Analysts covering the rental industry for Credit Suisse First Boston are often asked: What would happen to the rental industry in the event of a recession? The RER staff is frequently asked the same question. RER and CSFB joined forces with 10 executives from rental companies - small and large - to discuss how past recessions affected their business models and how they might react to a downturn in the foreseeable future. Following are excerpts from the recent daylong discussion, hosted by CSFB analyst Blair Brumley and RER executive editor Michael Roth in the offices of CSFB in Chicago. For a complete transcript, visit RER's Web site: www.rermag.com.
Blair Brumley: The one question that Michael Roth and I always seem to get from people is what's going to happen to the rental industry in a recession? That's why we convened this group, because everybody here has been through them and has seen things that work and don't work. In the recessions that you gentlemen have experienced, how much impact on the revenue stream have those downturns taken? Let's speak both in terms of number of transactions and pricing on those transactions.
Mike Watts: From our experience, which is more regional than most of the other people in the room, during the '89-91 period, we experienced a slide in revenues we calculated to be about 40 percent. And 40 percent, in a small regional market, could have been devastating had we not redeployed assets and gone into different markets.
The industry today is significantly different than during any [past] recession. I don't know that my crystal ball is able to predict the future, but I did witness an awful lot of late reaction and then overreaction.
Don Ahern: I lived through the '80s and the '90s recessions. I was a college student in the early '70s, so I really didn't experience that, although I was involved in my father's business, which did experience recessions, even back into the '60s. It appears there is somewhat of a 10-year cycle, where it hit kind of early in the decade.
As I grew up in the rental business, the market that we sought after, mostly, was the homeowner and the very small contractor. It felt like to us that recessions initially would bring a bit of an upswing to our business. But as the recession deepened, it got quite bad. So a fairly long-lasting recession could eventually catch up to you.
The Las Vegas community then didn't have a population that wanted to work on their own homes, to do things themselves. So, in good times, we were dealing with the handyman, the small contractor who's doing the work for these people. As the disposable income drops out of people's pockets, we found that they paint their own house instead of paying a guy to paint their house.
My business may be affected differently in the next one because we've grown out of that homeowner and small contractor market. We're doing business with a little larger contractor. The next downturn is probably going to teach us new lessons.
Gary Gabriel: Our businesses started out the same way, with the small tool rental/home owner business. I don't remember a recession, really, in the '60s or the '80s, at least in our area of the Midwest. We never saw the big dip down. We had consistent growth. In the '80s, we started to grow a lot more. As we got into bigger equipment, and it started renting better, we just kept expanding through the recession.
I think [the next recession] probably will not be as regional as it was before. On the East Coast, things were bad; 500 miles away in the Midwest, it was not that bad. We didn't have the overbuilding and did not have that big a downturn.
Tom Hawthorne: At the time the interstate highway program started, from '55 to '59, San Diego particularly, and all of Southern California, were just boom years. You couldn't cope with the demand.
But in 1960, in San Diego particularly, General Dynamics and Gulf Terminal Atomics were the only big employers in the areas, and they had major contracts all canceled at once. It was like a boomtown falling off a cliff. People were moving out of town; General Dynamics was laying off 700 people a week. So what did you do with that type of a recession? It was lay off everybody that you can, and you slumped back.
In 1991, the economy was coming off on a month-to-month basis, a little less each month, and you could cope with that situation and keep adjusting if you could realistically see what was happening to your business. In both conditions, there's no exception to having enough money to sustain yourself and enough hard work and management of your resources. Those resources, of course, are people and machinery and money.
Kevin Rodgers: Looking back at 1990-1991, our business was primarily in the middle of the country, from the upper Midwest down to the Gulf Coast, with the exception of Texas. Overall, we didn't see the huge drops that were experienced in the Northeast and on the West Coast. We continued to grow right through 1990 and 1991, albeit at a lower, single-digit rate.
New equipment sales dropped right off. But rental continued to grow. One thing that really helped us then was that rental was still relatively new, with market penetration somewhere around 5 to 7 percent. People were nervous about where the economy was headed, but yet there was still work going on, and rental companies were there to provide an alternative for people who needed equipment but weren't prepared to buy. So while we saw the business from our existing customer base shrink, we were able to achieve overall growth as a result of business from new customers. Some of our growth did come at the expense of the smaller mom-and-pop stores that just weren't as well-equipped to weather a financial downturn.
In the last recession, few companies were large enough to effectively transfer equipment from one market to another, to take advantage of a particular market where demand was still strong. Today there are several companies many times the size Hertz was back in 1990-91. So if business falls off in one market, companies are going to be looking to move the equipment to where they think there is demand, where the markets are still healthy, and that's something that we didn't have to deal with in our last recession.
Tom Bennett: We get asked this question all the time, and I always wonder how deep of a recession are we talking about? How widespread? Is it domestic? Is it global? But having been through a few of these in my career in this industry, to me a recession was having a major presence in Texas in the mid-'80s when the oil fields went bust. You could fire a cannon down Interstate 10 without hitting a car. That's a recession to me. But it didn't really have a lot of impact on other areas, geographically.
In the '90s, as Kevin just described, we felt it more on a regional basis than we did nationally, so we were moving fleet as we could. Mike said in his regional area, he dropped 40 percent. We dropped about 25 percent in volume, but our margins didn't drop as steeply as our volumes did.
