller during repossession. He can avoid the forced sale provisions of the Uniform Conditional Sales Act (Sect. l9) and its recording provisions. Bonding Requirements Many projects to be constructed have a bid bond requirement, 1 . . . C. W. Steadman, "Chattel LeaSing - A Vehicle for Capital EXpansion," Business Lawyer (American Bar Association, 1959), p. 5470 2 Uniform Conditional Sales Act, 5, 10, 14. 91 i.e., a bond must be obtained before the bid is accepted. A surety company will examine a contractor and attempt to judge whether he is financially sound enough to carry out the project that is being bid upon. The surety companies look to many things in making this judgment. They would like to see a current ratio of 2:1 although they seldom hold to it. Normally they desire the contractor"s working capital to be 10% of the value of all contracts they hold including the new bid. Rental and leasing payments during the coming year should be entries under current liabilities, but bondsmen are not investigative on this point. Although they realize that finance leases have non-cancellable terms, they do not always dis— tinguish them.l Incomplete investigation of indefinite rental—leasing practices permits a higher working capital position and an opportunity for larger contracts. Without a representative capital position required, contractors resort to more rental-leasing. Contractors want to conserve cash for specific reasons. In lieu of a bond, they can deposit a certified check for 5% of the engineer's estimate. This insures the owner that he Will be able to get the project done for the low bid. This outlay does drain the cash position of the contractor thereby __ . Interview with Charles Frey, Bonding Manager; U.S. Fidelity and Guaranty; Lansing, Michigan; April 6, 1961. 92 making renting and leasing attractive. The 5% cash deposit is often prohibitive. Thus, maneuvering the financial statements through rental and lease recording may be the only way for a contractor to qualify for the necessary pig pgpg. The contractors pay for this bond and it is the same cost Whether they rent, lease, or buy equip- ment. Many distributors say that this requirement is one of the reasons why the contractors want to lease. A Connecticut distributor attests that this is the most important factor in the growth of rental-leasing. Another type of bond that may be of value to the distributor is the contract bond. If a contractor becomes bankrupt or fails to pay, the protection against "mechanics lien" in some states insures payment on leased equipment. "Many states say that equipment or repair parts used on a job, particularly on public works, are lienable. Thus the bonding company is responsible for rental payments and repair parts payments used on a job for which it has made a bond."1 Required payments do not apply to a regular purchase contract, but will insure payment under a rental-purchase contract that has not converted to a conditional sale. l"Rental Purchases," Construction Equipment News (November, 1960), p. 11. 93 There are some who contend that a payment bond should be required of contractors who wish rental contracts. This would insure satisfactory payment or return of the equipment in suitable condition, even if the contract bond did not apply, i.e., the equipment was not designated for a specific project. This bond could be a costly requirement and is not necessary when dealing with reputable contractors. Of course, mis- understandings can distort customer relations even under the best conditions. Loss of some rents, of course, is a risk of this business and must be considered in rate making. The "reasonableness" of the rental rate is also subject to review by the Internal Revenue Service. In a recent case it was decided that the AGC, Contractor's Equipment-Ownership Expense manual could not be used as a basis for judging the reasonableness of rentals. The government had previously contended that the AED, Rental Rates for Construction Equipment "should not be considered by the court because the rates reflected are 'fantastic.‘ In a specific case, J. C. Mitchell, vice president of Euclid-Arkansas, Inc., and others from the industry appearing as witnesses,stated that the rates were reasonable and that the renting of heavy specialized equipment was infrequent during 1952 and 1953,as it was too expensive and too specialized. l Arkhola Sand and Gravel Co. v. U.S., 1523, U.S. Dist. Ct., 1960. 94 Arkhola rented a $63,415 Cedar Rapids Rock Crusher for "20¢ per cubic yard with no minimum rent." Along with rental of other equipment, it was furnished a $65,000 Bucyrus Erie 54B Shovel ”at not additional rental charge."l Most of the equipment was used for "the same rental which it had charged since the rate was established in 1937, e.g., 50¢ per cubic yard of concrete produced with no minimum charge." An analysis of this case revealed two important points: (1) If distributors are not mindful, rental rates for continuous use may be maintained at the same level simply by inertia. This would make renting unprofitable during rising price and cost levels. (2) Renting can facilitate flexible operations for the lessee and lessor. The distributor could replace equipment when he had a customer to purchase a certain rented unit. This flexibility can allow both to have equip— ment ready for use or sale when it is needed. State Laws An analysis of all state laws as they affect rental— 1easing is not included. An appreciation of some existing differences is necessary to realize that marketing effort in construction equipment leasing must be flexible when applied lIbid. 95 to interstate operations. At an AED Management Conference, members discussed this matter. "Each state, they pointed out, has its own laws, which it interprets in its own way. Any attempt to make specific recommendations, the discussion leaders admitted, would be Wishful thinking because of this diversity."1 They advised that leases be drawn to conform with each existing state law. Examples of interstate differences in legislation affecting rental-leasing would be enlightening. "A Kentucky court ruled that state law does not require the state highway department to rent construction equipment by competitive bidding."2 The state had to pay the full rent even though another portion of the contract was extralegal. The state of Washington is now trying to enact a bill to license only contractors who are financially capable. This would eliminate fly-by-night operators. A Wisconsin distributor who also operates a branch in Michigan stated: "The state pre-qualification regulations [in Michigan] penalize the legitimate buyer of equipment and favor the operator of leased equipment with easier bonding. In Wisconsin we do not lease [rental—purchase] more than 10% of our sale—lease total. In Michigan we lease 80% of our k l AED, "Rental Purchases," op. cit., p. 11. 