New lease of life for IT purchasing

4 Feb 2003

These days, no one would disagree that every company needs a good technology infrastructure – it’s seen as a given. The more important questions are: how much do you want to pay for it and how will you finance it?

At the height of the dotcom mania, the telecoms equipment manufacturers thought they had the answer. With new telcos popping up all over the place as a result of telecoms deregulation, vendor financing became all the rage as a way for telcos to build out their networks.

In 1998 and 1999, Lucent Technologies alone issued nearly US$10bn worth of vendor credit to all-too-eager entrants to the burgeoning telecoms sector. By mid-2001 there was over US$25bn in loans on the books of the world’s networking equipment giants.

It appeared the perfect solution: equipment vendors were inking new contracts every week while telcos could meet ambitious growth targets. When the internet bubble burst, however, the folly of rash vendor financing schemes was revealed. When bankrupt telcos defaulted on their loans equipment providers were forced to write down bad debts worth billions. In a single quarter in 2001, for example, Nortel Networks posted losses of US$19.2bn, US$15.2bn of which was due to write downs.

Such ‘lend to sell’ financing was very much an anomaly, a product of the extraordinary times and it would be wrong to tar the entire IT financing industry with the same brush. Indeed, most IT financing providers take a more prudent approach to risk management and apply expert knowledge of best lending practices.

Well-known names such as IBM Global Financing and HP Financial Services have long histories of providing finance to a broad range of corporate customers.

IT financing boils down to two simple options – lease or buy? But thrown into the equation is whether to manage – ie roll out, operate and maintain – your own infrastructure or outsource it. For PCs and other hardware, the user faces a range of financing and management options: they can buy and self-manage; they can lease and outsource the management; or a combination of the two. And each approach has its own merits and cost implications.

A word of warning – the nature of your company’s IT infrastructure will have a bearing on the options open to you. Jim Bergin, business process director at Glanbia, argues that unless you have a standardised IT network to start with it won’t be possible to go down the leasing or managed service route.

“Glanbia IT infrastructure was very fragmented across the group because of the various acquisitions that were made so there were non-standard PCs and software on a widespread basis,” Bergin recalls. “If you don’t have standard PCs and applications across the organisation and you outsource them, then the external company has to impose a standard, which is much harder for them to achieve. Consequently our strategy has been to standardise, consolidate and commoditise segments of our infrastructure and applications, which permits us to pursue a number of options – we can either purchase infrastructure, lease it or purchase a managed service. But until you get that standard in place implementation of flexible procurement options are difficult to achieve.”

In considering whether to lease or buy, two issues need to be considered. One is the cost of the finance (the rate of interest charged), while the second is the cost of the equipment. If the rate of finance is unacceptably high or the leasing company is putting too high a valuation on equipment that you know you could buy more cheaply yourself, then you will be more likely to buy than lease. And vice versa.

The bottom line is that unless users can see clear cost savings, they are unlikely to go the leasing route.

It is also worth noting that leasing companies impose certain restrictions that remove some of the flexibility of your IT decision making. For example, under a typical leasing arrangement, the leasing company upgrades your entire PC network every three to four years irrespective of whether individual users require new machines. If you find that some tasks don’t require faster computers whereas others do you may want to mix and match old and new machines, but typical leasing contracts normally do not allow for such flexibility.

IT financing schemes are usually associated with hardware purchases, but software vendors are starting to get in on the act, too. From the office productivity suites used by everyday office workers to the elaborate business applications and server systems in place in large organisations, software accounts for a growing percentage of the overall IT spend. Since the industry was first established, fixed-term software licensing has been the standard model for purchasing software and this is not about to change any time soon. However, with IT budgets being frozen or cut as a result of the economic slowdown, IT managers are increasingly looking for ways of minimising their software spend.

One company to recognise this trend early on was security-to-storage specialist Computer Associates (CA). Two years ago CA introduced an innovative licensing policy, FlexSelect, which instead of tying users into a fixed-term licensing scheme allows them to pay for the product on a monthly basis. This is particularly useful if, for example, an organisation needs a certain software product to deliver a short-term IT project and does not want to incur the unnecessary expense of buying it for the full year. Such was the case last September when a banking customer wanted an extra 20 developer licences from CA to work on a new application. Matt Brennan, country manager, CA Ireland takes up the story.

“We actually just leased them the software month by month for four months so the cost of the software was dramatically less. If they said at the end of a month ‘Listen, next month we just need software for 15 developers’ we’d simply reduce the invoice,” he says.

Brennan estimates that upwards of 65pc of CA’s customers have availed of the new licensing policy. But while its customers have benefited, so too has CA. The new pricing model has meant the company can now target small to medium-sized enterprises as well as the larger organisations that make up the bulk of its customer base. According to Brennan, the new system is also proving popular with service providers such as telcos, application service providers, internet service providers and data centres. These can lease additional software each time they add a new customer so that their software infrastructure grows in line with their customer base.

The success of CA’s approach suggests that there is a large untapped market for pay-as-you-go software. A recent Aberdeen Research poll bears this out: 21pc of the respondents indicated that they would prefer subscribing to software over time rather than purchasing a licence.*

Brennan does not pretend that CA would not prefer to be selling fixed-term licences to all its customers – it would make more money that way – but its new pricing option suits the economic conditions of today, he feels.

“In the current climate it’s harder to sign-off [on new IT investment]. Isn’t it better that an IT manager goes to his board and says, ‘Over the last three months we have proven that we can save you x amount per year and by the way we’ve already got it installed and our staff are using it’ rather than saying ‘I need this amount of money for this project’. It’s the walk before you can run scenario,” Brennan concludes.

*Aberdeen Insight, Less Money Equals New IT Innovations, October 2002

By Brian Skelly