Those down times made stronger managers of us for the good times. It also made us very cash-positive. We generated a lot of cash. We quit spending, we started repairing dents, so downturns are not necessarily all negative. But we will hit another one, and today we all have much better systems for looking at real-time information so we can manage through these processes. In those days, we were looking at the last week or the last month, and we couldn't react fast enough. Today, we can see a lot quicker, so we're better prepared.
Again, the real issue is the awareness of the rental industry. Today, the big, heavy, sophisticated customer that in the past would never consider doing business with a small, ugly rental yard looks at us as a viable way to get his needs satisfied. Those are strong drivers that will help the rental side of the business.
A mild correction in the market for six months, whether regional or national, doesn't have to be a terrible thing. We'll manage through the process, like we have many times before.
Laird Burns: My family business was a contractor/small contractor/homeowner-type business, and we'd watch the larger equipment start to slow down and watch the homeowner business increase. It was obvious, looking at our numbers, where it was going.
We moved to Los Angeles in 1985 and experienced the recession of the late '80s. In 1989, we referred to it as the faucet being shut off. Construction equipment absolutely shut down, and the homeowner/do-it-yourself business picked up.
Charles Snyder: I tend to think about recessions the way weather forecasters think about hurricanes. Is it a "category 1" or a "category 5" in terms of severity and duration? Having started in this industry in the early '70s, I personally experienced three recessions. One in the '76 time frame, then in the early '80s, and then the '91 recession.
The characteristics of each recession were different because it was a different category storm, number one. And number two, I was experiencing those downturns from a different perspective within the organization.
In the '70s, I was focused primarily on South Carolina. We never really felt it. In the '80s, I had transferred to Houston. In Houston, over a period of about a year, our revenues dropped by about 60 percent. In the '79-80 time frame, things were just booming in, and one day in '81 or early '82, we showed up for work on Monday morning and the phones quit ringing. It was that quick.
We thought we were very well-prepared for a possible recession; we thought we were reasonably comfortable because most of our focus at the time was on major oil companies with major projects and major spending plans with 1 1/2- to two-year backlogs of work. We thought we were in pretty good shape and had enough backlog to carry us through any downturn.
What we didn't anticipate was those projects' canceling in rapid succession. We saw our backlog dry up in just a few months. Not only were new projects not taken forward, the old projects that were already under contract and the work in the field were suspended.
In the '91 time frame, we grew right through it. We never felt it. You could probably sit down, using the category 1 to 5 analogy, and develop different behavior patterns, depending on the severity and the duration and also depending on the optimism or lack of optimism of your clients.
In 1991, we actually saw our business increase because a lot of our customers were optimistic that this was going to be a mild recession of short duration. They shifted pretty heavily to rental, so we saw our rental volume go up, even though pricing levels softened. We also saw our aftermarket business increase. A lot more parts and service business was generated because our customers were taking a breather, so to speak, to refurbish their fleets. They began spending more on parts and service, preparing for what they envisioned to be a short, mild recession and getting ready for the upturn.
So we saw our aftermarket business pick up, and we saw our rental business pick up. But I agree with Tom [Bennett]. Depending on the type of recession that you're talking about, you get different behaviors, and there are different regional patterns. Houston in the early '80s, that's one that I would personally not want to go through again.
Machines, people, money Brumley: Let's talk about how business should be managed, as Tom Hawthorne said, in terms of machines, people and money. How should those things be moved or redeployed? Can you really focus on bringing the head count down in a recession, or does that ultimately hurt you more than it helps?
Watts: Each company has the ability to redeploy those assets. Those that are more regional, certainly, can relocate [people] to another geographic area. Others that are already in those areas have to properly size all of their assets.
Gabriel: Everybody, probably, has a 10 to 20 percent mark that you could eliminate pretty easily and not affect your business, with the way the labor market is today. The quality of the people you have to hire today is not where it was 10 or 20 years ago. You could downsize, and it really wouldn't affect you that much.
Snyder: I agree, but along with that comes a challenge. If you could control your destiny, you would want to release those employees who were less productive and efficient. But those are usually not the first ones to go.
When people get nervous, the good ones are the first to find employment elsewhere. So it gets to be a real hat trick to manage that self-renewal process so that you can shed the less productive folks and hang on to those key people who really drive your success and are key to your succession planning for the future.
Michael Roth: Do issues of seniority come into play when you're dealing with downsizing?
Snyder: They always come into play. We take the position that we base performance and succession planning and promotions and terminations, or reductions of force, solely on merit. But the human side of us prevents us from executing on that as well as we'd like to because every organization has employees who have been around a long time. When you start looking purely at performance, you might make a different decision than you would based on seniority.
Shaun Flanagan: I've been involved with people over the years who in recessions adamantly refused to downsize because they had such a focus on the future. There was some normal attrition, and with that you may or may not have the luxury of having the right guy leave.
I admire that person who says, "No, it's a recession, I'm prepared for it, and my bottom line is OK, and I'm going to stick it out and go forward. We've got too much wrapped up in training. There's just too much time invested in the people." A real key is, are you equity-financed or debt-financed, and what's your comfort level during the recession?
Burns: If we could hire and retain qualified people, we could deal with the recession issue. But it always seems as though during the beginning of the downturn, those very qualified people, who you were relying on to help you through, get nervous and start looking for other things. And then you fall one tier off, and you have to bring in a second guard, and maybe they're not as well-prepared.