2 "Equipment Rental Legal Even though Work Wasn't," gagineering News-Record (November 19, 1959), p. 130. 96 sale-lease total." Bankruptcy Provisions The law generally favors the rental and rental—purchase agreement, but limits the ability to collect under the finance lease, unless the equipment is necessary for continued operation of sections of the business to keep loss at a minimum and then only on a voluntary basis with the trustee. First, the bankruptcy provisions affecting renting variations will be discussed. The distributor retains legal title in a rental-purchase agreement until the option is exercised. In case of a default, repossession can take place without going to court. One case gives evidence of this. A distributor rented out a crawler tractor with a purchase option. The contractor later declared bankruptcy. When the distributor showed the contract to the sheriff on the job site,he was permitted to repossess the crawler. Later this right was challenged by both the referee and other creditors,but it was upheld that the agreement was not a sales contract. The finance lease is treated as neither a rental nor con- ditional sale. Under the Chandler Act, Chapter X, the dealer may receive three years rental in a reorganization case and —__g op. cit., p. 11. Case reported in "Rental Purchases, 97 , . 1 one year s rental in a bankruptcy. He does not become a general creditor for the amount of the contract over the repossession value and the required payment. Recording of Contracts In most states, leases do not have to be recorded in 'the county court houses as do mortgage contracts. The W. VV. Williams Company of Columbus, Ohio, used the Chattel Lien ciepartment of court records to establish its right against cyther creditors' to the ownership of particular machinery. 'WSome of the W. W. Williams Company customers have objected to the recording of the lien, but the policy is strictly enforced."2 This company, which has eight years of leasing enqperience and recently organized the Mid-American Company as a leasing subsidiary, usually leases without the option to purchase. If one is requested, it will treat the lease as a conditional sale. Few states have, to date, instituted a Lease Lien section for recording. Illegal Clauses In the discussion of legal aspects of rental-leasing, If D. Gant, "Illusion in Lease Financing, Harvard Business Elia, Vol. 37 (March-April, 1959), p. 124. 2 McNab, loc. cit., p. 90. 98 some statements concerning illegal clauses are appropriate. The government places limitations upon the use of some clauses in contracts. The limitations are upon the marketing Iprogram of the individual distributor and are for the purpose of protecting the free market. Decisions arising from United Eflnoe, IBM, and other familiar cases, will not be repeated. IEt is common knowledge that "tying clausesfl sometimes called '“tie-in clauses," permit a product to be purchased only when cyther, perhaps unwanted, products are taken. The "supplies cilause" is illegal even if the leased equipment will not give Imxximum performance when a competitor's supply part is used. 'The government through its treatment of the cases shows interest mainly in eliminating the restrictive clauses and preventing monopoly before it starts, when there is evidence of:monopoly intention. Examples of restrictions and monopoly intent can be shown by some selected illegal clauses: This equipment must be used at full capacity during the time that rents are based on the units of work completed. A return charge shall be collected when the equipment is given back to the lessor.2 The leasing contract is invalid if the user rents other machines from any competing equipment [distributor]. 1 H. Greenfield and F. Griesinger, op. cit., p. 86. 2 CTA, op. cit., No. 21, p. 13. 99 There is a higher rental charge [exacted from those] who lease other equipment from competing machinery [dealers].l Other legal conditions (consent decrees) that reflect on leasing operations are presented in the next section. .Altogether, these have widespread implications on the marketing effort . Consent Decrees The classic United Shoe Machinery and IBM consent decrees . . . . . 2 luive been explained extenSively in another dissertation. The auztual results to the marketing organizations are often different from those intended by the decree. The ultimate effects of such decrees rest with the industrial consumers amd follow an acceptable marketing principle—-the customers can control the direction of marketing effort by their action in the market place. One writer stated with respect to IBM°s 1956 decree, "Many large users of its equipment continue to 3 prefer rental arrangements." Many companies recently were instructed to sell merchandise . R. Alexander, et. al., Industrial Marketing (Homewood, Illinois: R. D. Irwin, 1956), p. 249. Babione, o . cit., p. 303. "Big Profit from Rental Revenue," Financial World, V°l~ 108 (December 11, 1957): P» 10' 100 rather than offer only to lease. In a consent decree, the government gave American Machine and Foundry five years to introduce a sales plan for its vending machines. The Pinspotter is one of its "most leased" products, but was exempt from this directive. Mr. Carothers, of American MaChine and Foundry“s lflarketing and Planning Division, said the rationale behind 1ihe exemption was this. Brunswick offers a comparable pinboy Inechanism. Should the customer wish to buy--he goes there, jJE he wishes to 1ease-—he comes to AME. With alternatives gfiiven for an equally substitutable product, the government feels that the market is given free choice. 