Large corporations aren’t immune from making basic cost miscalculations, either. When Cleveland-based industrial-equipment maker Eaton Corp. entered a contract to lease computer servers some years ago, the deciding factor should have been residual-value predictions, according to vice president and treasurer Bob Parmenter, who was not involved in the decision at the time. Those who did call the shots, however, were seduced by the convenience factor.
“They looked at month-to-month instead of total costs, so the bias was toward leasing,” Parmenter says. “When leases came to their normal end, rather than deciding to dispose of the equipment or find a new lease, they continued to lease. It was a very bad economic decision.”
Among their mistakes, Almquist and Parmenter’s predecessors failed to recognize that some lessors expect the high back-end returns to offset the low payments they dangle up-front. According to industry statistics, lessors on average realize 15 percent yields on the equipment they lease, says Susan Franklin, CEO of American River Partners, a Cohasset, Massachusetts-based consulting firm.
“Most lessors make money through some obfuscation in the lease,” maintains Michael Keeler, CEO of Ecologic Leasing Solutions, a lease management outsourcing company in Great Falls, Virginia. “If the rates are pushed down at the beginning of the lease, the rates at the back end go up.”
There are more-standard reasons that front-end costs are low, maintains ELA president Michael Fleming. Smaller monthly payments reflect higher residual values of the equipment, and also come with longer lease terms. Back-end terms are simply meant to protect the leasing company, which assumes the risks associated with the value of the equipment. “It isn’t that the lessors obfuscate,” says Fleming. “The main problem is that lessees just don’t think about the lease as an ongoing thing that has a beginning and an end.”
Still, a lessee that pays too little attention to that end can incur significant costs. Lessors often set deadlines for lease-renewal notification as much as six months before the end of the lease, for example, and being late can subject the lessee to steep penalties or commit it to another lease term at the same rates. Such costly results are common, leasing experts say, because lessees often don’t recognize the importance of leased equipment until they have to replace it.
Returning equipment on time doesn’t always prevent add-on costs, either. Lease terms often have “all or nothing” clauses, meaning, for example, that the return of 95 of 100 leased computers doesn’t keep the company from incurring full lease payments. Sometimes a few items may be lost or damaged, or there might be an unexpected need to retain a few computers, yet with an all-or-nothing clause the company still pays in full.
“If you have a company leasing 100 computers, all installed at the same time, unless you’re brain-dead you’ll understand that a moment will come at the end of, say, three years when you have to transition to the next wave of technology,” counters ELA president Fleming. Companies should be able to see in advance the need to keep back a few computers, and then they can negotiate “a staged end of the lease,” he says. “You can put in language that allows a transition.”