Let off the lease

After years of concentrating on dazzling users with technological innovations, the IT industry is getting back to basics. The growth of IT finance options – such as on-line rental, leasing and outsourcing – has arrived almost without hype, but is infiltrating businesses and finance departments of all sizes.

Mirroring the user-friendly payment plans available on the high street, the leasing of IT equipment allows finance directors to take hefty capital outlays off the balance sheets to streamline their budgets. The trend is occurring across industry frontiers. Oracle is conducting a US trial of a Web-based pay-as-you-use scheme for its applications, in an ingenious appeal to the mid-range market, which reduces the heavy initial outlay for an ERP package. In October, Baan – before announcing a 20% reduction in its workforce – unveiled a licensing agreement with Microsoft which allowed users to rent Baan software for $100 per desktop, per month. The three-year agreement includes Microsoft’s SQL Server with NT as a platform.

Adrian Reynolds, marketing director of PeopleSoft, said his company is involved in process outsourcing through partners such as PricewaterhouseCoopers, although European demand was still small. ‘We’ve not seen the market requirement yet,’ says Reynolds. ‘It is not a fad, but it’s still in its infancy in Europe.’

Up to the Big Five

Reynolds feels the Big Five will be a major factor in pushing this trend, adding that a couple of them have approached him. ‘They have the process knowledge and they’re the ones who will make it happen.’

He also questions whether Baan’s bargain basement $99-dollar scheme will make much headway in the market.

Further down the IT chain, financial software specialists Systems Union and Sage have both recently released user leasing deals.

IT finance can be broken down into three main areas: rental and lease, on-line pay-per-use (using Internet servers to record each time an application is used) and outsourcing.

Rental and leasing packages are making the greatest in-roads into the accounting community. Systems Union, the mid-market pacesetter in financial software, launched a leasing programme last September for customers and resellers, in partnership with Dana Commercial Credit, a specialist IT finance house.

The Advantage Programme allows customers to lease Sun Systems software and services over a fixed period of time. Leases can be one-off or multi-site and may include implementation and maintenance costs for the first year.

Chris Town, a corporate sales manager at Systems Union, says the decision to offer users a leasing payment scheme was down to mutual self-interest.

‘We’ve found that people want to keep their systems longer, even though technology has been developing faster,’ he says. ‘Software companies also want to keep their users for longer, because it costs less than finding a new one. As a result, the vendor provides more upgrades.’

The scheme, which currently only has a handful of clients, is made available to customers either directly or through Systems Union resellers.

The project has been a while in the pipeline. According to Town, one factor that held up the launch was finding the right finance house to partner with. ‘We had the idea for a while,’ he says. ‘But it took us some time to find a partner we were comfortable with, and which understood the technology driving our software.’

Further evidence that IT finance is more than just a marketing fad came with last week’s announcement from Sage of a lease-purchase scheme for its resellers and large accountancy user base.

In partnership with finance house Lombard, the accounting specialist will offer lease purchases from a minimum of #1,000 for a maximum of three years. Both upgrades and extra applications can be written into the contract and when the lease-purchase agreement finishes, the customer owns the software. The scheme, which will be marketed entirely through Sage resellers, starts at the beginning of next year.

Mark Searles, director of the Sage software division, insists there will be a big enough market to justify the service. ‘It makes life as easy as possible for the end user. If a customer buys our Line 50 product for #350, and our payroll module for #300 with Sage cover, it very quickly gets to over #1,000. It’s a small figure.’

Searles is quick to add that the service is not intended to be a cash cow. ‘This is the most competitive scheme in terms of price, and we don’t want to be making a profit from it. This is a value-added service,’ he says. Sage aims to have 5% of its customers on the scheme within a year.

Think of the tax advantages

From an accounting perspective, there is a strong case for leasing or renting equipment. David Maxwell, director of lease accounting and evaluation at KPMG, emphasises the tax advantages for a company thinking of leasing equipment. ‘The person who pays for the equipment can claim a capital allowance and pass on this benefit to the customer in the price. Leasing also allows a manufacturer to take the lease off the balance sheet.’ Although small to medium-sized enterprises can net the most capital allowances, leasing is not included in these tax benefits.