1 Interview, New York City, May 15, 1961. CHAPTER IV SURVEY ANALYSIS OF RENTAL—LEASING Significance of the Questionnaire and the Sample It was noted in Chapter II, that a pretest questionnaire was administered to thirty members of the Associated Equip— nuent Distributors. This pretest questionnaire with the sum— nmirized answers is found in Appendix I. A number of improve— meznts were made in the form of the questionnaire as a result 613 the pretest and the intensive review of the required asso— ciated data, parts of which are found in Chapter III. Modi— fixcations could thus be made in the wording of the question- rniire so that the distributor would understand more clearly Whert information was desired. Certain questions were designed 1K) elicit attitudes toward the alternatives to purchase. The firual questionnaire is reproduced in Appendix II. The format of the questionnaire and the distinctions draVfll among the alternatives to purchase were reviewed with membems of the AED Executive Advisory committee. It was hoped that by proceeding in that manner, some of the confusion that at times accompany a mail survey might be eliminated. The questionnaire was sent to a random sample of AED members in the continental United States. The results Of the O s 101 102 maiJHing were as follows: INumber of questionnaires sent ———————— 201 , INumber of returns -------------------- 107 53.5% Number of tabulated returnsl ————————— 100 49.7% Sample size as a percentage of the population (total distribu- tor membership of AED) ——————————————— 14.3% The first step taken after the questionnaires were sum— Imairized was to determine if the returned questionnaires were tyqutel of the population of AED membership. Typicalness imaes judged on two important characteristics: 1) sales volume, aiiél 2) profit, as a percentage of sales. The method of apply— ing; the test is mentioned in the design of this study, Chapter II. The sales volumes of the distributorships in the sample weiae compared with the median sales volume, $1,922,148 for all disrtributors, as reported in the Cost of Doing Business survey. ThEE differences in sales between the sample and the population Werta not significant.2 'The profit, as a percentage of sales for each firm in the sanuple was compared to the median of 2.25% for all distribu— tOIES. The differences in profits between the sample and the Six returns could not be tabulated. One dealer returned the Comer letter with the comment, "I am sorry but I'm too busy to 1£x3k up the figures." Three returns were too contradictory. O‘Were satisfactory and helpful, but arrived after tabulation. Fight returns included personal letters that gave useful lnformation. The Normal Approximation to a Binomial teSt was used at the 5% level of confidence for both the sales and profit differences. 103 popnilation were not significant. .Additional information was recorded after each questionnaire was; returned. The types of equipment rented and.the geo- graphic location of each distributor were noted. Similar gecmgraphical distribution of the respondents to this question— nad_re and the one sent for the AED, Cost of Doing Business Stmggests that the same population was examined. The AED sur— \ne3z has 14 regions comparable to the 9 divisions within the ‘lhijrted States which were used in this study. The following ‘taJDle shows the geographical similarity. TABLE 9 Comparison of the Geographic Area of the AED Survey ‘ Jwith this Study ‘ Divisions AED Replies Thesis returns AEI) Regions Used in ' as Percent as Percent of Thesis of Total Total 1. 2 . 3 7 13% 16% 4, 6 8 13 17 5 9 8 8 7,8 4 16 22 9 5 10 11 10. 13 6 15 9 ll 2 8 3 12 1 9 6 14 3 8 8 k Ehource: AED, Cost of Doing Business, pp. 36-39. In View of the typicalness of the thesis replies as pre— ViouSly noted, and the geographical similarity shown in Table 9, 104 it is reasonable to apply the results of the mail survey to all of the AED distributors. Before reporting the results of this study, however, it is desirable to contrast some of these answers with answers from a questionnaire mailed to contractors. The construction industry has been provided with much satatistical information to help firms assess the progress kxeing made. Most of these data refer to the amount of con- eatruction that has been ”put in place" and the dollar gross or ruimber of units of equipment sold. Three questions in the tfliesis questionnaire were arranged to facilitate the compari- son) of data from a survey of over 200 contractors. This sur- 1Je§r appeared in one of the leading trade publications sub— scusibed to by contractors.l Although the survey may present scune readership bias, it contains most of the elements of gernuine research structure. The researchers, Michael A. prxznck, Editor, and Arthur Dix, Director of Research for (knudver-Mast Publications, use prevalent techniques. A revieav of the national readership shows conformity to the geoglfiaphic location of the respondents to the thesis ques— tionruaire. There is little reason to doubt that it is a reZPresentative sample of the market for equipment among COntractors. x "Lease the Machines You Need Now," Construction Equip- mgflEJ September, 1958, p. 40. The survey is used with per- mission. 105 It is recognized that there are over two years of time between the receipt of these two surveys. In making a judg- ment about the significance of this time span, two factors should be considered. First, the history of renting in this ibusiness has been comparatively long. The procedures have loeen the result of 30 years of industry experience. There is no reason to believe that practices will radically alter iJl a Short time. The second thought bears a slight difference iirom the first. Finance leasinghas been recently introduced cni an extensive basis in this industry. Therefore, many of tflue contractors might not have noted the difference in their resplies. This is discussed in greater detail when the evalua— tjxon of reasons for leasing is undertaken. The first comparison made with the contractor survey con— cxarns the use of the purchase option. The question asked the ccurtractors is reprinted in Table 10. This is followed by the cllhestion asked of the distributors so that the basis for com- Efiufiison can be clearly seen. This presentation sequence will 1Deused for the other comparisons. 'The reader will notice in Table 11 that the thesis replies weregrouped into seven categories for comparison of the data in Table 10. This was done by the accepted practice of moving the replied percentage into the nearest category. Similar grOuPing is also made for Table 13. The data for purchase Optioncomparison are in the following tables. 