Procurement Strategies: Benefits of the Lease with Title Transfer Approach


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This ISG white paper examines characteristics and benefits of the lease with title transfer strategy, and discusses various scenarios where this strategy can be applied.

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Procurement Strategies: Benefits of the Lease with Title Transfer Approach

  1. 1. PROCUREMENT STRATEGIESBenefits of the Lease with Title Transfer ApproachBy Daniel Evola, Analyst,
  2. 2. INTRODUCTIONWhen a company develops a procurement strategy for the acquisition ofequipment, it seeks a standard process for working with vendors to obtainequipment in a manner agreeable and familiar to both parties. One oftenoverlooked procurement method is the lease with title transfer strategy – acapital lease procurement method that allows a company to lease equipmentand obtain ownership upon the final lease payment.The bones of this strategy do not differ much from other commonprocurement strategies, such as traditional leasing or financed purchasing.Lease with title transfer is also very similar to leasing with a $1 buy-outoption, but excludes the legal obligation to send the lessor $1 to obtain titleof the equipment. Despite its similarities to other strategies, a lease with titletransfer approach offers multiple benefits that should not be overlooked.This ISG white paper examines characteristics and benefits of the lease withtitle transfer strategy, and discusses various scenarios where this strategy canbe applied.PROCUREMENT STRATEGIES ■ DANIEL EVOLA 1
  3. 3. FLEXIBILITY IN FINANCING TERMS Compared to purchasing, the lease with title transferBoth the purchasing and leasing approaches to asset method provides a “smoother” cash flow when acquiringacquisition typically offer the opportunity to negotiate equipment, as the price of the equipment is spread outvarious pricing terms. The purchase approach provides a over a term specified in the lease contract, rather thancompany with an opportunity to negotiate payment paid up front as it would be with purchasing.terms, potential discounts and the payment type.Purchasing also gives a company the opportunity to Cashflow 120negotiate package deals related to the variouscomponents of a transaction. Larger transactions are 100usually easier to negotiate, since they involve an 80opportunity to bundle certain portions of the transaction 60at a discounted price. 40Through the development of lease rate factors, leasing 20also allows a company to negotiate the same variables as 0if the equipment were being purchased. The company Yr 1 Yr 2 Yr 3 Yr 4 Yr 5negotiates with the lessor to develop lease rate factors Purchase Lease w/ Title Transfer Traditional Leasethat result in an acquisition cost that is less than or equalto a desired net present value. This approach tonegotiating lease rate factors that satisfy a NPV threshold The chart above illustrates the annual cash flows of threecan also be used with the lease with title transfer model. procurement scenarios for equipment with a five-yearFor example, if a company only wants to use the lease useful life. The purchasing scenario represents a one-with title transfer model if the net present value equates time up-front payment, and the two leasing scenariosto 105% or less of the original equipment cost (indicating represent a three-year lease. Because title of thea 5% premium), it can negotiate the lease rate factor equipment doesn’t transfer to the lessor at the end ofwith the lessor to ensure it equates to the desired NPV. the third year with the traditional lease, a new traditional lease needs to begin in year four, meaning there is neverKeep in mind that a lessor will not be able to provide the a time without payment being owed.same pricing on a lease with title transfer transaction asthey would on a traditional lease, since they will beforegoing the potential profits from re-sale or secondary PROVIDES THE OWNERSHIP ADVANTAGES OFleasing. If a consumer was leasing a computer for 36 A PURCHASEmonths and the lease payments equated to roughly 75% Many rules or restrictions are associated with leasingof the net present value of the equipment, the consumer equipment. These rules generally prevent the lesseeshould expect to pay a slight premium for a lease with from handling leased equipment in a completelytitle transfer transaction because the lessor will want to unrestricted manner, which they would be able to had itrealize the foregone residual value. The premium will been purchased. Two of the largest restrictions on leasedtypically cover a substantial portion of residual value the equipment are not allowing the lessee to move thelessor is foregoing by agreeing to the lease with title equipment to a new location during the life of the lease,transfer transactions. nor modify the equipment in a way that alters its original state.MINIMIZING CASH OUTLAY The first major restriction mainly affects largerOne of the biggest disadvantages to purchasing as a companies with multiple locations. If the equipment isprocurement method is that it requires a large initial cash procured by a traditional leasing method, the lessor mayoutlay. Leasing on the other hand, requires little or no forbid the lessee from moving the equipment to adown payment up-front in order to obtain the location not specified in the original leasing contract. Byequipment. This means that a company can retain its using a lease with title transfer method, since title of thecash and perform other business functions with it. equipment will eventually pass to the lessee, lease contract terms that allow the equipment to be moved as pleased can be easily negotiated.PROCUREMENT STRATEGIES ■ DANIEL EVOLA 2
  4. 4. The second major restriction applies to nearly all leased ELIMINATE COSTLY LEASE EXTENSIONS ORequipment. Traditional leasing generally has strict rules UNFAVORABLE BUY-OUTSthat prohibit the lessee from modifying the equipmentbeing leased. For example, an automotive lease contract Leasing equipment allows a company to utilize an assetwill state that the lessee is not allowed to perform any for a specified period of time at a price that is typicallymodifications to the vehicle. If any modifications are less than the purchase price. By essentially renting theallowed, the lessor will most likely require that the lessee equipment, a lease facilitates a periodic refresh of thereturn the car back to its original state before the lease equipment, allowing a company to consistently updateexpires, or pay a penalty fee. Here again, utilizing a lease its processes and systems to operate on the most currentwith title transfer method makes it much easier to technology at a much cheaper price than purchasing.negotiate the terms of the leasing contract, so that these However, leasing is only advantageous if a companyrestrictions do not prevent the lessee from handling the