Oct 31 2006

Spend Management

Local and state governments debate the pros and cons of leasing versus purchasing technology equipment.

Wylie Wong

IT DIRECTOR MARK YEARWOOD finds leasing attractive because it may be the only way Lubbock, Texas, can afford to equip city workers with the new PCs they require to do their jobs. Currently, some city planners and public works employees use four- to six-year-old computers, but they need more processing power and memory to effectively run the geographic information systems software they use.

Since nearly one-third of Lubbock’s 1,200 computers are three years old or older, some individual city departments requested funding for new PCs this fiscal year. However, city leaders rejected their requests due to budget constraints.

To get lower prices on volume buys, Yearwood wants to centralize all PC purchases under his department for the next budgeting cycle. Though he historically bought all his IT equipment, Yearwood is considering leasing his new computers.

“My focus is on getting technology refreshed, so leasing is appealing,” Yearwood says. “In talking to PC vendors, the consensus seems to be that there’s probably not much difference between leasing and buying when it comes to overall total cost.” However, leasing reduces the amount of up-front cash required, he says.

Faced with lean budgetary times, some local and state governments are debating the positives and negatives of buying versus leasing IT equipment. In the town of Oro Valley, Ariz., for instance, IT staff members prefer buying so they can reuse old computer components or redeploy older PCs to employees who don’t require high-powered computers. On the other hand, a California agency prefers leasing PCs because employees are assured of receiving new computers every three years.

Leasing is an affordable way for cash-strapped government entities to pay for new hardware and software without having to write a large check upfront. Determining the best, most cost-effective option is complicated and depends on contract terms, such as the lease’s length, interest rates and the purchase options. Most leases last two to three years and provide the lessee the option of either purchasing or returning the equipment at the end of the agreement.

“It’s mostly a financial question,” says analyst Andrew Bartels of Forrester Research in Cambridge, Mass. “Is buying the best use of your capital? With leasing, you save on capital expenditures up front. You also spread out your spending on computers and similar technology over several years, making IT spending more level and predictable.

“Leasing can actually be cheaper than buying if you get a very low interest rate from the leasing vendor; otherwise, it’s generally more expensive than buying over the long run,” Bartels says.

Vendors occasionally offer special lease options, such as zero percent financing. To further persuade customers to lease, some vendors or leasing companies throw in extra services, such as free security software, technical support, and disposal services at the end of leases, says analyst Rob Schafer of the META Group in Stamford, Conn.

Pros and Cons

In Lubbock, Yearwood’s IT budget allows him to buy technology infrastructure, such as servers and networking equipment, every three years. But he currently has no control over PC purchases because that’s managed by each individual department. With the support of other department heads, Yearwood plans to consolidate PC purchasing under the IT department and have a PC funding plan in place for the 2005-2006 fiscal year budget.

Yearwood sees two major benefits to leasing. First, with a three-year lease agreement, he could get 400 new computers every year, which would result in new computers every three years for each of the city’s 1,200 employees. Second, at the end of the lease, he wouldn’t have to waste money and staff time recycling the PCs or trying to sell them to salvage dealers. Instead, the PC vendor would dispose of the machines.

“The technology refresh and the disposal of the computers are appealing,” he says.

Yearwood also sees one major benefit to purchasing: the ability to use the technology for an extra year or two beyond the typical three-year life cycle. With leasing, he couldn’t keep the technology for an extra year unless he extended the lease.

The state of California is exploring its purchasing options and studying whether leasing or buying makes the most economic sense. But one California department that leases its computers believes that approach is more productive and cost-effective than buying. Before the department began leasing technology equipment, most of its computers were not compatible. Employees had everything from Apple Macs to PCs with Windows 95, 98 and NT. Because of the different operating systems, sharing files was an ordeal.

To outfit the department’s employees with new computers, the IT department decided to lease. Though the process of swapping out old computers with new ones takes effort, leasing ensures that every computer is up to date and compatible with the others. This results in cost savings because IT staffers don’t have to repair old computers that break down or deal with the inefficiencies of having incompatible computers. Each leased PC and monitor includes a three-year warranty, which further reduces costs.