Peter Clark, group financial controller at Conrad Advertising’s London head office, rents Windows and Microsoft Office software as well as networking hardware from Hewlett-Packard, on a quarterly basis. He heard about the scheme through a mailshot from an HP agent. When deciding on the deal its financial advantages were uppermost in Clark’s mind. ‘We bought a load of software after an increase in the number of staff,’ he says.

‘It stays off the balance sheet and after three years, we own the equipment for a 1% peppercorn rent.’

‘The cash flow benefit is the main one and it just goes through our profit & loss accounts as an operating lease. It also reduces our fixed assets and so it’s easier to budget for.’

Clark admits, however, that the rental scheme means more per year for the 90 users in the London office. The rental comes in at #120,000 for three years compared to #102,000 for a straight purchase.

But, until recently, finance houses have not loomed large in the software industry. One explanation could be that finance companies have failed to understand the dynamics of the fast-moving IT industry.

An alternative, and probably fairer explanation, hinges on the high-risk nature of leasing or renting software.

If a customer defaults on a lease agreement for a TV, the finance house can seize the asset and resell it. Software, on the other hand, can become effectively worthless within a couple of years.

ECS UK, a finance firm and subsidiary of Societe Generale of France, has been running a leasing service since the 1980s. It will carry out an audit of a company’s IT inventory, run asset registers on behalf of clients and calculate depreciation costs for them.

Off-balance assets

Michael Baker, director of business development at ECS UK, emphasises the financial benefits of the service for FDs. ‘What we do is similar to financial facilities management. Why not get someone else to manage the assets for you? We’ll manage them and they won’t appear on the balance sheet,’ he says.

Baker adds that while he works increasingly closely with FDs to learn about their budgeting cycles, auditors are often concerned about residual values placed on IT equipment. ‘If they put a 10% residual value on IT, will it be worth it in a year’s time? You need to have a direct discussion with them,’ adds Baker.

With $16m of new leasing sales in 1997, IBM can also lay claim to an impressive heritage. The IT giant also has an impressive reach in the hardware market – over 50% of mainframes sold in the UK are financed by IBM. Known as FSL in the UK, the financier has two arms: customer financing and commercial financing for the channel.

Jeff Smith, UK and Ireland director for global financing at IBM, explains that a typical mid-range deal will comprise #200,000 for an AS400 computer, #50,000 for the IBM operating software and an additional #200,000 for third-party software.

‘There’s been a mass explosion of customers using leasing for IT purchases in the UK. Our business has quadrupled from 1994,’ he says.

Smith traces the surge in demand to a robust software industry. ‘Big banks are doing some very large software transactions. They like a total solution of hardware, software and services,’ he says.

Another obvious plus point for leasing is the flexibility that it offers. With the twin forces of the euro and the year-2000 problem looming against a gloomy economic backdrop, few companies relish shelling out hundreds of thousands of pounds in advance on new IT systems.

The increased overlap between IT and accounting is reflected in many organisations such as IBM’s 150-strong UK financing team. ‘We have a large number of English ICA and CIMA accountants in our sales force, says Jeff Smith. ‘It’s very useful if they operate as a consultant and offer accounting advice.’

Outsourcing provides the third and often overlooked form of IT financing.

In the last year, it has undergone something of a renaissance with hardware and software suppliers seeing it as an extra revenue stream and another way to maintain customers. QSP, the Gateshead-based accounting software developer, typifies this market trend. Last June, it launched an outsourcing service called SMS for existing clients such as German IT giant Siemens, which could either be run remotely or on site.

Richard Hannam, corporate communications manager for QSP, argues that outsourcing offers finance departments the assurance of minimum service standards. ‘Reliability is one reason for outsourcing so there’s a guaranteed service level built-in, involving ‘downtime’.