106 TABLE 10 Contractors' Use of the Purchase Option How often do you exercise your purchase option? 100% 22 replies 90% 27 75% 18 50% 26 25% 9 10% 13 0% 6 Question asked of the Distributors % of the purchase options are exercised. TABLE 11 The USe of Purchase Options by Contractors and Distributors Percentage of Contractors Using Distributors Dif- tflue Options This Percentage Experiencing ference IExercised This Percentage of Usage Number of Adjusted Number and P t Replies Percent Percent ercen 100% 22 l7 l6 1 9O 27 23 29 6 75 18 15 18 3 50 26 21 22 1 25 9 7 9 2 10 13 ll 3 8 O 6 5 3 2 121 100 100 23 107 To facilitate comparison, the contractor replies are ckuanged to percentages. All 100 distributors answered this qplestion, so the results are both in number and percentage. A.,significance test was applied to the average difference of? the percentages in Table 11. The same test will be used iri the subsequent comparisons. The null hypothesis that tliere is no significant difference (23) is accepted.1 fiflierefore, it can be said that there is conformity in the emiswers of these two groups. There is similarity in the euztion of the contractors in the use of the options and the experience of the distributors concerning the purchase (nations. It is realistic,then, to assume that the contrac- tors' actions are not too variant from the behaviors of other Customers on this point. A proper purchase option is, of Course, the closest bridge connecting a rental and outright Sale. Only the exercise of the option separates the two Imathods of distributing equipment. There is some indication also” that while the contractor represents only 55% of the diStributors' business, the contractor may use the option as the remainder of the buyers do and be representative of the total market in the use of the purchase option. ‘ 1 , The computed Student's T was 1.27; T = 2.44 for the 5% level of confidence with 6 degrees of freedom. 108 The purchase option is a very important part of the remrting business and is a practice of long tradition in the ccnnstruction equipment industry. Based on this and the lack of? significant difference in these replies, there seems to ‘bez little change on this point that has taken place in the th0 years between surveys. The second comparison that is made with the contractor Stirvey is the forecast plans to lease as opposed to buying dhiring the fiscal year,l959,with the experience of the dis- tuributonsin rental—leasing during the fiscal year, 1960. 'Ehe questions asked in the two surveys are listed, respectively. TABLE 12 Contractors' Plans To Lease (Rent) In acquiring equipment this year, what percentage do you plan to lease compared to buy? Lease vs. buy for new equipment Portion mggpliggw No. Leasing 62 10% 30 25% 26 35% 5 ' 50% 18 75% 3 _ 90% 6 100% 12 _.o'-.-.-’p -,v--- --v u" ‘- .4 .-. I'm-r.- '--.1\-. “ 1" g. Question asked distributors Total dollars resulting from rental and leasing account for what percentage of your company's sales? 21.6% [ill] .1, IllltI‘] 109 TABLE 13 Ihental-Lease Portion of Construction Equipment Acquisition ‘—~ A I “4 I I C m o H a m H a m m o m #19 m w O'U m m H 440 m m p 83.5 88:2,? ”3838 03 0*; B 88 «Bu-It!) USE-H .Qma) 4J0 4J.-QU\1 0:4 m m s +I§.£ U» m 0.4 m-H m S Um -H : Chv<.Q U m a m :3 Q B m m U m QaQ q B m Q-H a 0% 62 19 38 21 17 10 30 23 19 26 7 25 26 25 16 28 12 35 5 5 3 6 3 50 18 13 11 15 4 75 3 l 2 1 l 90 6 2 4 2 2 b 100 12 l 7 l 6 162 89 100 100 52 The data were categorized and placed in Table 13 following the same procedures mentioned for Table 11. The test applied t0 the average difference of percentages showed that signifi— cant difference (52) between the two sets of answers exists. The reader notes that this is a comparison of plans to lease on the part of the contractor with the results of rental— 1ease experience. There is little similarity between the 110 expectations and the actual occurrences. One can realize that time use of the purchase option is to cover the uncertainty akxout the continued utilization of the obtained unit. The piiivilege of removing anxiety caused by doubt of whether the eqpaipment will be profitable for the firm, costs the contractor agxproximately 5% more in the rental or carrying cost over what tlie charges would be for a straight rental. From (a) in Table 13, one can note that many contractors Eire able to do business without resorting to rental leasing. Tfliey may do rental—leasing only as a last alternative; there— fore,they make no plans to engage in it. Distributors may find.that they must do a portion of it to meet the demands of some customers. There is little reason to question that even.the distributors leasing a high percentage of their business have some customers who do no renting and leasing. Once the distributors engage in the practice of rental- leasing, it is comparatively easy for this method of dis— tribution to rise to the 20% level of total sales. The aver- age renting and leasing volume as a percentage of all of the distributors' sales was 21.6%. From the lower portion of Table l3,(b), there is an indica- tion that a greater percentage of contractors than distributors rely on renting exclusively. This difference in the percentage between the two answers, along with other disparities, may be lll ch1e:to large amounts of renting done from other contractors, rerther than from the distributors. There would be no reason tc> assume that the characteristics of length of the contract lpexriod, type of contract, and the use of the purchase options as; shown in the first comparison table, would be similar to true contractor-distributor arrangements. Few contractors ‘MCNJld offer another contractor the option to purchase on a rented item. It seemed appropriate to compare the reasons why contrac— tr>rs rent and what the distributors View as the reasons why ccnitractors rent or lease. This was a test to see if distrib— utcxrs as a group were able to perceptively determine the motxlvations that guide the contractors' behavior. The quewstions asked the contractors and the distributors, respec— tiveely, are shown in Tables 14 and 15. TABLE 14 Contractorsf Reasons for Leasing (Renting) Wfluat are your principal reasons for leasing equipment? 