We've ended up downsizing every recession. We've found that during the very prosperous years, a lot of fat gets layered on. When things are going well, you have a tendency to provide more luxuries. As the economy starts slowing, we start looking closer at things: "Do I really need it today, do I need it tomorrow, or do I need it at all?"
Managing machines Rodgers: I'll talk about the machines. If you have sound management information systems, you should be able to recognize when you're starting into a slowdown, more so, say, than an equipment sales company. Based on my experience as an equipment dealer, it seems that often in the past there was little warning. When the recession hit, it was like somebody just turned off the spigot. Almost overnight people stopped buying new equipment.
On the rental side, you get more notice of things slowing down - you watch trends, you measure utilization, both physical and revenue utilization, and you keep in touch with the people in the field.
So as far as the machines go, the first thing that we would do once we recognize a slowdown is to stop new equipment purchases. We'd tell our people that if they need additional equipment, they need to look first within the business for underutilized rental equipment or equipment that is not generating sufficient returns and move the equipment to those markets where they can generate an acceptable return.
We'd also expect them to be in contact with our fleet manager, who is constantly looking around the company for underutilized rental equipment or equipment in markets that do not produce sufficient returns. Our rebuild center is another source for equipment providing a low-cost alternative to buying new. If we still can't locate the equipment within the organization, then we'd look to buy it used. Buying new would be the last resort.
Ahern: The next recession is going to be different. The industry has changed in the sense that there are now large national players and some large regional players. Equipment is going to be moving overnight, and we're able to do that now more than ever. There isn't a night goes by that we're not shuffling equipment, via common carrier, from one little market to another little market, sensing the demands and the needs. We have an MIS system where we can look at every store and utilization rates and very carefully pinpoint where we want to pick up a piece of equipment and shuttle it to another store.
And those decisions are getting made now, sometimes in the late afternoon, and that equipment moves to a different city and is on another job by morning, a 12-hour turnaround. The bigger you are, the better you're going to be at being able to facilitate that and understand your market.
[My company is] a small, regional player relative to Sunstate, which is a larger regional player, and the nationals. I don't really understand what's going on in the Texas market or the Northeast. But I can react to the cities I'm in, and the more cities I'm in, the more I can react.
But unfortunately, when you get to the people side of things, you can't move people overnight like you can move machines. But we'll be deploying our people out and about, and we're probably going to spend more money on hotel rooms.
Early on in a recession, as an industry, we're going to be much more reactive than we've been in the past. But ultimately, if the recession deepens and gets into that category 5 hurricane, we're going to end up with no place to go but to hunker down for the storm.
Burns: We're just in Los Angeles, but even in L.A., there are pockets that are hot and pockets that are not. We keep trying to shift the assets to the best possible location, try to clean out those assets that aren't generating revenue, whether it's through auction or general sales.
Just being able to have the information and be able to react immediately is worth a hundredfold compared to what was available 10 to 15 years ago. It used to be more seat-of-the-pants. Now you can actually see statistics.
Snyder: We've got a lot of upside as an industry from the standpoint of yield management. The rental car companies and the airlines have pretty much turned yield management into a science instead of an art. We're on the front end of having that capability, with good management information systems, detecting early warning indicators and looking at where rates are trending down versus where particular rates are trending up. It helps to decide how we move fleet to capitalize on higher rates and higher-demand locations, and how we de-fleet in regions that are softening up. That's the good news.
But there is also bad news in that our customers used to be more local, and now they're more regional and national. Our industry is more regional and national. Depending on the severity of the next downturn, we all may be scrambling to find what works, and to move fleets to the right areas, and to restructure and downsize. But if it is a category 5, your competition and your customers are doing the same thing, and my fear is that we may find ourselves in a situation where there's no economically viable place to redeploy assets.
Dump the fleet? Brumley: I'm struck by a lot of comments about being able take equipment and move it to various places so that utilization can be made as strong as possible within your organizations. My question, from the outside looking in, is will there be a need to sell machines and just get them out of the fleet? Or are you afraid that all the exits might be sealed off when that kind of a situation presents itself?
Flanagan: It goes back to Don's comment about being visionary. If a reactionary person, if that's a proper word, acts too quickly, whether it be with people or with fleet, we'll use the word attrition, or maintenancing out the fleet - it's a balance between being proactive to dump the fleet. When do you do that, when are you overreacting? Because I do fear that now that we have so many public companies, they are, by design, more quarterly driven, thus less focused on the long-term future, and they may be forced to do more "bumping" of their fleet and overreacting. I'm not sure as a competitor how that would impact us, whether it would be good or bad. It could have some impact on equipment value.
In the last large recession, the analysis that we came up with as it impacted our fleet was about a 7 percent difference in the resale value. I'm not sure what others' experience was.
Brumley: Do you think you're going to be pressured to dump the fleet, Tom?
Bennett: I don't really think so. We tend to measure our fleet, which is our single largest asset, by cat(egory) classes. Now there's pressure to dump certain categories of equipment, but not the fleet. Utilization is a good thing. It also drives your cost up. The higher your fleet is utilized, the more expensive it is to keep it busy. So we're looking at utilization. We're looking at returns. And we're looking at it on a cat-class basis.