If you change from a big mainframe to a Unix system, you need technical support 24 hours a day and that means at least three people. If one of them is off, it leaves you exposed,’ he says.

The money up front

Payments are usually made for either six months or a year in advance, although individual terms can be negotiated.

Of course, Hannam is bound to talk up the outsourcing market, but recent five-year deals with the Northern Rock Building Society and a ‘large utility’ suggest a healthy demand. Hannam believes the rise of outsourcing as an IT finance option is partly because IT departments no longer see it as a threat. ‘There used to be a ‘suck it and see’ attitude to outsourcing in the earlier days, but it’s not such a sensitive issue now. Application outsourcing is no real threat to an IT department. They’re not going to be out of a job,’ he adds.

IBM’s Jeff Smith, has seen FDs take a more direct interest in the financing of IT projects. ‘The FD in a small or medium-sized enterprise is often responsible for the IT function, so they’re involved with the decision.

The large PLCs often have a special treasury department and can easily borrow #100m at a time.’

The proliferation of flexible payments plans, will soothe nerves in finance departments while improving the balance sheet. It therefore makes sense for both users and vendors, particularly in the uncertain economic climate.

To misquote George Orwell, some things are still true even if software vendors say they are.

A CASE STUDY

ECS, the Richmond-based IT finance specialist, has carved out a lucrative outsourcing and asset management niche among media organisations, with household names such as the BBC and Classic FM among its clients.

When Classic FM relocated its sales operations, the radio station had to set up a new 100-user computer system and infrastructure. Steve Horner, financial director and general manager of Classic FM, says: ‘With the life cycle of computer technology decreasing, we had to have a flexible system to run applications software. Using ECS allowed us to update technology when necessary.’

Where Classic FM has gone for a simple operating lease for its administrative systems, the BBC’s installed base of over 12,000 PCs – spread in different units across the country – encouraged it to put the systems management out to an external supplier.

Peter Lickiss, general manager for the BBC’s IT services, says contracting out all its PC requirements to ECS allowed the BBC to improve the use and management of its desktop machines.

ECS takes ‘cradle-to-grave’ responsibility for all BBC PCs, from procurement management to disposal. The equipment is depreciated and phased out over a three-year period.

Lickiss adds that the lion’s share of IT spending has swung away from mainframes and mid-range applications to PCs. This has forced IT managers to reassess exactly how they calculate the real costs of PC procurement, maintenance and disposal.

Other long-running IT trends, such as the rapid innovations in hardware and software, make IT management more complex.

Tony Holgate, director of ECS, worked closely with the BBC to ensure a smooth transition from a system where the BBC bought and owned the assets, to the ECS asset management scheme, where the supplier owns the kit.

Outlining the advantages of the asset management system, Holgate says: ‘Our asset management solution moves the responsibility for computer equipment and related managerial tasks away from the customer.

‘We can introduce tighter controls on asset recording, tracking and disposal. This also allows customers to benefit from a best-of-breed approach.’

Holgate also argues this approach encourages long-term planning.

According to Tony Field, managing director for ECS the economic downswing will boost demand for outsourcing. ‘Companies will increasingly have to hire out more and more personnel to deal with issues such as owning and managing their PC base. In this age of headcount reductions, the former is unlikely.’

IT FINANCE – A SURVIVAL GUIDE

Do you really need to lease equipment?

Check your existing arrangements. Will leasing be cheaper than existing IT finance arrangements?

Will it give you more or less flexibility?

What rights have you got to terminate the deal? Can you upgrade the hardware or software? And can you extend the lease?

Choose your finance package on a number of criteria

‘It’s a big mistake to presume that the cheapest deal is the best one,’ says Smith.

Check that the financier house has expertise in IT

‘IT has specialist requirements, says IBM’s Jeff Smith. ‘The technology moves very quickly so you should be able to hand back equipment and terminate the contract. If the financier has a quick re-marketing facility it can re-sell it.’ Are all the options unconditional?

You might be allowed to terminate a contract early but doing this could require taking on extra equipment in the new deal.