The paper describes how equipment financiers can create a leasing business from scratch, with top industry processes, technology standards and limited upfront investment. While it discusses several challenges financiers face, it notes the entrance of third-party providers have enabled financiers to mitigate much of the risk associated with launching operations.
With relentless competition driving product innovation, the need for manufacturers across industries to provide asset financing directly to their end customers is steadily increasing. Additionally, the equipment financing industry in general is seeing two key trends: First, new growth is being driven by emerging economies like LATAM and Asia — for example, China’s equipment leasing market has expanded 30-fold during the last five years, with estimated $300 billion in assets.1
Second, in established markets, growth is projected to be driven by specific and niche asset classes, with traditional equipment — such as IT and construction — likely to see slower growth rates. For example, as per an ELFA report, spending on IT equipment in the United States in 2012 averaged at 2.3% of GDP, as compared to a 5.3% 10-year average. Considering these emerging trends, captives of Original Equipment Manufacturers (OEMs) and startup equipment financiers need to find creative solutions to build their businesses as they embark on their equipment finance journey.
Operating models that enhance the ability to launch flexible product offerings and create operational capacity for introducing value-added services, like fleet and insurance, is the need of the hour. With financiers increasingly entering new geographies — such as Europe, China, Latin America, Asia or Australia — finding local financing partners is becoming all the more time-consuming and challenging, further driving the need to create a radically evolved business unit, which enables scale and speed to market.
Emerging financiers face several challenges when starting their financing operations:
- Setting up a new lending business (especially for non-finance companies): For captive OEM’s, asset lending is a far cry from running a manufacturing business. Captives and startup financiers face typical challenges, like establishing a technology platform, managing credit assessment and building operations teams from scratch. If they get the assessment of the borrower wrong they could end up with a lot of non-performing assets and a bad book. Established banks and finance companies are naturally adept at evolving in this space but it is not the core strength for an organization starting up afresh.
- Understanding the ‘nuts and bolts': As financiers set up their asset financing function, fulfilling some fundamental requirements like creating lending policies, defining procedures, setting up processes, accounting books, system configurations, reporting framework and subcontracting can become daunting tasks, especially when there is limited know how in-house.
- Building scale to sustain: Keeping pace with the parent manufacturing entities’ geographic reach is a goal for captives; availability of financing programs is a primary driver impacting product sales. The traditional approach of building lending operations hinders a startup’s ability to build scale quickly.
- Large capital outlays: In order to meet hiring, infrastructure and regulatory requirements, potential lenders face huge capital outlays from investment in people, software, hardware, retrofits and platform upgrades. This leads to major cost challenges from day one — clarity to sharply focus investment capital to maximize returns can be a game changer.
- Understanding the ever-changing regulatory maze: Equipment lenders entering the business must comply with multiple regulations, many of them vague and conflicting; these include the Dodd-Frank Act, the Equal Credit Opportunity Act, the Bank Secrecy Act and the Fair Credit Reporting Act. Non-compliance can result in penalties, and despite the uncertainty surrounding many of the regulations, any program investments must be acceptable to auditors many years down the road.
- Linear cost structures: Creating a business model where operating costs do not increase in proportion to the increasing asset base is an important differentiator. Limited application of “best in the industry” practices restricts the ability of startups to fundamentally alter their cost structures.
The new ideal: Powerful partnerships
For lenders entering the equipment financing business, strategic partnerships can often provide effective and efficient solutions to meet strategic and financial objectives. The overarching drivers to embrace a partnership model are based on core fundamentals, like the ability to focus on creating tailored financial products, drive product sales (captive OEMs), raise capital and manage credit/ residual value risks. This calls for partnering with strategic vendors that bring to the table in-depth experience in managing lending operations and a state-of-the-art technology offering.
Interestingly, partnerships not only free up management bandwidth, but also enable financiers to scale up or scale down operations rather quickly. Since non-core business operations are managed by expert partners, financiers can intensely focus on managing the core elements of the business and their customers.
Partners with global scale and deep domain expertise in equipment financing can provide “complete back office in a box” solutions. Their offerings include services like writing policies and procedures required to run day-to-day operations, creating complete operating processes with metrics and then hiring experienced teams comprised of risk managers, operations, accounting and technology experts.
The key points to keep in mind for financiers evaluating strategic partnerships:
- Partner with deep domain knowledge: Creating a part of the lending organization outside your four walls comes with built-in operational risks.
What becomes critical, therefore, is identifying a vendor that understands the ‘nuts and bolts’ of running operations. This includes deep process level understanding, adept use of analytics tools, clear definition of metrics and a well-defined governance mechanism to track day-to-day operations. There are multiple transformations that have been collaboratively led by partners and financiers in their journey towards collectively building robust financing operations, through a combination of process, analytics and technology interventions. Some examples include:
––Asset financiers have improved their deal conversion rate by 5% to 8%, by 50% reduction in cycle time driven by an improved risk notification process, multiple modes of deal submission and a dedicated deal closure team*
––Built-in ‘early warning signals’ in the credit and portfolio management process, reducing losses by up to 15% to 20%*
––Eight percent to 12% of operational cost reduction by eliminating reworks in the booking and documentation processes
- Create a business model that facilitates product innovation: The very genesis of creating partnerships is to build flexibility to launch innovative products, product variants and differentiated offerings. A combination of a proficient technology platform and a strong operational framework can bring the required product innovation across geographies. For example, through implementation of a partnership model, a startup financier was able to launch its asset finance business, with geographically customized product variants, in three continents within a span of 18 months.*
- Technology platform simplified: Strategic vendors bring innovative technology solutions with no high upfront licensing fees.* Instead, for just $25,000 to $50,000 per month and tied to business volume growth, you get what you need without compromising on features or functionality. Financiers get a complete suite of products ranging from dealer portals, front/middle office systems, seamlessly integrated back office solutions and invoicing solutions integrated with the general ledger.
- Partnerships that facilitate speed to market: A partnership model enabled a U.S.-based equipment manufacturer to launch its financing operations in just three months from scratch!* Creating management bandwidth to focus on core deliverables can facilitate market expansion that is not possible to achieve through traditional methods of building a large portfolio across geographies.
- Ability to radically reduce the cost of setting up and running operations: The paradigm shift is from large upfront investments to cloudbased, ‘pay-per-drink’ models. Transitioning from heavy capital expenditure to variable pricing models result in reduction of end-to-end operational costs by 30% to 60%.*
- Experience in program management at a global scale: Strategic partnerships give startup financiers the benefits of instant economies of scale. A vendor with proven ability to execute large-scale projects is critical when an equipment financier is looking for a long-term and globally deployable operating model.
Starting equipment lending operations once required considerable time and resources, but now the entrance of third-party providers have enabled financiers to mitigate many risks associated with launching operations. Lenders with funding sources in place and an option to partner in the creation of a turnkey solution bring the benefits of direct customer lending in a quicker, more cost-effective manner with lower risks.
This paper has been authored by Diwakar Singhal, Senior Vice President, Commercial Banking and first appeared in Monitor in May/June 2014.
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- Alta group website
Reference: *Genpact insights