6796 Need equipment for short period 5096 Need specialized equipment for one job 4096 Easy way to pay for machine for long term 3096 Able to deduct leasing cost from income tax 2596 Try out machine before buying 1236 No down payment 1196 Minimize maintenance costs 896 Want to use newest machines in the market 1|“Total is more than 100% because some respondents checked t we Or more answers. 112 TABLE 15 Distributors' Perception of Contractors' Reasons for Rental—Leasing The one main reason why Rental- Finance Rental contractors want to use: Purchase Lease Need equipment for a short period 1) 70 l —— Can pay for machine easier 2) 1 40 12 Deduct payments for income tax 3) 12 ll 19 Try equipment before buying 4) 4 12 l Chonserve working capital 5) 6 24 22 Want newest machines 6) 3 8 10 Meet bonding requirements 7) 2 1 3 The question asked the distributors varies slightly. The alternative for a possible reply of "need specialized equip— ment for one job" was omitted for it was very similar to the One above it. In the interest of brevity, significant dif— ference, and clarity, it was dropped along with the weight assigned to it so that no distortion would arise. "Minimize the maintenance costs" was taken out of the pretest question- naire at the suggestion of some in the AED who mentioned that few contracts are written with maintenance provisions. It was noted by previous review of the industry contracts that they did exclude maintenance. Two examples of maintenance terms fellow. 1. On straight rentals on non—tractor equipment the lessee agrees to maintain said machinery and equipment in the same condition as when delivered to it by lessor, usual wear and 113 tear excepted, and to pay all claims and damages arising from defects therein or from the use of handling of said machinery and equipment, . . . on all tractor equipment the conditions in paragraph 5 apply except that the lessee agrees to fully maintain the machinery covered in this contract while in his possession . . . with no exception made for usual wear and tear. On all rentals with pur- chase options the conditions in paragraph 5 will apply with the exception that the lessee agrees to fully maintain non—tractor equipment as well as tractor equip- ment with no exception made for usual wear and tear. 2. Service: (a) Lessee will pay for and provide all electric power, oil, gasoline and lubricants consumed by and required for each Unit, and all repairs, parts and supplies necessary therefore. (b) Lessee will at its sole expense at all times during the term of this Agreement maintain each Unit in good operating order, repair, condition and ap— pearance and keep the same protected from the elements.2 The latter of the two previous quotes from rental—leasing agreements, was adopted by John Deere for new equipment. That agdreement carries a six months warranty on the reverse side Of the last page,covering materials and workmanship, but this (kDes not constitute a waiver of the lease conditions. It seems clear that distributors do not intend rental— iERising to include maintenance (”gross lease”). Rather,maintenance Seeuns to be a marketing aid that must be given to assure that: the conditions are satisfactory and that the machinery is iri good order. Contractors expect the service, for after .__~_____________ 1 Terms and Conditions of typical AED Contract, p. 2. Equipment Lease Agreement, Boothe Leasing Corporation, used by the John Deere Co. for their customers. 114 all, "80% of those who lease don't read the contract or pro- vide the required insurance.1 Many distributors are also aware of this ”obligation by default" for the thesis survey indicated that 45.2% include normal maintenance in their contracts and expect the practice to continue. Because in some cases, more than one answer was checked in the contractor questionnaire, all of the indicated per- centages in those categories that were used were added as points that were adjusted to 100%. The percentages were adjusted by differential weighting, for comparison with the distributors' analysis of why contractors rent. Sometimes Inore than one reason was checked by those who replied to the tflaesis survey and in those instances, a random number table “Has used to select the number to tabulate. Distributors were asked to make a distinction between the rental—leasing Viiriations since it was thought that the reasons are dif— fErrent. A last line was left open for an inserted answer so tflnat a forced choice did not have to be made. The distribu- txxrs could then specify a reason rather than select the most iniportant from the ones given. Framing the question in this way ILed to some additional information. ”Meet bonding Interview with Leslie Willson; U. S. Fidelity and Guar- anty, Insurance; Lansing, Michigan; February 7, 1961. 115 .ssslttiiijze:::£2§::Fi;i:, mm ooH 0mm ooa ooa mmm mma . mma mu. 6 MI. 6 a am Hi W m mmcasoms 86636: 8:63 6 ova Hm om 6H a «m cm M NH Hmpammo emerges m>ummcoo m s a a s 8H pa 6H M 6m mcflssn muoumn pamsmflsam sue a H ha m ma .6H me am W om x68 msooca Hom. pcmssmm posemm m m om a Hm mm mm as _ .oa gmflmmm mcflroms How mam cmo m 6H am OHo mm am an an N ms6 6oauma m buonm How bsmamflsqw pme i mHHHHmH mHHH mHHumH mHH mH HHH HH W H wmmzo Insm awe mommno one scum lusm msflmqu mucus mHou Immwa paw Iamucwm coaums lawnsmm coaums IQHHu nowhu lamp Hmu paw uHm>m you nam>m umflo 1coo ucmm ucmm Hmucmm QH mxomso Ge cflmuno muou moswnmm HOpDQHHu mocmuwm mommnousmlamusmm mnouomubsou Iomuusoo IMHO Imam IMHO paw Hopcmm hQB he msfimmmq ubmflmnum paw How bswoumm mo mxombo pwxomso mmmnousmlampgmm .Hmucmm How mucwoumm m mm mxomnu Housnflhumaa memmwm mcommmm Hmmfiocflum mEom Housnfiupmfla paw Houomuusoo gnu an pm3mfl> mm mmmmq Ho \ paw ucmm mHOpUMHusOO has mGOmmmm 0H mqm<fi 116 requirements" was inserted by two repliers and mentioned in personal letters by two others. The score might have been much higher for that reply if it had been listed. This is recognized in the complete analysis. In Table 16 there is a comparison of the reasons given by contractors for renting with the distributors' perception of contractors' motives to rent and lease. The first two columns, rental and rental—purchase, when changed to per- centages (Ip and IIp), are used for the first comparison. Because finance leasing was still in the embryo stage at the time of the contractor survey, most contractors apparently omitted this.in their reasoning; thinking only in terms of rental arrangements. The predominance of (a) in the table, appears to support this judgment. They view it as short- term; non-committing. Distributors realized this fully and made no error:hnthe comprehension of contractors' reasons,(b) The sum of percentage differences (22) was not found to be a significant difference.1 In summary, distributors did very 'well in analyzing the relative importance of the reasons why contractors rent equipment. The last two columns of this table indicate total dis- tributor replies for renting and leasing and the inferential ‘ l Computed T was 1.25; T = 2.57 at the 5% level of confi— dence with 5 degrees of freedom. 