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Don't Buy That Hardware!

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CIOL Bureau
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When an IT manager finally takes on the CIO mantle, he is often faced with

responsibilities that sometimes go far beyond technology issues, and he has to

deal with arcane terminologies that have more to do ends up dealing more with

finance than technology. He is required to justify all his investments in IT.

There is constant pressure to use innovative techniques to bring down the total

cost of ownership (TCO) and maximize the return on investment (ROI).

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Therefore, finance and not technology happens to be the greatest challenge in

IT today. Says SR Balasubramanian, VP, information systems, Hero Honda, "A

major challenge confronting decision makers today is making the right choice

when it comes to paying for the technical assets essential to business

operations." Growth in the current technology marketplace is being driven

by faster product cycles, faster depreciation schedules, e-business

implementation and focus on integration and infrastructure.

India Inc is on a growth mode and there is greater requirement in terms of

technology upgrades and flexibility to deploy better technology, without having

to deal with capital losses associated with the sale of obsolete equipment. What

works wonders, under the given circumstances, is financing or leasing of IT

infrastructure. Says Srinivas Chakravarthy, Country Manager, IBM Global

Financing, "Financial offerings are required to be structured in line with

the technological life of the IT assets as well as customer usage pattern, to

provide CIOs with adequate investment protection."

The power of leasing



Indian corporations have traditionally been cost conscious. Most technology

investments tend to become more cash hungry, over a period of time, with

expensive maintenance and disposal costs. Says Alan Van Niekerk, CEO, RentWorks

India, a rental services provider to technology companies across Australia, New

Zealand, South Africa and India, "What you see is not what you get. Renting

the IT infrastructure provides more return on the rupee spend."

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The benefits of leasing are multifold. Says Arindam Bose, head, IT, LG

Electronics India, "A purchased asset is a fixed asset that becomes a

hurdle to technology refresh in the long run." Benefits include reduction

in TCO, hassle-free technology refresh from time to time, conservation of

capital, preservation of existing credit lines and, last but not the least, tax

benefits. Says Ramesh Vishwanathan, Country Manager, HP Financial Services,

"Leasing means no large sum outlay. Costs can be spread over the lease

term, which even out your cash flow and retain capital in the business for

longer."

Look

Before You Leap
All

you should consider when opting for a lease
Initial

Capital Outlay
If the total cost of equipment exceeds the

available operating budget, leasing may be the one way to avoid

an initial capital expenditure



Interest Rates Changes in interest rates will affect
future payments and the total financial commitment of the lease.

For instance, if a lease is renegotiated, the interest rate

applicable to remaining payments may change, affecting not only

the monthly payment but also the total amount paid out over the

life of the lease 



Tax Liability Depreciation can be used to offset income
tax purposes. This can be beneficial for equipments that

depreciate so quickly that the value of depreciation can be

applied against earnings, to limit tax liability



Fair Market Value Monitor the fair market value, or
current resale value, of the equipment, before deciding to

return or purchase the equipment at the end of the lease term.

For instance, it makes sense to purchase equipment that

maintains a high percentage of its original value.



Length of Lease Set up lease term lengths that do not
extend into the useful life of the equipment. For example, it

would not make sense to lease 1,000 PCs for three years if they

are likely to depreciate, significantly, in two years.



Cash reserves may also be utilized better to reduce secured debt facilities,

which negatively impact the balance sheet of companies. Says RentWorks' Niekerk,

"Traditional lease and asset purchase facilities are now recorded on the

balance sheet as financial debt, which may unnecessarily affect existing credit

limits and financial ratios and tie up security that could be used for other

business purposes."

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While a lease is customized to each transaction's particulars, the

fundamental choice is between an operating lease and a finance lease.

