CEO & President, Amembal Capital Corporation & Amembal & Associates
e-mail: [email protected]
Leasing is a financing method now practiced in most countries throughout the world. In fact, recent statistics indicate leasing is currently a $500 billion industry worldwide. Different countries, however, are in different stages of development, ranging form the nascent to the mature industries. Regardless of the stage of development, some companies will choose to grow domestically while others will achieve targeted growth via overseas expansion.
There are, of course, numerous strategies a company can invoke to achieve targeted growth. The focus of this article will be on one solution in particular, that of entering foreign markets that offer superior growth potential. More specifically, this article will focus on how to decide which foreign market(s) to enter based upon an analysis of a given country's position in the "leasing cycle."
Though the term "globalization" has become a trite expression, in that many lessors have already, on many occasions, considered foreign expansion, the goal of this article is to provide a new perspective on the decision to enter new markets visa-vis the leasing cycle concept. By providing a framework within which to make the decision, a lessor can better evaluate its own competitive position relative to the potential market.
My active involvement with leasing throughout the world has created the opportunity to study the development of leasing industries, from the nascent to the mature stage. Although each country's leasing industry occupies its own unique spot in the development cycle, there is a common pattern of progression as an industry grows and matures.
This pattern of progression, hereinafter referred to as the leasing cycle, consists of six stages.
The Leasing Cycle
Finance leases
Flexible/creative finance leases
Operating leases
Innovative leases
Maturity
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Stage 1: Finance Leases Finance leases represent the first stage of the leasing cycle. Leasing is just becoming recognized as a form of finance and there is relatively little competition. Finance leases are full payout leases, with noncancellable terms, in which the lessee buys the asset at the end of the lease.
The purchase price, at the end of the lease term, if any, is generally very nominal. The finance lease is very similar in structure to an installment loan and is used heavily as a form of vendor finance.
Finance leases are generally considered to be tax leases (that is, the lessor is entitled to retain the depreciation benefits of ownership). The lessor derives its profit in a finance lease from the spread over its borrowing costs and the tax benefits of depreciation, if any. the lessor's tax benefits of depreciation are not priced into the lease (used to lower the lessee's cost) but are kept in their entirety by the lessor.
The payment pattern in a finance lease is one of level payments. The lessee is responsible to pay all the expenses of ownership such as maintenance, insurance and any taxes. Other distinguishing features include full expensing of the lease payment by the lessee for tax purposes and the providing of 100% financing. Also at this point in the cycle, there is a lack of accounting and tax guidelines. The Indonesian leasing industry is in the finance lease stage of the leasing cycle.
Stage 2: Flexible/Creative Finance Leases
The next stage of the leasing cycle represents the response to growing competition within the leasing industry. Although the base ;product remains the finance lease, as competition increases lessors find they must differentiate their product. One method of differentiation is to structure the lease to meet the lessee's cash flow needs. As a result, one characteristic of this stage in the cycle is creative lease structures.
Lessors also offer additional services as another means of differentiating their products. For instance, residual options, other than the nominal option, become available at this point in the cycle. These options would include lease renewals and the option to purchase at a fixed value. The building in of residual acts to lower the cost to the lessee, further differentiating the lease from a traditional loan
As the industry grows, new products/institutions are created. Leveraged leasing is introduced as another financing vehicle and captive leasing subsidiaries are formed by manufacturers to support the sale of their products. Accounting and tax regulations are promulgated as a precursor to the next stage in the cycle, that of operating leases. The Nigerian leasing industry is in the creative/flexible finance stage of the leasing cycle.
Stage 3: Operating Leases
Movement by lessors into the operating lease stage of the leasing cycle is generally precipitated by the issuance of accounting and/or tax guidelines that create a bifurcation of products. Another motivating factor is the continued acceleration of competitive pressures as more players enter the leasing marketplace.
It is during the operating lease stage of the cycle that lessors first begin to take true residua risk in their assets. Movement into this stage of the cycle presupposes a developing /developed secondary market for used equipment as the lessor must now manage the new risk created by ownership of the asset at lease expiry. Coping with this risk requires asset management and lease remarketing skills.
The asset risk is not limited to end-of-lease events, however, as operating leases do not necessarily go to maturity. Growth of the operating lease market is fueled b lessees seeking off balance sheet financing, a hedge against residual risk and a lower periodic cost. Lessors, due to market pressures, are forced to price their leases on n after-tax basis and pass the tax benefits of ownership on to the lessee in the form of lower lease rates. The types of assets leased under operating leases range from vehicles (with established secondary values) to computers, in which there is a high risk of technological obsolescence. The United Kingdom could be classified as being in the operating lease stage of the leasing cycle.
Stage 4: Innovative Leases/Products
The farther along the easing cycle that an industry progresses, the more intense the competition becomes. One result of this increased competition is the continued efforts of the leasing industry to differentiate its products, not only from other financial offerings, but also from competition within the leasing industry. Other motivations include efforts to infuse more equity into the industry and a continued search for innovative, lower cost financing instruments. The types of products that characterize this point in the cycle include income funds, wrap leases, securitization, venture leasing and project finance. The UK leasing industry is entering this stage.
Maturity
There comes a point in the leasing cycle when the penetration of leasing begins to level off due to a saturation of the market. there is an abundance of lessors offering a wide variety of products, with little differentiation between the products. The leasing industry has matured and its products have almost become a commodity. Because of this, there is very little scope for product differentiation. Lessors, therefore, begin to differentiate their products through value-added services such as more rapid turn-around times on documentation and credit, flexibility in the lease structure and the level of customer service.
Maintaining profitability becomes a prime issue to lessors in a mature market. A shift from external (product) focus to an internal (operations)focus occurs as lessors address the expense side of the profitability equation. Lessors look inward and strive to become low-cost providers. At the same time, more money is spent on research and development and improving the technical skills of the lease company's personnel.
A consolidation of the industry in the form of mergers and acquisitions is a natural outgrowth of the mature industry as companies attempt to increase revenues through expansion into new markets. Others seek new markets trough product lines that are different from those they have traditionally offered. Given the globalization of the leasing industry, lessors in a mature industry also look more and more to business outside of the domestic market as a means of increasing revenues. The United States leasing industry appears to have reached this stage.
Beyond Maturity
It is uncertain what the next stage of the cycle will be, as there is not yet a leasing industry that has progressed beyond the maturity stage. The leasing industry has been in existence for many years, however, and will continue to thrive as there are many opportunities throughout the world that still may be capitalized upon.
Conclusion
Based upon my study of many international leasing markets, I have noted that every country/industry progresses through the same stages, although the length of time spent in each stage can vary substantially. For example, the United States entered the first phase in the 1870s. From that time, it took 120 years for the U.S. industry to reach its present stage of maturity. The UK leasing industry, however, reached the innovative leases/products stage in only 30 years. Without a doubt , this trend toward more rapid progress through the various stages will continue due to the transfer of technology.
It is the contention of this article, that by analyzing and understanding a country's position in the leasing cycle, a company can make a more informed decision with regard to which country or countries to enter. Without a doubt, there are significant obstacles encountered when entering a foreign market. Lessors who make the decision to expand overseas must be able to add value to the existing market if the are to compete with domestic lessors. This failure can exist in the product sophistication and knowledge lessors possess given their advanced position in the leasing cycle. This introduction of new product ideas is the transfer of technology mentioned earlier, which pushes the newer markets forward into the next stage, expediting their progress through the leasing cycle.
Posted 3 September 1998. With minimal revision, these observations remain just as valid today as when first made in 1991.