Some good friends of mine are in Canada and the Northeast. They have a three- or four-month recession every year. They use the winter months to renovate the fleet and get things ready. We're talking about managing those fleets. That's what we need to do whether it's class 5 or a class 1, which is nothing more than seasonality.
Rodgers: I don't believe that we would have any undue pressure to unload fleet in a downturn solely to meet quarterly earnings targets. We sell a very small portion of our fleet, with sales of rental fleet equipment averaging about 5 percent of total revenue or about one-half the industry average. This past quarter - June 2000 - we were 8 cents a share below the Wall Street estimates. To put that in perspective, the difference between making the Wall Street estimate number and coming in where we did was boosting fleet sales from roughly 5 percent of revenue to 9 percent of revenue. I felt that was something we could easily do, and we discussed it but ultimately decided against it because when demand is strong it just doesn't make sense to replace low-book-value equipment with new equipment that is going to generate the same revenue.
I'm not saying that we wouldn't sell fleet if it made sense to do so. But we are trying to make decisions and run the business based on the best long-term interests of the company.
In 1990 to 1991, there was very little shifting of equipment from one part of the country to another. Whereas in the next recession, that certainly is something that we're going to have to contend with. As far as the next recession's effect on sales out of the rental fleet, again it comes back to the question of how severe will the next recession be? If it's no worse than '90-91, I wouldn't expect our margins on used equipment sales to be significantly affected. I would expect them to remain in the range of 30 to 35 percent, about where they've been for the past 10 years. We don't do a lot of fleet sales and rarely sell at auction. We typically sell the rental fleet through our rental sales force, and that tends to get you a better price.
Bob Miner: I believe that one of the keys to managing through the recession is recognizing early in the process that the economy is slowing and quickly adjusting the size of your fleet accordingly. If we are agile and not in denial, we can downsize our fleets correctly without impacting the used equipment market on a macro scale, since the entire amount of used equipment sales coming from the rental companies is very small in comparison to the total used equipment market. If we're slow to the switch, if we're greedy and we say, "Well, I'm going to go two or three more quarters" or "I think this is just a temporary problem," we could be caught with a significant amount of underutilized equipment, which will hurt profitability. We believe that having an advanced MIS is critical in giving us the right information at the right time in order to make these crucial fleet decisions.
Knowledge is the key - knowing what's happening with your customers' business, not being in denial of what's happening with the economy and being agile enough to downsize your fleet ahead of the curve before everyone starts selling used equipment regardless of price.
Flanagan: Everybody here has some presence in Southern California. What are you going to do if everybody comes down I-5 and west on I-10 because California - Southern California especially - gets into it a little bit later than everybody else? There's so damn much equipment in the country today that nobody really has talked about what is it going to do to bring it to Southern California or to Vegas because there's a great market there. Or bring it to the Midwest. It's just a matter of time before everybody figures out you can't get a truck because they're all booked coming west.
If you're in a category 5, no amount of equipment shifting, no amount of planning, even though we all have great [information technology] systems, will save you.
I don't think we've recognized yet the amount of equipment in the country and the effect that's going to have overall on everybody if a category 5 settles through the United States. A lot of the bigger, wealthier public players will take a look at going to Europe or South America.
Snyder: I think the North American market is in the best position to deal with a downturn. If we define North America as Canada, U.S. and Mexico, then you've got contiguous territories, and moving assets across each border is getting easier and less expensive.
Our international presence has taught us that the infrastructure is a lot different when you get outside North America. And it gets to be tougher to redeploy or sell fleet when it's needed.
That's good news for our industry. The longer that we can continue without a major recession, the better position we will be in because each day, as an industry, we are creating more efficiency.
Is it going to be two years from now that we hit the downturn, or is it going to be 10 years from now? The longer out it is, the better position we will, collectively, be in.
Brumley: There seems to be a sense, if not an outright consensus, that moving products from place to place will be helpful to your business. Utilization, obviously, will be better overall as long as there's a number of reasonably sized strong markets to endure all this. Hearing a lot of people saying, "Gosh, there's a lot of equipment," if we start shrinking down the number of available places to send it to, there is a train wreck out there somewhere. Is that fair?
Watts: I have a slightly different slant on that. I would say that when you look at Laird, Don, Tom Hawthorne and myself, who are regional players, our options as far as putting these assets in a different market are totally different than the people that are already in those markets today.
When I started the business, I left somebody else's employment and started during the recession. In a later recession, I took assets from our base of operations to another market, and I was able to do that and gain market share and still grow the business.
How will customers react? Brumley: There's a lot of conversation about how different classes of customers have behaved in a downturn - homeowner, large contractors, small contractors - and what we should expect from them.
Bennett: The way the rental market has increased, a downturn is going to help. With all the promotion and advertising that have been done in the past 10 years to promote rentals, we've educated the contractors that it makes economic sense to rent, to not have to add to their fleets.
In recessionary times - and I've seen that in the '90s - contractors cut back their purchasing of equipment and rentd more.
Burns: One thing that has happened since the consolidation started is that we have some very savvy customers. Whether through education, from advertising to Internet, from rental salesmen, we get calls now from people who are ready to negotiate. I never had contractors call in and say, "I want a Bobcat or a loader or a boom for a day, and I want to negotiate." We never experienced that until the last three years.
Even the homeowners are savvy now. They know that they're the ones who are picking up the tab for the discounts that are given to the contractors and the bigger industrial accounts. And they're savvy enough to start requesting, "Look, I'm going to have it for three days. What can you do?"