Operating Lease: An operating lease is desirable by corporates because it

allows them to treat payments as an operating expense. It protects the lessee

from overpayment, resulting in lower monthly installments. Operating leases

offer tax advantages as payments are treated as off-balance-sheet costs. Says

Niekerk, "Operating lease is not treated as a depreciating asset, it is

treated as an operating expense." Also known as true lease or fair market

value lease, it is preferred by companies operating under intense budget

constraints, or cash-rich companies that are concerned with increasing

productivity than to expend it on 'enablers' for the business. When leases are

structured as true leases, the end user may claim the entire lease payment as a

tax deduction. The equipment write-off is tied to the lease term, which can be

shorter than depreciation schedules, resulting in larger tax deductions each

year. The deduction is also the same every year, which simplifies budgeting.

Finance lease: Unlike an operating lease, it is a full-payout or non-equity

transaction. In other words, the full value of the leased equipment is paid

along with the interest during the life of the lease agreement. Besides the

regular lease payments, the lessee is also responsible for maintenance, tax and

insurance changes. Says HP Financial Services' Ramesh Vishwanathan,

"Typically, Indian companies prefer to own the equipment at the end of the

lease period for a nominal payment. This is a typical characteristic of the

Asian culture as opposed to a more mature global market." Also most vendors

offer initial discounts. A finance lease is similar to an automobile lease, at

least structurally.






However, the real difference exists in terms of resale value, which is zilch in
the case of IT equipments, at the end of the lease term, which is, typically,

three years. If the lease is structured in a manner that would limit the amount

of corporate income tax, it can more than offset the tax liability associated

with the earnings. A finance lease is suitable for a company that is short on

operating budget money but with room for capital budget. Typically, lease

periods are 36 to 48 months. A fair-market-value lease for 36 months is less

expensive than purchasing over a 30-month lease period.

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The market options



Two key vendors offering financing options are IBM Global Financing (IGF)

and HP Global Finance. Then there are players like RentWorks, who offer both

hardware and software on rent, which is, technically, an operating lease. A

typical IT lifecycle is one that would span the following stages: IT transition,

where one needs to maximize financial return on the legacy equipment;

acquisition of new equipments; management of solution cost over time and

finally, cost and risk associated with end-of-life disposal.






Service providers offer solutions for new asset lease where equipments of the
customer's choice are given on lease; asset recovery services, where unwanted

and obsolete IT equipments, with residual value, are resold to the service

provider, in some cases, thereby converting IT assets to cash; and exchange

plans which give clients the flexibility to replace some percentage of the

equipment with new equipment, during the contract period.






While all financing companies provide services on more or less similar terms,
what varies is their business model. While HP Financial Services requires at

least 30% of its customer's IT infrastructure leased, to comprise of HP

products, RentWorks is vendor-independent and leases equipments that are

selected by the customer from the vendor of his choice.



While HP Financial Services requires at least 30% of its customer's IT

infrastructure leased, to comprise of HP products, RentWorks is

vendor-independent and leases equipments that are selected by the customer from

the vendor of his choice.

Arindam

Bose, head, IT, LG Electronics



“Purchased hardware is a fixed asset that becomes a hurdle

to technology refresh in the long run”

Arvind

Kumar, CIO, Anand Automotive Systems



“Most Indian companies try to derive maximum usage and

push the products to obsolescence”

SR

Balasubramanian, VP, information systems, Hero Honda 




“Outsourcing is probably a better option to leasing and many
companies will look at the same”
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Financing options also vary from one enterprise type to another. Schemes for

large IT enterprises (over 1,000 employees) may include multi-vendor hardware,

software and services installations, with assistance from dedicated financing

specialists. Schemes for medium enterprises (100-1,000 employees) combine and

balance the flexibility of small business offerings with the competitive rates

required by large enterprises and, finally, schemes for SMBs. Interest rates

fall broadly in the 4-12% range, with the exact range varying from vendor to

vendor. Says HP's Vishwanathan, "The rates are higher for SMBs where the

risk is also higher."