efficiently manages its leased as freely as they would had it been Leasing terms are generally negotiated so that the netpurchased. present value of the lease payments is less than the original equipment cost. However, if a lease is extendedUTILIZE ASSETS FOR LIFE upon its initial term, or late return fees are incurred, the savings from leasing are quickly diminished as the lease isThe lease term for leased equipment is generally shorter extended. By utilizing a lease with title transfer strategy,than the useful life of the equipment. This is because the a company eliminates the possibility of undergoing costlylessor structures the original lease with the plan to lease extensions, since title of the equipmentrealize some degree of residual value on the back end of immediately transfers to the company upon fulfillment ofthe lease, whether through re-sale or secondary short- the final lease payment. Should a company decide toterm leasing contracts. A new car, for example, can often keep the assets it’s leasing rather than return them, theonly be leased for terms of 24 or 36 months, so that lessor will have the freedom to give the company a buy-when the original lease expires and the car is returned, out quote that is equal to or greater than the amountthe dealership can then sell it on a secondary market (as they could sell that equipment for on a secondarya used car) or issue a second short-term lease contract to market.another consumer.When an original lease expires, the consumer can send Leasing A Serverthe equipment back to the lessor, undergo a costly leaseextension, or accept a costly buy-out quote. A lease with Lease w/title transfer transaction allows the consumer to obtain Title Transfertitle of the equipment upon expiration of the originallease, then have the freedom to keep the equipment for Lease & buy-outthe remainder of its useful life, or until a refresh isdesired. The time that the equipment is kept without any Lease & 24 mo.payments being owed is when the savings are realized. ExtensionFor example, if Company ABC needs a dozen high- 0% 50% 100% 150%capacity servers to support the development of a new Initial Lease Additional Paymentslocation, it can obtain the servers through a 36-monthlease, despite the servers having a 60-month useful life.At the end of the lease, if the company still needs theservers, it can send them back and refresh with newequipment or undergo a costly lease extension/buy-out,which would eliminate the financial advantage the 36-month lease initially provided. Had the company electedto utilize the lease with title transfer strategy, it couldavoid any additional payments and have the freedom touse the equipment for its entire 60-month useful life.PROCUREMENT STRATEGIES ■ DANIEL EVOLA 3
  5. 5. For example, if a company enters into a 36-month A lease with title transfer strategy helps to eliminatetraditional lease for a server with a 60-month useful life, nearly the entire end-of-lease management system, sincethe lease payments may equate to roughly 75% of the the equipment becomes the lessee’s property uponservers value (25% a year). At the end of the lease, the completion of the lease. A lease with title transferlessor is not likely to give the consumer a buy-out quote strategy eliminates the need to have a team in place toanywhere near the remaining 25%, since the server coordinate the packaging and shipment of the leasedwould sell for considerably more on a secondary market. assets back to the lessor. A lease with title transferIn this situation, a quote of roughly 40% is more realistic. strategy also eliminates, or at least postpones, the needAdditionally, a 24-month lease extension (to bring the for a “refresh plan” for equipment coming off of lease.server to its 60-month useful life) would cost the The company will simply have more flexibility incompany roughly 50% of its original NPV, assuming the refreshing the equipment.monthly payments remain the same at the original 25% ayear. Using a lease with title transfer transactioneliminates the possibility of unfavorable buy-out or lease CONCLUSIONextension quotes. No single procurement strategy is best for all companies, and many different factors should be considered before selecting a procurement strategy, including:ELIMINATE END-OF-LEASE ASSET  Budget restraintsMANAGEMENT  Volume of equipment and leasesTraditional leasing as a procurement strategy requires an  Nature of the equipment the company is procuringend-of-lease management system, which is often  The company’s ability to manage and refreshcomplex, time consuming, and inefficient. End-of-lease equipment on timeasset management tasks include: These are just a few of the factors that need to be  Disassembling the leased equipment considered before pursuing any single or combination of  Packaging the equipment procurement strategies. However, if developing a steady  Shipping it back to the lessor & tracking the refresh cycle, avoiding large initial cash outlays and shipment getting the most out of the equipment are priorities, a  Updating any asset tracking databases to reflect lease with title transfer strategy should be considered. shipment details and asset status  Potentially develop a refresh plan to replace the equipment that is shipped backThe most difficult part of managing an end-of-lease assetmanagement system is timing. The equipment needs tobe disassembled and sent back to the lessor before theend of the lease, or else the lessee may incur late fees orback-rent charges. This means accounting for the time todisassemble any equipment and package it, and the timeto ship from the working site to the lessor. For example,if Company ABC sends its leased servers back to thelessor one month late, the lessor could charge thecompany an additional month of rent or a late fee.PROCUREMENT STRATEGIES ■ DANIEL EVOLA 4
  6. 6. For further information, please contact Alex Kozlov, Director of Marketing, Americas, at alex.kozlov@isg-one.comor +1 617 558 3377.Information Services Group (ISG) (NASDAQ: III) is a leading technology insights, market intelligence and advisory servicescompany, serving more than 500 clients around the world to help them achieve operational excellence. ISG supportsprivate and public sector organizations to transform and optimize their operational environments through research,benchmarking, consulting and managed services, with a focus on information technology, business process transformation,program management services and enterprise resource planning. Clients look to ISG for unique insights and innovativesolutions for leveraging technology, the deepest data source in the industry, and more than five decades of experience ofglobal leadership in information and advisory services. Based in Stamford, Conn., the company has more than 800employees and operates in 21 countries. For additional information, visit 121812 © Copyright 2012 Information Services Group – All Rights Reserved