Leasing also spreads costs over the term of the agreement. In contrast, a department that purchases its machines must add a substantial amount of money to the budget for new PCs every three years—unless it’s willing to live with outdated computers.

Many government agencies that lease IT equipment choose three-year agreements with the option of buying the products for $1.00 each at the end of the contract, says James Bailey, a Jacksonville, Fla.-based team leader in CIT Office Technology Finance, a unit of CIT Group in Livingston, N.J. This type of agreement is also known as a capital lease.

However, CIT is seeing growth in fair-market-value leases, which are also called operating leases. These leases offer monthly payments that are lower than the $1.00-buyout lease option, but when fair-market-value leases expire, agencies must either return the machines or purchase them for their estimated worth.

Buying and Owning

Current economic woes have forced many government departments to extend the life of their existing technology, says META Group’s Schafer. During the boom years of the late ’90s, most IT departments upgraded servers and storage equipment every three years. Now, they’re trying to add an extra year of usage, which could save a municipality an additional 10 to 12 percent in annual procurement costs, he adds.

Stretching the money spent on IT equipment is a goal of Kevin Verville, IT administrator for Oro Valley, Ariz. He prefers to buy equipment when the capital funding is available because he likes to reuse older technology throughout the organization.

“Generally, at the end of a lease, that equipment is returned and exchanged for new equipment,” he says. “But we can redeploy our computers to a location that may not need the latest technology, so we can extend our dollars a little further.”

When computers are no longer useful, the Oro Valley IT staff strips them and removes reusable components, such as hard drives, memory, video cards and networking cards. Then, if an employee’s hard drive dies, IT staffers can replace it with a hard drive from an older computer.

“We standardize, so we can take a part from one computer and put it into another one without worrying about compatibility issues,” Verville says.

Both buying and leasing have their advantages and disadvantages. Ultimately, the choice depends on a community’s IT needs, its financial situation and what makes economic sense for a particular technology. If communities can’t afford to buy technology outright, leasing is a viable alternative.

“Leasing is all about preservation of cash,” CIT’s Bailey says. “It allows government agencies to purchase equipment with manageable monthly payments.”

Leasing Caveats: Getting the Best Deal

IF YOU LEASE, read the fine print, advises META Group analyst Rob Schafer.

Some leases have “evergreen” clauses, he warns. For example, if you fail to notify the leasing company of your intentions to buy or return the equipment six months before the end of the lease, some leases automatically renew for a year.

Schafer also cautions organizations to be specific with fair-market-value pricing. Negotiate a price up front, he says, or negotiate the method that will be used to determine the fair market value at the end of the contract. If no specific dollar amount is cited, agree to get three estimates: one from a company chosen by you, one from a firm chosen by the leasing company and a third estimate from a company agreed on by both of you. The average of the three estimates should become the purchase price.

Protect yourself in case you want to upgrade your technology before the end of the lease, Schafer adds. Make sure there are no penalties for getting out of your lease early. A lease should have protection for financing upgrades.

And, of course, try to lock in the best interest rate.

Two Types of Leases

The two main types of equipment leases are the $1.00-buyout lease (capital lease) and the fair-market-value lease (operating lease).

$1.00-Buyout Lease (Capital Lease)

Lasts longer than 75 percent of the equipment’s estimated economic life.

Features an option to purchase the equipment for less than fair-market value. In this case, it’s $1.00.

Ownership is transferred to the customer at the end of the lease.

The present value of the lease payments exceeds 90 percent of the fair-market value.

Fair-Market-Value Lease (Operating Lease)

Lease term is for only a small portion of its useful life.

Customer essentially pays rent to use the equipment.

This option offers the lowest monthly payments.

At the end of the lease, customer can purchase the equipment at fair-market value, return it or extend the lease.

Source: CIT Group, Investorwords.com


Many government agencies that lease IT equipment choose three-year agreements with the option of buying the products for $1.00 each at the end of the contract.