Part of this education is awareness of costing and pricing, and it's not just from the consolidators. I don't want to hammer on that because we also have companies like Costco, Price Club, Home Depot, HomeBase, where the whole focus is less for more. At some point, somebody has to wake up just like those companies I mentioned. They all have loss-leader products to get you in their stores. Once you're in, the chances are good that you will buy additional products that are higher-margin items, thus making up for the low-margin items. I think that's part of the attitude and part of the training that we as an industry have to start working on.
Long-term rental gains? Brumley: In a recession, regardless of depth, length, geographic spread, people are going to look at rental more often. The experience does, in fact, take their overall cost of doing business down. Do you expect that any kind of share gains that do occur, at the expense of ownership, would stick coming out the other side?
Watts: I'm not sure it would be as much a conscious decision to rent as it would be more of a conscious decision on their part to not buy. Everything changes for them, and if they feel that they're in a recession, with uncertainty where the next job is, that in itself would be the primary driver.
Not to say that once they do get greater exposure to a rental company that they may feel more comfortable, that it is dependable. But they go back to their own comfort zone, and it's going to take a longer process for them to understand which way they make better money. It's a risk issue as much as anything for them.
Miner: Most construction contractors are very knowledgeable regarding the benefits of renting, but I don't believe many industrial customers are. Many industrial and manufacturing companies have never rented equipment before. But when the economy softens, these industrial customers will be seeking opportunities to improve their balance sheets and cash flow. Once they recognize that there are well-capitalized rental companies capable of providing a reliable supply of modern, high-quality equipment when and where they need it, it will present an enormous new growth opportunity for our industry, which will be sustained and even expanded upon, post-recession.
This industry is growing faster than the general economy, with most of that growth being driven by customers learning that renting saves them money. Rental companies are experiencing explosive growth, pure organic demand growth. I am convinced this is because customers are making rental more a part of their day-to-day routine business as opposed to just utilizing rentals during peak periods.
Snyder: I know what I'm getting ready to say is not going to be well-received by some, but there is this popular notion that contractors are making a dramatic shift from ownership to rentals. I can tell you that we're not seeing that.
Our customers are using rental as a way to supplement their core owned-fleet needs. But what we're also seeing today - and I think we have to think about this in terms of the next recession and what kind of behavior do we see in the industry - we're seeing our customers today buying a lot of the equipment being auctioned. So they haven't really shifted their philosophy with respect to what they own versus what they rent.
They're seeing some good values in the marketplace. They have elected as a management philosophy to supplement their fleet needs by 10 or 20 or 30 percent with rental. But at the same time, we have seen very few who have made the shift from total ownership to total rental. And those same customers are the customers that are buying a lot of these machines to put back into their fleets from an ownership perspective.
Brumley: Which raises this question: If there is a shift toward rentals, relatively small, as Charles feels, or somewhat larger, is that going to be offset by the differential in used equipment prices?
Snyder: That raises another question: What are the outlets for the surplus equipment in a downturn? And many are excluding today's customer base as an outlet. And I would not exclude that. Those customers are going to be there and will provide an outlet for a lot of the 3-year-old and 4-year-old used fleet that goes on the market, either because we want to sell that fleet to make room for fresh replacements or because we are de-fleeting because of a softening of rental demand.
Ahern: I don't see contractors buying in a recession. I think that what the market is percentage-wise will be enhanced, but overall rental will be down.
Bennett: I agree with Don. It depends on how early on in the growth of rental because everyone is cautious. It's a question of how deep is it going to go and how widespread and how long is it going to last. It will eventually catch rental as well.
Gabriel: I have a good example on that. A very good friend is fleet manager of a large underground contractor that works all over the country, and their long-range plan is to downsize their fleet from about 90 percent ownership versus 10 percent rental to a 50-50 split.
Distribution changes Brumley: Let me throw a hypothetical to the group. What about the possibility in a recession that a major OEM says, "Here's a business showing better growth than our manufacturing business. Here's a business that has margins every bit as good or better than our own, and we know it's important. We know we've got to do something"?
Put a probability curve on the notion that at least one major OEM in the next recession steps up and buys, at the very least, a large regional, if not a national, rental company.
Flanagan: I believe another OEM will step up and buy another rental channel. Whether they do that as an offensive strategy or defensive strategy, I'm not sure. I think we'll see that sooner rather than later.
Watts: I think it's got to be one of the big guys, and they've got to go after one of the great big guys to make it worth the flak they'll get from the rest of the world. If they're going to make that offensive push, it's got to be a home run because they're going to lose that distributor base, and all the relationships right on down the line, from the OEM to the user, are going to have to evolve.
Miner: The evolution of OEMs will be different depending upon their own specific situations and strategies. Caterpillar, for example, has a strong dealer network, so its strategy is going to be very different from other OEMs that don't have that network.
Five years from now, the entire distribution chain will look very different, regardless of whether we've been through a recession or not. There are still a lot of inefficiencies in the process of putting equipment in people's hands. Rental is doing a good job of taking some of those inefficiencies out, but there is still a significant amount of inefficiency remaining. A weakening economy could accelerate that process.