117 discrepancies in evaluation of contractor motives. When the reasons for finance leasing were introduced, percentage dif- ferences appeared. The sum of percentage differences (38) indicates significant difference.1 The fifth reason for renting and leasing showed a difference (c) in both compari— sons. One basic factor contributed to this. The wording was changed in the thesis questionnaire to state the reason in terms presently used in this industry. From the comparison data above, it seems that distributors have an accurate perception in interpreting rental motivations of contractors» but do not accurately perceive the reasons for leasing. One suggestion is recommended. From noting the dif— ferences at (c) and conducting a preliminary content analysis of some representative distributor ads, an overstress of the "conserve working capital" appeal was found. An adjustment could be made in this part of their effort. Changes in the Market and Profit In this section attention is directed to basic changes that may occur in the sales and the profits of the distributor as the result of marketing effort. Principal attention is directed to the relation of rental—leasing to the profitabil— ity of the firm. K 1 Computed T was 16.2; T = 2.57 at the 5% level of confi— dence with 5 degrees of freedom. 118 Before the distributors were asked to review the advan- tages and disadvantages of rental-leasing activity or record their personal feelings toward it, they were asked what the effects of the variations of it were on their sales and pro- fits. This question is shown below with the answers (number of checks) that were received. TABLE 17 Effect of Rental-Leasing on Sales and Profits Will each of the below increase (or slow the decrease) of: Total Sales? Profits? Yes Np_ Yes Np_ Rentals without the intent of purchasing . . . . . . . . . . l) 51 43 2) 70 22 Rental-purchase with an option to buy that may be exercised . 3) 87 9 4) 75 13 Finance lease with no option t1) purchase and payments equal to full price .. . . . . .. 5) 49 35 6) 49 30 Inasmuch as no population figures are available for Table 17 and some ofthe other tables that follow, statistical analysis Was; applied to check if the numbers of ”yes" and ”no" were sirgnificantly different from a 50—50 chance division for the (listiibutor population. From thies analysis of Table 17, it Vfiis seen that most distributors feel that rentals will increase Ilrofits (2), and rental—purchase business will increase both Sales (3) and profits (4). From the other answers, there is 119 an inclination to believe that the effects are beneficial for the distributors,but no clear indication is given. Now that some of the market results have been briefly examined, one can inspect the application of marketing effort to accomplish the profit increases in the individual firms. The following questions were placed two pages later in the questionnaire in hopes of preventing bias from an attempt to make these answers correspond to those previously recorded. Rank each according to its Rank according to the amount profit percent of ”sales." of your marketing "sales” But (l)pfor the least profit effort used to promote each. percentage, through 2,3,(4) Rate (1) for least effort, for the greatest percentage: through (4) for greatest mar— keting effort: 26. Outright sales :L 30. Rentals _2” 27. Finance leases _;L:;7#1::31. Finance leases «j; 28 . Rentals 1 32 . Rental-purchase _3 2E9. Rental—purchase Tij’TI’f’533. Outright sales _4_ Q'= .4 The above example shows how one respondent marked the anéywers. The lines connecting the two columns are drawn in 'bY' the writer' for this example. It should be noted that the number 4 was used for the "greatest," since a percentage of Prrxfit on sales was asked first. Four percent is higher than 3 19ercent, 3 percent than 2 percent, and so forth. This rank- ing association could have helped distributors for these might 'be realistic actual percentages. As a check on the ranking 120 accuracy, the answers were checked with those of question 35 ("What percentage of your 1960 marketing effort was for rental and leasing?"). If their rental and leasing effort was less than 50% and they recorded a 4 for any of the rental— leasing variations, the total rank portion was disregarded. This only happened on two of the questionnaires. In the above answer, the lines indicate that three dis- crepancies occurred. One was that the least effort was put on marketing the finance lease, while the person believed that this earned the second highest profit percentage. There were two differences (2d) in this rank. The other two dis- parities had only (1d) each. The rank correlation (Q) is positive, .4. It is noted that this is not statistically Significant alone, but it is significant when averaged with the other 94 rank correlations. All firm replies were subjected to this rank correlation ir1 similar fashion and the weighted results of their scores are presented in Table 18. The average of the rank correlations (+.l6) indicates SCHne positive relationship between profits earned and market- ing'efforts; however, it is far from a perfect correlation (4f1.0). It is obvious from the low average rank correlation, tllat.the firms do very little correlating between marketing efforts and profits earned, as a percentage of sales. Other Specific interrelating factors are noted later. 