Beware of Opportunistic Foreign Manufacturers from Emerging Markets

According to Craig Paylor, former JLG president and aerial industry veteran, equipment rental businesses should hang on to their aerial work platforms for a longer period of time than in the past. The reasons go beyond the future of available financing and center on the need for U.S. equipment rental businesses to build value in their existing fleets.

With the rental market depressed and no sustained recovery expected until sometime in 2012, the environment is not conducive to buying new equipment, Paylor notes. Even more daunting is the prospect of obtaining financing when the economy does finally bounce back. "If the market returns in even marginal terms sometime within the next six to 18 months, what is the likelihood that you can take your balance sheet and cash flow statement and get any kind of reasonable financing rate without having to sign your life away as collateral? The answer is: not very good," says Paylor.

With this in mind, it doesn't make sense to sell off every underutilized piece of equipment that's sitting in the yard, because it will be hard to replace. "Sure, a certain amount of equipment can and should be sold if you can make a reasonable return. But what is reasonable in a market like this?" Paylor says. "You can almost be assured that any piece of equipment you sell at auction will end up being something you have to compete with in the future, as a rebounding marketplace always creates opportunities for new startup companies."

As the economy recovers, manufacturers will see the cost of commodities go up as soon as producers can justify an increase. "Steel, rubber, engines, hoses, motors, pumps and everything in between will start up in price long before the job starts are plentiful enough to allow rental rates to climb back to levels with reasonable returns," Paylor predicts. "This means pressure will be on all manufactures to raise their prices so they don't have to absorb this margin hit. Most manufacturers will try to push the price increases out as long as they can, but in the end, the commodity companies will demand the price increases or [manufacturers] simply will not get any material."

The result, Paylor says, is a virtually inevitable price increase to the distribution network. "How this is handled will be determined by the stage of recovery for each manufacturer," Paylor says. "But as these prices put pressure on margins at every point along the value chain -- vendors, manufacturers, rental companies, end users and finance companies -- you could see the basis for a perfect storm."

The perfect storm to which Paylor refers is an ideal setting for new manufacturing companies – most likely emerging from Asia, India and other markets -- looking to enter the giant markets of North America and Europe. "Think about a Chinese company that decides to build a product that looks a lot like any one of the market-leading products in any rental category. They will have a product designed so much like the existing one that the service parts fit either the original or the new one," he predicts. "It will be built in an area of the world where labor costs are a fraction of the cost of U.S. or European rates. They have trillions of dollars to finance any possible purchase by new distribution, even if it is backed by their own government. Maybe most important, they are not worried if they make any money on the sales for some period of time, possibly years, because all they really want is to have their product become accepted by the rental customers and end users as reliable."

He continues, "So these new manufacturers have a lower price, plenty of capacity, almost unlimited finance capacity in a market where finance will be extremely restricted, and a mindset that success is going to be judged not by profit but by acceptance of the product, which is a much longer-term proposition. In a time when so many U.S. manufacturing companies are or have run to China to build their products in order to take advantage of the low labor rate or to allow them to compete in the Asian marketplace, their new hosts are building similar products to come to this market with advantages few U.S. manufactures can match."

Sound like a perfect storm? Paylor says it will only take one or two major U.S. rental companies to decide their only path to survival involves buying the cheaper Asian products and these international companies will be on their way. "Just look at the automotive business if you doubt it can happen," Paylor says.

In order to head off this potential threat, Paylor says U.S. manufacturers must first be tough competitors in these Asian markets. "They have to play hard ball with prices and form strong relationships with distribution," he says. "Most of the rental concepts of our market are new to the emerging markets so the distribution and all the parts of their company have to be trained on how to handle customers in these settings. Second, we have to understand that financing of our products to our customers is not an option if we want to have a solid shot at orders coming from a distribution base that has suffered significant hits in profits and margins. Third, we have to make sure our products can be productive for many years. A piece of rental equipment that only lasts five years is a product that has to make a completely different financial return for a rental company than one that will be productive and make a solid return for 10 or 12 years."

Keeping a product in fleet, well maintained, for longer periods of time can be the key to keeping new competition out, Paylor states. "The giant opportunity is the installed base of equipment. How much value any product has is judged by the total life-cycle return and almost every brand made in the U.S. has a good story to tell. My advice is to think about what you have built with your customers at every level as far as confidence in product is concerned. We all represent a brand -- manufacturers, distributors and even end users, to some degree. Support that brand from cradle to grave and give your customer a reason to NOT want to change. In the end, faith in a product, loyalty to a business partner, confidence in your ability to adapt to a changing marketplace by adjusting your services to match the new customer needs, and the belief that all things run in cycles, should convince you not to hastily jump into a product or business venture that is unproven just for a short-term gain."

In addition to brand value, the ability to leverage technology is going to be another important factor in the survival of U.S. manufacturers and rental companies. "The electronic 'communication' between manufacturer, distributor, and even end users will be a key component of a healthy rebound in the rental business. Machine ordering, parts ordering, electronic service diagnostic and paperless account settlement are still on the cutting edge and likely to help North American manufacturers keep a solid relationship with the rental companies."

He concludes, "Companies like SmartEquip are going to be part of the future. While not completely merged into the back office of all the rental companies at this time, they are well down the road. This type of technology can not only take cost out of order processing and management, but is the basic foundation of a system that will help owners of equipment manage the profitability of the rental fleets for the entire life cycle of the product, and do so in conjunction with customers and manufacturers as partners in the process. It will be some time before international manufacturers can fully engage this type of system."