Snyder: The theme of the question around what happens in a recession seems focused on rental. But if you ask it a little bit differently, then it could portend more damaging impact elsewhere. If the question were "Who gets affected first and by how much in the event of a downturn - is it the end-user customer, is it the dealer, is it the large rental consolidators, or is it the OEM?" then, in my mind, it's at the OEM level. They would feel it first.
We all develop and drive our business strategies either based on aspiration or desperation. The first thing you do is you quit buying, quit spending.
But the OEMs only have about three places to make money. They either sell product, sell aftermarket parts or finance the product. And they've got to feed the manufacturing process to compete on a cost-per-unit basis.
We're probably looking at a sort of boomerang reaction in that in the event of a downturn, in acts of desperation, OEMs do certain things that affect both the rental channel and the dealer channel in ways that we can't predict. We need to be keeping our eyes on the OEM side of the business, as well as on our customers, and looking for actions and reactions, and then thinking how we deal with those, because we're in the middle of the channel.
Hawthorne: What does that do to our dealer organization? What does it do to the dealer organization when consolidators can buy for less than the dealer can buy it for?
I don't know what's going to happen to the dealer. I'm glad I've been one for as long as I have. I don't know how long it's going to be. But I know I will be in the rental business. That's the way the trends are going. That's where it's going to have to be.
The acquisition peak? Brumley: In past recessions, there has been, I sense, an ability not only to grow the business organically and spread results out geographically but also to buy competitors, to consolidate. Might we see less of that in the next downturn than we have traditionally?
Rodgers: Again, it comes back to severity, but I don't see the next recession acting as a catalyst for acquisitions. In the last recession the consolidation phase of the industry was just getting started. Today, in most of these markets, companies already have a fairly significant presence. Once we are in a recession, everyone will probably have too much equipment, so why go buy somebody?
I believe companies will be more likely to leverage their know-how rather than their balance sheets, to enter markets through start-ups by better utilizing the rental fleet assets that they already have rather than buying somebody else.
Ahern: I, right now, have no motivation to acquire anybody else. But in a recession, I might be interested in buying an organization just to acquire a location where I couldn't go into that community [because of zoning. Many] cities are getting to where they view us as a junkyard, and they don't want us. In Vegas, where I've got family in the city, I can't get even get [facilities], at least not on the west end of town.
Bennett: I don't see that the recession has much to do with stimulating acquisitions. In our case, it's going to have more of a strategic basis, if there's something out there that makes sense through good times or bad.
Roth: Would a recession be the time to become more aggressive in terms of marketing or adding fleets, or is it more a time to be careful, consolidate what you have and downsize in assets?
Flanagan: It might be a good time to start sticking your nose into other areas like Don and Mike have done. It's going to be hard, if not impossible, once a recession hits to be able to go in somewhere as a new player and try to take the market from established companies when there's probably already a surplus of equipment.
I agree that, strategically, you'd probably acquire existing locations. But I don't think you want to wait until the recession to try to expand.
Watts: If all of us are managing our businesses the way we think we are, which includes aggressive marketing, not a whole lot really needs to change.
Winners and losers Brumley: My simplistic definition of a recession - at least as it relates to all of us here in this room - is too many machines chasing too few projects. How do you find the winners, and how do you find the losers?
Watts: Maybe you look at those that may be too leveraged. That's where you're going to have some problems. Most of the companies have been pretty careful about trying to hold that leverage in check.
I agree that the recession is not going to drive acquisitions. Companies are not going to want to leverage up if their currency is not going to allow that. They're going to have to come up with some other type of an equity plan so that they're not overleveraged.
Flanagan: I think the winners are going to be the well-funded people. You're not going to be able to go through a recession with a heavy debt load because you really start figuring out what that "I" in EBITDA is, don't you? When you start getting into that part of the world, it's over.
Equity injections are going to be the key to a winner. In a normal recession, what do you do? Who's running 40 hours a week with the drivers and the mechanics? So what happens in a recession? You start to pare back naturally. You get it down to 40-hour weeks.
You pare your fleet down. I just don't think you cut into the heart of it. You can probably find a few better people, or maybe you'll lose the ones you really didn't care so much about. But if you can manage your overhead and the debt load, the good companies are going to come out of it fine, just managing those assets.
Miner: Companies that don't know their true costs could get hurt. This is a return-on-assets business. If you assume that in a recession revenues will soften, it will be critical to get all your costs in line, and if you do, you should be able to withstand a moderate recession without getting seriously hurt.
Bennett: So many other industries are out there that are very low-growth but extremely profitable. We'll see, as less growth develops, that it has a lot do with management teams. That doesn't necessarily mean we're not profitable.
Age the fleet? Flanagan: The first thing I would do is stop, for the most part, the purchases of new equipment. How long does a recession typically last, three years? What's the average age of the fleet [of the companies represented] in this room today? What could it really be without harming your [operation], three years more? It certainly could in our case.
So if your fleet is 2 to 3 years old, it could go to 5 or 6 years old, which is where I really think it ought to be. You guys [consolidators] started providing new machines into the market, and it is a good thing, that's what everybody competed with. They had to, to stay up. But if you go back - if recessions force you back to 5- and 6-year-old equipment - and, Tom, you said you're turning the fleet 15, 20 percent a year, that's a five- or six-year turn ...
Rodgers: For the most part the fleets today are so new that companies could easily age their fleets two to three years without affecting customer service. We all make more money on an asset that's 3 or 4 years old than we do on a 1-year-old asset. To stretch out the age of the fleet can actually be a very good thing as long as the equipment is properly maintained.