121 TABLE 18 Rank Correlations of Profits, as a Percentage of Sales and the Marketing Efforts Rank Number of Firms Correlation Reporting +1.0 21 .8 11 .6 2 .4 12 .2 8 0 5 - .2 8 — .4 9 - .6 l - .8 10 -l.0 8 95 It should not be construed that the investigator suggested “fliat variations of distribution ought to be the most profitable frbr the firm. It may be that, in reality, the rental—purchase is; the least profitable for some firms (four specified that aliswer) while it is the most profitable for 20 others. It is Orily suggested that their greatest marketing effort should be Orl the methods of distribution that offer them the most profit, assauming marginal net profit is equal to the previous net pro- fit: per unit. No definite patterns developed in the column ranks. In Ixufl<2used on areas that assist in understanding the variations EarIdactions in construction equipment rental-leasing with some eIllphasis on the extent of straight leasing. A review of the 139 literature, interviews, and a survey questionnaire were used to gather the data to test the hypotheses. Up to this point, the findings were set forth in discourse fashion, interwoven with quotes, tables, calculations, and logical inferences. Capsules of pertinent evidence, with a judgment at the end, ‘Nill now be listed after each hypothesis concerning con- struction equipment marketing. IHypothesis 1. There is a close relation between the marketipg_ eaffort for rental-leasing and itsypercentage of total sales. a) The difference between the average percentage of the 'total marketing effort used for rental-leasing (25%) and the aaverage percentage of total ”sales” resulting from rental— .leasing (21.6%), could occur by chance. In marketing terms, 1ihere is a similarity between the amount of rental—leasing and the effort used to foster it. b) The following analysis is made of the greatest mar— kleting efforts by firms for rental—leasing compared with eifforts for outright sale, and the result on total distribution. 1 Computed Student's T was 1.09. T = 1.96 at the 5% level of confidence . 140 TABLE 33 Responsiveness of Distribution Methods to Marketing Effort Number of Firms -——- Percent of —-— Differ- Method of . . Distribution Us1ng Greatest ence in Effort (4) Firms Distribution Percent Outright sales 71 80 78.4 1.6 Rental—leasing 17 20 21.6 1.6 88 100 100.0 3.2 TABLE 34 Effectiveness of Marketing Effort for Rental-Leasing Volume IDifference, to the nearest 5%, between percent of total Number of firms Elromotion for rental-leasing experiencing the and the rental-leasing given difference percent of total sales Percentage Difference Number 0 25 5 29 10 17 0—10% 71 15 13 20 10 25 3 30 2 45 1 100 c) As seen above, most firms have a 0-10% difference. 141 An approximate 10% of difference between the percentages of efforts and results could be normally expected. Thus, firms experiencing less than 10% of difference show reasonably close alignment of their promotional effort and "sales" from the alternatives to purchase. Seventy-one of the firms experiencing "sales" in proportion to effort illustrate significantly the effectiveness of marketing effort when (iirected at the alternatives to purchase.1 There is close relation of rental—leasing promotion and the results from it. d) The comparisons made in a), Table 33, and Table 34 :indicate that the differences between the percentage of rnarketing effort for rental—leasing and the rental-leasing Eictivity are usually small. The investigator also checked tinese percentages to determine their relationship at the \farious degrees of rental-leasing (proportion of firm sales). It was found that marketing effort for increasing rental— leasing was most effective when it represented between 23 arni 33 percent of the total marketing effort.2 3 Efforts usually "lead" rental-leasing activity. Thus, \_____ 1 Computed T = 4.2; T = 1.96 at the 5% level of confidence. 2Normal process for evaluating "Controllable Determinants”. CC>Inpare J. Howard, Marketing Management (Homewood, Illinois: R.D.Irwin, 1957), pp. 70-74. Elasticity (e) of marketing effort is approximately 3. 3 . . . The lack of "instantaneous adjustmentfl assumed in demand aanalysis theory,complicates the measurement of causal effects. COmpare J. Howard, loc. cit. 142 the increase in marketing effort might not be the result of firms witnessing an increase in rental-leasing and then exerting effort in proportion. Distributors feel that efforts can cause rental—leasing. They wish rental—leasing to be 26% of their sales and they devote 25% of their effort for it. Although there is strong indication that marketing effort is the independent variable and increases rental- leasing; rapid expansion of the market, cyclical sales :patterns (as shown in Table 24), and seasonal variations gprevent absolute conclusiveness. Individual firms, however, can determine the relationship by analysis of their budgeted efforts and results over a time period of rental—leasing experience . e) There is a close relation between marketing effort for rental-leasing and its percentage of total sales. Hypothesis 2. The greatest marketing efforts are directed aE_‘those methods of distribution that earn the highest pro— ms. a) A rank correlation between effort and profit as a Emercentage of sales was calculated for each firm,and results Were averaged in Table 18. There is only a slight positive CC3rrelation , . 16 . b) The comparison in Table 20 exemplified that profit as; a percentage of sale was identified with profit for the firm. 143 c) When marketing effort was directed according to profits, firms earned profits above the distributor' median of 2.25% of sales (Table 19). d) Only 5 of the 21 perfect correlations indicated any pattern of ranking. Extensive differences exist between firms. e) Emotional feelings can affect activity: "We consider rentals as a curse." ”When they want to rent, we talk them out of it." f) As pictured in Table 25, only 27% (25) started rental- leasing to increase profits; most entered it as a defensive competition maneuver. g) The greatest marketing efforts are not directed at those Inethods of distribution that earn the highest profits, as a jpercentage of sales. - Iiypothesis 3. Straight leasing is not pgomoted asaa primary 'marketing method. a) Table 27 shows that finance (straight) leasing use has a secondary place in the sales and marketing effort. It is not used creatively to make more outright sales. b) Only 36% of the distributors engage in straight leasing. c) Fifty-eight of the distributors expressed concern akxaut the distributors' loss of importance in the channel of djdetribution (Table 28). This is a seemingly sufficient reason to refrain from developing leasing fully. 