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August 17, 1988

RULES FOR SURVIVAL NOW THAT COMPUTER LEASING HAS BECOME A ZERO SUM GAME

By CBR Staff Writer

Double-u, a, ar, we wrote on the sheet of paper, and showed it to our young nephew Russel. This, we explained, means war. War is one of his favourite card games. He does not yet realise that this battle for the deck has certain abstract mathematical properties shared by other activities. Nor does he know that these properties now characterise mainframe computer leasing. The card game War is a zero sum game. What one player loses, the other wins. Betting at a race track is zero sum when the bookmakers are included, but as far as the punters are concerned, it is a negative sum game. There are also positive sum games; on good days Wall Street offers a few. Computer leasing used to be that way, too, but it isn’t any more. Not in the mainframe market, anyway.

Dismal science The business of financing mainframes has become mature. This is a term favoured by economists, chosen by practitioners of that dismal science because it appeals to their keen sense of boredom. In business, mature is a euphemism for an activity that once paid off as regularly as a bookie on a crooked cop’s beat… but is now as trustworthy as a lounge lizard. Both lessees and lessors will have to adjust. If the leasing market were growing apace, users could pretty much count on the solvency, if not prosperity, of their leasing companies. In a mature market, leasing companies that don’t reckon with conditions will inevitably get into trouble, and, consequently, so will some of their customers. As a lessor runs short of money, the lessee runs out of freedom. Almost regardless of contractual obligations, the unwritten laws of leasing permit a lessee to change his mind… as surely as they forbid a lessor from reneging on a firm deal. This no longer obtains when a lessor is broke. Some lessors are dealing in computers the way Catch-22’s Milo Minderbinder traded eggs: Milo lost money on every one, but made it up in volume. This is troubling but explicable. Leasing became a zero sum game only recently. Quite a few leasing companies grew prosperous under prior conditions, when there were plenty of mainframe shops that didn’t know what a third-party lease was. The climate of ignorance was also one of great opportunity. Lessors taught prospective lessees how to get more for their money and were rewarded with contracts. The evolutionary process fed on itself. Lessors’ healthy profits attracted more players to the game. Lessees’ substantial savings forced users unfamiliar with financing practices to bone up on leasing. As a result, today’s savvy shops know all the angles, and lessors know where every prospect lives. Sophisticated financing has become an inescapable part of computing, not only for mainframes, but for most midrange installations, too. Even IBM, which had built the foundation of its empire on month-to-month equipment rental, had to give up its lucrative old ways and create captive Credit Corp. The lessees have come out way ahead. So have the lessors, but they must now play a zero sum game requiring more skill. In order to achieve fast growth in the mainframe sector, a lessor can’t depend on a vast supply of new prospects. Nor can a leasing company count on a boom in mainframe installations; the user base adds MIPS at a moderate pace. To grow quickly, a lessor has to take business away from the competition.

Some third parties have concluded that their future expansion will come from leasing equipment other than mainframes. Most of these companies have built expertise in the IBM midrange, the DEC market and the PABX trade – fields that are similar to the mainframe world. Others, having pondered their options, have determined that their best course lies with the trade that they have plied all along; companies with this attitude are often smaller and more efficient enterprises. Despite the harsh environment, some lessors seem to be growing like crazy. In a few cases this is because they actually are crazy, offering deals unlikely to enrich anyone besides the user and the commissioned sales rep. Lately, one or two of the nuttier lessors have calmed dow

n, but their episodes of fiscal imprudence could recur at any moment. Some of the silly companies have rich parents – utility companies, for instance – but others do not. While poorly managed leasing companies have made mistakes, their wiser competitors have grown stronger. When the market pegs lease rates too low, the smart lessors have made the prudent choice: they have walked away from deals. This may impact their revenue, but it will have a salubrious effect on their solvency. The good health of these more responsible lessors will directly benefit their customers. The typical mainframe lessee will not keep a machine for the length of its initial lease. Many shops need upgrades before their leases are up, while others require unanticipated extensions. When a lessor grants an exception, it is not doing the user a favour, it is doing good business. The long-term relationship between lessor and lessee is extremely valuable to both parties. There is no question caution plays as important a role in the user’s strategy as it does in the lessor’s. But risk-avoidance, like risk-taking, can run to excess. In trying to sort through several bids, the user may safely eliminate any quotes that seem outrageously low along with those that are unaffordably high. But an inexpensive lease offered by a competent lessor is another matter entirely; it’s probably the deal one should take. In the real world, things are rarely this simple. It can be a chore to compare the terms and conditions offered by various lessors. And judging the quality of a leasing company is even more difficult.

Brains don’t run out The most important consideration in selecting a lessor is its competence. In leasing, as in most other fields of endeavour, quality and quantity may coincide, but they are indubitably distinct. Some competent lessors are small firms run by individuals with no interest in building an empire. Similarly, there are large firms that have had more luck than brains. The user who cannot see why the distinction is important will eventually learn that brains don’t run out. This is a lesson best taken under conditions that won’t have a material effect on one’s career. A user can assess leasing deals with a technique borrowed from the game of chess: in order to get a fresh perspective, turn the board around. A lease is a simple economic agreement. Once a lessee’s interest rate is known, the only unknowns are the initial cost of the equipment and the presumed residual value. Either of these last two factors determines the other… and the initial cost is easy to figure. Having determined what the lessor thinks the machine will be worth when the lease ends, the user can make a judgement about the lessor’s competence. A third party that is very good at remarketing equipment may comfortably invest a few extra points in a lease. So can one with access to optimistic investors willing to bet on a high residual. But a leasing company that repeatedly takes huge risks with its own money cannot survive. For such a company, mainframe leasing is not a zero sum game. It’s a zero hope game.

Copyright (c) 1988 Technology News of America Co Inc. All rights reserved.

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