Gabriel: The quality of equipment is much better today than 10 years ago. Your maintenance cost is definitely down. If we have a recession, you can run your equipment longer without that big cost upswing.
Snyder: The question you're looking at is do you change your strategy with respect to how long you keep an asset because of a recession. The answer is no. Dealers that have more of a rent-to-sell mentality, as a part of their normal operating strategy, tend to want to sell out of their fleet before they reach a major repair point in the life cycle of the product. And then you have that parts and service business coming back to you as a dealer. Done properly, you drive aftermarket business and contain fleet maintenance costs. That strategy is prevalent with what you might call hybrid dealers that own significant rental fleets but also have a rent-to-own bias. Those who have a bias toward doing major repairs as a normal course of business represent the other perspective. In either case, you don't change strategy just because you're faced with a downturn.
Miner: We have a good idea on a predictive basis when maintenance costs are going to spike up, and we manage our fleet on that basis. So as we become bigger, we have more data, which gives us a better understanding of where those break points occur that would help us manage our fleet.
Managing a fleet to get the maximum return on each asset is something we have to do every day as good managers, in a golden period or a recessionary period. MIS systems helped us do that better in the past 10 years.
The lessons of history Brumley: What has recessionary history taught us that we haven't talked about?
Bennett: That we are not bulletproof. It has taught us a little humility, and it has also taught us to be much better managers.
Brumley: All the people around this table have been there and done that. But there may well be a lot of people out there in the business, particularly at the field level, who haven't. How much of a concern is that?
Snyder: It's a major concern. Even though a few of us here have some gray hair, it's been a long time since we've had a category 5 recession. And we've heard some of the folks around the room say that we actually grew through the '91-92 recession.
In our organization, we track our employee demographics very carefully. About 65 percent of our employee population has been with the company less than 10 years. And it's been longer than 10 years since we've had a significant recession. So you are bringing up an important issue. We have a lot of people in key positions who have never been through one.
Two things jump out at me. One is that we've got to collectively pay attention to the early warning indicators. And two, we have to understand that, if others have the same kind of profile that we do, we have a lot of younger managers in key positions who have never been through it. And they're the ones on the front lines.
So it's our job to make sure that they recognize that they haven't been through it - to coach them and help them so they understand issues around cost management, debt management and cash-flow management.
Burns: We have always been a resilient industry. We can add assets to build the business, we can hire new staff to help build the business, and even if we overbuy or overhire, the business seems to survive. However, in recession, you don't have the same luxury. The focus has to be put back to managing costs, which we probably don't do a good job of during good times. I think we're going to have to learn how to be better cost managers.
Rodgers: The importance of cutting back on capital spending cannot be overemphasized. The most likely way that rental companies will get in trouble in the next recession is if they fail to recognize the slowdown and keep adding to their fleets.
As long as companies are smart enough to stop adding to their fleets when they see that demand is trending down, they can withstand and get through even a very severe recession. I'm not talking about earnings; I'm talking about survival. In 1990 and 1991, we were running around the country looking at rental companies to buy. I remember looking at one company in the Northeast that was down 60 percent from the year before. But they survived and eventually prospered because they had that foresight to stop adding to their fleet; they downsized and got their expenses in line with their revenues.
It's the strong cash flow from the business that makes the industry so attractive. So long as you turn the spigot off for new equipment purchases when a recession sets in, you should not only survive but may well find that your free cash flow is even stronger during the recession than it was previously during the so-called "good times."
Brumley: So, as you look at the industry today, which has evolved and changed dramatically since the last period you can even remotely identify as a fairly decent recession, given all those changes, what is going to be different?
Snyder: I'm seeing more willingness among competitors to form alliances, taking the approach that we all can't be all things to all people. We don't want to build too much capacity or too much infrastructure. And if we can work together on certain opportunities, either on an alliances basis or a third-party, re-rent basis, if we view each other less as competitors and more as partners in the industry, then there may be opportunities to mitigate some issues with respect to a downturn. I'm seeing more openness and willingness to do that.
Burns: That is what this industry was built on, really. The whole concept of helping each other, sharing information, trying to help customers - the ultimate goal was always to help customers.
The information explosion Bennett: Back in the '90s and '80s in the oil bust, we didn't have this MIS technology available to us. Today, at least we can unite and be so much bigger so that we can hopefully make good business decisions.
Rodgers: It will help us react quicker by enabling us to spot the early warning signals. And it also will help us on the tail end as we come out of a recession. The improved information systems we all now have should smooth out the curve on both ends, going into a down cycle and coming out of a down cycle. Of course, if it is a category 5 recession, no level of technology is going to make a company immune from the effects of a market saturated with rental equipment.
Bennett: Information is important for the store manager to see how his business is going, number one.
And secondly, he's got the opportunity to play with his models, to say, "OK, if I do this, what will that do to my business? Oh, I'm better than 10 years ago?" He's got more data, he's got more flexibility in his business model because of technology. I'm not talking about the Internet here; I'm talking about MIS systems.
He's got more data points and more opportunities to model things for his particular store and help him manage through that period than he had 10 years ago. The information is quicker, more accurate and more adaptable.
Snyder: Historically, it seemed like in the down cycles the general economy was very well-connected. Everybody either was down, or everybody was up.