144 d) Eighty-five percent of the firms, as illustrated in Table 29, sense a general lack of understanding of leasing and, therefore, cannot promote it to a great extent without a complementary ”educational program." e) Supplementary comments lend support to the hypothesis. One interviewee stated, "I wish they [manufacturers] would get out of the finance business." A respondent from South Dakota wrote, "Just started [it] here the last couple of Inonths"; and from West Virginia, ”we do not recommend the finance lease." f) The above reasons, indicate that straight leasing is not promoted as a primary marketing method. .Hypothesis 4. Straight leasing does not account for a large Lyortion of equipment distribution. a) Straight leasing accounts for 12% of the total rental- leasing business, as figured in Table 22. This is only about 2.8%iof all construction equipment sold. b) Only one distributor uses an independent leasing Company'as the main source of lease financing. c) The dollar volume is only $44 million and this is cOnfirmed by another main source of information. d) Straight leasing is not used where credit restrictions Exrevent a financed sale (Table 21). e) For the reasons above, the hypothesis is accepted. CHAPTER V MARKETING ADJUSTMENTS FOR RENTAL-LEASING PROGRAMS An analysis of customers' attitudes comprises an important input for marketing strategy in the case of construction equip- ment as with any other goods or services. Accordingly, it is worthwhile to examine the advantages and disadvantages of various forms of rental—leasing as perceived by the contractor as lessee . Evaluation of the Reasons for Rental-leasing py the Contractor There were significant differences shown in Table 16 between the importance accorded to reasons for rental—leasing as viewed by the contractors and the importance as perceived by distributors. 'Ihese discrepancies in viewpoint may stem at least in part from faulty marketing feedback to the distri- butors. Another reason for the differences noted may be due to the assessment by the distributor of the validity of the J:easons listed. The distributor respondents may have voiced "acceptable" reasons while believing other "unacceptable" reasons germane. This mode of response, if the conjecture holds, is analogous to the guest making an“excuse" to the hoslizess for not being prompt when the true reason cannot be merltioned to her. The marketer also may have difficulty in 145 146 stating the reasons for a customer's action when he believes that these reasons are irrational, incompatible, invalid, immoral, or illegal. Answers by the distributors may, in part, reflect how distributors think contractors ought to be influenced to rent or lease. In Table 35 are set forth the benefits to the contractor- lessee of straight leasing, rental—purchase, and rental. The 'table is followed by a critical analysis and explanation of scme of these benefits. Bonding requirements are met more readily when rental— }purchase or renting is used rather than leasing. Over 14 references to this were made in the replies to the question- naire, all unsolicited. Even larger numbers might have mentioned this if a specific statement about bonding had been included. Earlier reference was made to bonding. It will be recalled that.the bondsmen's appraisal is less favorable if a long- terulfinance lease obligation is mentioned in the balance sheet than if no such contract has been incurred. Notwith- standing this effect of a lease on eligibility for bonding, E3 Study of 600 companies revealed that 189 firms did disclose thsé leases in the financial statements. 1American Institute of Accountants, Accounting Trends and IEfigpniques in Published Copporate Annual Reports (New York: uld permit some contractors to utilize it. "Leases frew f needed units through rent receipts than through depreciation sndhedule evidence. Some construction equipment may not be rwequired after the contract period and the cost of selling jrt (with any losses suffered) may not be incurred until after cxantract payment has been received. Depreciation is some— tximes difficult to show or compute for a short period. Ikllowances for it may not equal the actual expense incurred. "Scme corporate officers feel that rental expense is more arzceptable to contract auditors than depreciation on fixed- Eisset purchase."1 It is easier to allocate expenses, forecast .Cnosts, and compute bids. when the costs are stable and the equipment is available. Lessors advertise 100% financing. A term purchase requires 51 down payment, but leasing requires only rental payment. :[n some cases, this is 3.3% of the price each month. All (Iosts of financing with the lease are borne by the distributor (Dr lessor. The usual down payment under a purchase contract is 25% for most industries. However, it is closer to 10% l . . . F. GrieSinger, op. c1t., p. 86. 152 :in.the construction equipment industry.1 The discussion about eextent of financing, then, concerns an extra 6.7% (lo-3.3). ILessors lease only to financially sound firms. In those czases where credit is no problem, "it is just as safe to sell enquipment with little or no down payment as it is to enter quon a long-term lease with no initial deposit."2 When the conditions mentioned earlier under Tax Aspects sure met, the rental payments may be deductible. Many lessors freel that it is the lessee's responsibility to care for his CHMn tax problems.3 Until further tax rulings are made, the sd:atus will not be completely clear. Even assuming full ékeduction, the tax over the long-run amounts to no less than tflie tax would be on an outright purchase taking into account iJiterest and depreciation, using, for the latter, either the srtraight line or the sum-of-the-digits method of deduction. Imaasing just accelerates deductions and postpones tax. When lxaase payments are completed and renewal rentals are being Efiaid, interest and depreciation are still being deducted under iihe purchase plan. Unincorporated contractors may wish to \_ 1Business and Defense Services Administration, Construction lflgchinepngeview and Outlook for 1960 (Washington, D. C.: 11.8. Department of Commerce, July 18, 1960), p. 8. 2Karl H. MacDonald, "Is the Leasing Boom Really Healthy?, ‘ , .1 u a TV”: .. “"'1]'I]]I]]]]]]fi]]])]]]]j]]m]S