It's not just hardware but also software that can be taken on lease. While

hardware is given on lease, software is financed through loans, which

technically differentiates a lease from a loan for the finance company but means

little to the customer who pays for the entire package. Licensing, in case of

software, lies with the end customer. Says Vishwanathan, "No sub-leasing

happens for software." This makes standalone financing of software

difficult. Software financing is gaining prominence as there is greater demand

for mission-critical enterprise solutions like ERP, e-business, customer

relationship management and business integration, that tend to entail large

front-end expenditure and overwhelm IT budgets.

Financing and India Inc.



Has financing of IT infrastructure taken off in India? Yes and no. Says

Arvind Kumar, CIO, Anand Automotive Systems, "The ideal lifeline for any

hardware is three years. Most Indian companies try to derive maximum usage and

push the products to obsolescence." He observes that financing to ensure

technology refresh from time to time and combat obsolescence may not be the

primary concern if one is to go by typical Indian psyche. "Keeping pace

with technology transformation is more critical for banks or IT or ITeS

companies", says Kumar.

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Balasubramanian of Hero Honda prefers to leave critical financial decisions

to the company's finance department. Says S Chhabra GM finance, Hero Honda,

"Cash rich companies like us prefer a purchase to a lease. It is the

interest differential that drives a purchase-decision." Counters RentWorks'

Niekerk, "Interest is only one factor in the equation. What about the cost

of disposal; the cost of using out dated equipment; cost of AMC for old

equipment that is worth less than the AMC; cost of having to reverse decisions

that were made earlier due to change in circumstances and cost of inadequate

infrastructure due to budget constraints?"

Kumar and Balasubramanian may not have sent very positive vibes, but players

in the finance space are quite upbeat about the changing mindset and the deals

that they have been signing to lease IT infrastructure. Observes HP's

Vishwanathan, "It is the lack of awareness that is the major

roadblock." A factor that contributes to inadequate awareness is the

chequered past of the leasing industry. Non Banking Finance Companies have

always used leasing as a tax shelter and have failed to promote the advantages

of leasing.

A change, nevertheless, is in the air. RentWorks has 130 customers. Companies

like Hindustan Lever, ICICI Prudential, Nicholas Piramal, DHL, TCS, E&Y and

LG Electronics, among others, have started taking IT infrastructure support on

lease. The most common equipments that are rented are PCs, laptops, servers,

mainframes, routers, modems and printers. LG Electronics, for example, has

leased a server worth Rs 7.5 crore. Sectors driving the growth are ITeS and

banking, in addition to FMCG. HP Financial Services has names like Bank of

America and General Motors, in India, and PSUs like Bharat Heavy Electrical

Limited, in its kitty and is currently negotiating with some other leading

names.

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Also driving the leasing and financing growth are startups and SMBs. As says

HP's Vishwanathan, "Startups and SMBs often have inadequate infrastructure

and, unlike cash-rich companies, are incapable of making purchases to ramp up

the existing infrastructure." These are typically companies that are left

with no choice but to take the required IT infrastructure on lease, to meet the

requirements of a particular contract or a project.

The outsourcing route



Bharti Televentures has outsourced its hardware, software and IT infrastructure
requirements to IBM. Payments made to IBM will be linked to the percentage of

revenues generated by Bharti Televentures and the revenue payment is modeled to

decrease with the increase in Bharti's revenues. Says Hero Honda's

Balasubramanian, "Outsourcing, as opposed to leasing, is a better

option." This could well be the sentiment of a cross-section of CIOs in

corporate India.

Financing of IT infrastructure is still evolving and has a long way to go

before it matures. India Inc is still trying to identify the best route to beat

technology obsolescence, create tax-friendly balance sheets and generate better

TCOs and higher ROIs for companies. Sums up Ramesh Vishwanathan of HP Financial

Services, "India Inc should aggressively look at solutions to reduce the

vintage value of existing equipments, take advantage of declining customs duty

and fair market value and meet the requirements of the dynamic market."

What is going to be the next trend and how soon, we will have to wait for some

more time, perhaps, to know.

Bhaswati Chakravorty

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