Today, it seems like we go through rolling recessions, by industry segment. If mining and metals is down, silicon wafer manufacturing is up. If health care is down, road building is up. It seems like, rather than a broad recession, you have more regional or rolling recessions by industry category. It tends to smooth out the overall cycle.
If that's true, and if that is the pattern going forward, then to the extent that we can diversify our customer base, we'll be in a better position for not only shifting our assets geographically speaking but shifting our assets from the standpoint of customer and industry segmentation.
Educating employees Rodgers: Our industry as a group, and I include our company, has done a poor job of educating employees down to the branch manager level about what return on assets really means, how you measure it, why it's important and what realistic returns can be achieved. In my view there is nothing more important than educating our employees about return on assets. It will help us in good times as well as bad, and nothing will better prepare us in terms of recession. For the past few years the industry has been driven so much by growth that basic return on assets has often been overlooked in preference to increasing market share.
Snyder: You've got to manage the income statement, the balance sheet and cash flow. And you've got to get that local understanding in the branch level to really get total traction throughout the corporation.
Rodgers: I look at our company and try to determine what separates the operations that are doing extremely well versus the ones that are struggling. Sometimes one company simply has a better market. Most of the time it comes down to better management. Even more simply, it often comes down to a stricter management discipline, knowing when to say no, understanding that 90 percent utilization is not necessarily the goal and finally recognizing that there's probably something wrong if they are getting every deal they go after. Each of these things ties back to a basic understanding of the importance of both the income statement and balance sheet.
The next three years Brumley: We've seen three very impressive years in this industry. Let's think about the next three. What's going to be different? What's going to be better, and what's going to be worse?
Flanagan: It's going to be a lot better industry from a service standpoint.
Burns: We're going to see a change in the assets that we actually own. Maybe I'm speaking more from my size company, with the Lowe's and the Home Depots taking the cream of the crop. We have to reconfigure the fleet to be able to compete with what's going on. I don't think that we'll be as broad-based.
E-commerce is coming. Whether it starts on a reservation basis or an equipment sales basis, it is coming. The majority of the business will probably be handled by the larger companies, but I think that there will still be a strong niche for mom-and-pops or our size company. We have to be more creative in terms of the way we handle our businesses. Although big is better to a degree, smaller companies can react much quicker to the customer's needs. I think that's just a characteristic of a small business.
Dealers are going to have change. They certainly can't be completely eliminated. As somebody suggested, you've got a tremendous amount of assets out there being utilized by people other than the equipment rental industry, but the relationship between the dealer and the rental industry is going to take a huge evolution. I think that's already in process.
I agree that you need to find out what it costs you to operate. That's what's going to determine who succeeds.
Hawthorne: The better-managed companies will do much better, those that hire professional people. People are the biggest single factor, more than the color of the paint.
We've got more and more customers who are becoming colorblind. They want service, service, service - certainly McDonald's proved that. Fast-food restaurants can't exist today without a drive-through window. You have to do it centrally - dispatching, 1-800 numbers. ... It is going to be "Just call me, and we'll take care of everything from there." You're going to have to figure out better procedures and better ways to be more efficient to do that.
Rodgers: My view for the next three years is that demand is going to stay quite strong for 12 to 18 months. But some time demand will soften and business will slow down. My view is based more on a gut feel as a result of traveling around the country and talking to people than anything else.
I think there is about a 50/50 chance that, as a result of bringing too much equipment into the market, the rental industry itself will be one of the primary causes of a downturn in business, driven mostly by lower rates. If we can keep from flooding the market with too much equipment, we are likely to move into a category 1 or 2 type recession that shouldn't be any worse overall than the recession of 1990-1991, where growth will continue albeit at a single-digit rate.
If we continue to add to the oversupply of equipment - and the country on its own moves into a category 1 or 2 class recession, coupled with a failure on our part as an industry to properly educate our employees down to the branch manger level to understand that their business must be run with reference to both an income statement and balance sheet - those three factors could converge to [contribute to a] recession.
Bennett: I don't see the next three years being as dramatic as the past three years. We're going to see more of an improvement of efficiencies. We're going to get better at running our businesses. We're going to work on our margins. We're going to do things through e-commerce.
We're going to be taken to task by our customers on these things. On the other hand, when my parent company's board asked me what would happen if I witnessed a 5 percent drop in the market, I told them, "Don't forget, guys, the market has been very high-paced." So it depends on how quick that 5 percent drop comes. If it pitches over the next 12 months or so, that's not necessarily a bad thing.
When it gets down to territory management, there's a world of opportunities out there. If we could sit down and say, "OK, your territory is Illinois. Construction is only one piece. What else is out there? Who hasn't even thought about rental that could use it?" - that's territory management. We're not even cracking the crust here as to what this potential is.
During the first 10 months of 2000, 1,372,900 housing units were started compared with 1,422,900 units for the same period in 1999, a 4 percent drop. - U.S. Commerce Department
Economic growth slowed to an annual rate of 2.4 percent this summer - its weakest pace in four years. - U.S. Commerce Department
The chance of a recession over the next 12 months is at most one in four and between 30 and 50 percent over the next 24 months. - The Bond Market Association
The chance of a recession over the next 12 months is at most one in four and between 30 and 50 percent over the next 24 months. - The Bond Market Association
The current record-long economic expansion is in its 10th year. - The Federal Reserve
