HardwareToday: Guide to Leasing

Last week, HardwareToday explored the buy vs. lease decision process. This week, we provide a guide to leasing with an eye on the major U.S. server vendors.

We step through the lease evaluation process and compare lease offerings from the top-six U.S. server vendors.

The leasing space is valuable for vendors. Technology refresh options, prevalent in many leases, mean customers return for hardware revision to revision. We’ve culled information from the vendors themselves to introduce or offer fresh perspectives into the wild world of server hardware leasing.

Vendors use leasing offers as part and parcel of an overall competitive campaign. Consider, as a prime example, Sun’s HP Away Migration Special Lease Offer, which grants below-market rate financing for 36 months in exchange for a Sun-sponsored migration away from HP Tru64 systems.

1. Negotiate Contracts Prudently

Leases provide such a quick and short-term inexpensive technology infusion that enterprises may neglect to scrutinize the lease contracts for financial hazards. “The lease contract can make or break a deal,” says Gartner Research Director Francis O’Brien. “Enterprises should develop lease contracts that provide flexibility and contractually enable business changes.”

From the get-go, some vendors seem to sense this customer requirement better than others. “Fujitsu can craft the terms of our leases to meet the customer requirements for term, payment and buyout options. Rates will be based on required lease options and market conditions,” says Richard McCormack, vice president of product marketing for Fujitsu Computer Systems.

Although pleasing the customer (and culling the customer’s return business) is of primary importance to vendors, vendors and enterprises often agree from the outset on what basic lease terms should look like. McCormack adds “Currently, we find that most of our server leasing customers are interested in lease terms of 36 months, with most requiring operating lease treatment.” (The standard lease vendors offer is a 36 month operating lease.)

2. Ensure That Fair Is Fair

An operating lease is synonymous with a fair market value (FMV) lease, and “a fair market value lease is usually the best option for a company that needs to stay on the cutting edge by rotating their technology every 2 to 3 years,” according to Laura Thomas, spokesperson for Dell Financial Services of Dell Financial Services’ (DFS) Corporate Communications group. “[Dell’s] FMV lease is designed for easy upgrade through Dell with the return of leased equipment to DFS,” adds Thomas, “while still leaving the customer an option to extend the lease or purchase the systems at [the] then fair market value.”

However, according to Gartner’s O’Brien, the lessee and the lessor may define FMV in different terms. “We recommend that clients develop and document a clear understanding of how FMV will be calculated,” she said. O’Brien describes the typical benefit of negotiating FMV. She notes that if a vendor uses a stipulated loss value to determine FMV, in the end, the enterprise will end up paying too much if the stipulated value is undetermined. After 36 months on the rack, a typical server is worth 10 percent to 12 percent of its original price; however, in a typical FMV end-of-lease clause, the lessors may stipulate an FMV as high as 25 percent to 30 percent of the original cost. Diligent negotiation may bring this amount down to 20 percent or less.

How much can negotiating save you? “Some lease contracts we have seen have had stipulated loss value schedules that require the lessee to pay 55 percent of the original equipment cost if they want to buy the equipment at the end of 36 months,” says O’Brien.

3. Turnabout Can Be Fair Play

A 36-month FMV lease, although the most common option, is almost never the only option. Most vendors offer a wide and customizable variety of lease options. For example, Sun lists lease terms ranging from six months to 60 months as basic lease periods.

“Sun Microsystems Finance allows customers to mix and match lease term length, purchase options, and payment structure,” says Kris Snow, senior director, Sun Microsystems Finance. Snow adds that options offered for Sun leases include step payments (which match expected gradually declining return cost-to-lease payments), six-month deferred payments, and irregular payment cycles based on the lessee company’s unique revenue flows, presumably known in advance and ideal for enterprises in industries with seasonal spikes.

Another lease option is the sale leaseback, which IBM and others offer. In a sales leaseback, ownership of a previously purchased server is transferred to the vendor for tax and asset management reasons. “A sale leaseback lets you turn your fixed assets into liquid ones, making cash available for other investments or upgrades,” according to IBM Global Financing’s Media Relations department, “It also offers highly competitive rates, while at the same time it eliminates the risks of ownership such as equipment obsolescence and disposal.”

Using the sale leaseback still brings FMV into play in the end, as the price the vendor doles out for the hardware is based on its FMV. This is one case where, rest assured, the vendor will aim low in assessing the market value of the hardware. And, of course, really playing unfair with your lease will damage your credit rating and is far from an optimal way to conduct business.

4. Match Lease Terms to Estimated Equipment Use Time Frames, or Simply Refresh Technology Consistently

“Leasing works best when you match the term of the lease to the amount of time you expect to use the equipment,” says Gartner’s O’Brien, “so if you know you are going to use the equipment for four years, a four-year lease would be less-expensive, but it would likely not be an operating lease.”

Some vendors may bank on a lease not ending at all. Technology refresh options, which replace leased technology as newer technology becomes available or desired, are widely used by some server vendors. “A hallmark of leases and financing transactions offered by Unisys Leasing is that nearly 75 percent of these transactions never reach end-of-term but are [instead] restructured to accommodate technology enhancements,” says Mark Staehnke, vice president of Unisys Leasing Global Programs. A technology refresh is of value in enterprises where servers have a fast turnaround life; however, the trend toward utility computing can extend the life of older systems and may underscore the overall need for obsolescence protection in some environments.

5. Track Carefully

Ensuring that server lease deals stay beneficial requires keeping careful inventory of each piece of server hardware, which obviously includes tracking when the lease comes due. This may not be apparent to lessees or stressed by lessors in the heat of the acquisition. According to a February 2000 Gartner research document, “Leasing Servers, the Business Issues,” asset management routines that track machines, order replacements, and facilitate end-of-lease returns are necessary prerequisites for leasing. Failure to comply can be costly. “Whether through inadequate time to plan for replacement equipment or poor asset control,” the document reads, “missed lease return dates can be expensive.” The research document also recommends requiring notification from vendors 90 to 120 days before the lease’s expiration date.

6. Consider End-of-Lease Options Before the Lease Begins

According to O’Brien, when it comes time to return server hardware, less reputable lease vendors may try to play tricks, such as subtracting damage costs or costs for carelessly unreturned hardware.

A reputable vendor will be clear about end-of-lease options. IBM, for example, provides a slew of End of Lease information, including packing and return instructions, and also allows for online lease decisions. Ambivalence in presentation of end-of-lease practices should be a warning sign that a lease organization might not be on the up and up.

It is also more desirable to, where possible, lease from the vendor itself or from a closely linked leasing organization. Vendors that want your return business are less likely to penalize harshly in the hopes of turning one-time profits.

7. Make an Extra Stop and Run the Contract by the Finance Department

If your company doesn’t already require it, asking the Finance department to ratify a lease will likely go a long way in strengthening internal relationships, should conditions go south or change quickly and you need support for a new (or suddenly vacated) acquisition.

Vendors understand how financing departments differentiate deals. “The Unisys Leasing focus is built around having on-site professionals who are experienced with both the technology and the financial sides of the Customer engagement,” says Unisys’ Staehnke, “Recognizing that one size definitely doesn’t fit all, these people work directly with the Customer to insure a financial framework that best addresses their needs.”

When shopping for a new server hardware vendor, consider the strengths and weaknesses in the leasing department as part of the overall assessment.

We’ve supplied a chart to help get you started exploring the options from the six major enterprise server vendors: Dell, Fujitsu, HP, IBM, Sun, and Unisys. Vendors are listed in alphabetical order.