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How new IT financing models are opening corporate wallets

Drastic times call for drastic measures, and for IT management, times are as drastic as they get. IT budgets – which even during the dot-com bust still showed growth – are now widely frozen or cut. And with cash in short supply, CIOs and IT directors are often struggling to find the resources to maintain business-critical services let alone fund vital projects.

For vendors faced with evaporating sales prospects, that situation has triggered a rash of new financing offers with suppliers as diverse as Microsoft, SAP, Avaya, Dell, and Hewlett-Packard putting forward innovative offers designed to get their cash-strapped customers spending again.

The most conspicuous of these is the 0% finance deals where systems or software are provided for no capital outlay, and then paid off without interest in monthly installments over as much as three years.

For example, Microsoft is offering 0% financing for three years on all its Dynamics ERP software – major products such as NAV, AX, SL, ERP, GP and CRM – covering licences and the first year’s enhancements. The five-month promotion, which runs till 20 March (but may be extended), is open for deals valued at $20,000 to $1 million or local currency equivalent.

In a similar vein, until the end of January, HP was offering 0% for licensing and support costs, in excess of $100,000, on its business technology optimisation products (including all its systems and applications management software) and its information management products (including its data warehousing, document automation and archiving software).
Such deals – common for selling cars, kitchen and sofas but almost unseen in the IT industry – are just the extreme, credit crunch-induced example of the raft of financing options proving increasingly attractive to IT buyers.

But although the crunch has of course made all businesses re-evaluate their spending habits and rethink what they look for in a deal, it has also exacerbated a major trend that was already under way: the move from paying for IT with large chunks of capital, towards monthly installments financed out of the operational budget.

Lease of life

In 2007, when few businesses had an inkling of what was ahead of them, IT market researcher IDC assessed the business-IT leasing and financing industry. In 2006, it found, it was worth a combined $70 billion worldwide. By 2010, it would be worth $100 billion, the report predicted.

Change was also afoot in the kinds of project that were to receive finance: hardware financing constituted 70% of the market in 2006; by 2010, it was predicted, software and services financing would make up 50%.

A more recent survey, published by IDC in October 2008, asked companies that were using some kind of financing package to pay for IT what the benefits were.
The pluses cited by respondents included operational, as well as purely monetary factors. These were: protection against obsolescence, (many deals allow customers to upgrade for free or return equipment once they have paid a certain amount, liberating them from legacy millstones), convenience and ease of approval from senior management, and the fact that many deals included disposal of hardware.

Chief among the financial benefits – as identified by 80% of respondents – was the ability to align reporting the cost of a given project alongside the delivery of results – i.e. on a monthly basis. This makes it far easier to see how well a particular implementation is performing.  

Other top answers were the fact that moving to monthly payments allowed companies to preserve their cash resources (over 75% of respondents) and the ability to decide when the expense of a given IT project is recorded relative to budgetary periods (over 75%).

Frozen funds

Guy Smith, former European head of Cisco’s finance arm and now chief sales officer for online business funding marketplace Smartfundit.com, has also seen the current economic climate put IT financing on the radar of larger companies.

“Liquidity in the markets is more restricted than it has been for decades. Companies that were deemed cash rich six months ago are now hanging on to their assets for dear life,” he says. “The demand for a financial solution [for buying IT] has never been more prevalent.”

Others are witness to that broadening of the demand. According to Philip White, CEO of IT financing provider SysCap, the fall out from the credit crunch has had an effect on the kind of company that is in the running for financing.

“Of course, we’ve seen companies in the SME environment [traditional candidates for financed IT] either go out of business, or we’ve seen buying decisions deferred or cancelled. So it has removed some companies from the market,” he says.

“But we’ve also seen large organisations that would previously have used operating capital or bank loans to finance IT move to a pay-monthly model,” he adds. “Plus, in the public sector organisations, especially those who had money invested in Icelandic banks, people have been looking for money elsewhere. So it has also brought new entrants to the market.”

Both argue that the 0% financing offers initiated by hardware and software vendors are not necessarily the best deals to go for.

“Zero per cent offers are headline grabbers, but, as always, there is no such thing as a free lunch,” says Smith. “And very rarely do these offers last for an extended length of time. They are an offer that has a start date and an end date.”

For Kirill Tatarinov, corporate VP of Microsoft Business Solutions, the interest free deal is simply a response to “the stress in the credit regime that people are experiencing” – not just its end customers but the partners it uses to sell its ERP systems. On the announcement of the 0% deal late last year, several of those partners claimed they had seen previously dead deals suddenly back in their sales pipelines.

“What we have seen with the 0% financing offer is that when customers are looking to invest in technology to give them a productivity gain, it takes the edge off the investment decision, they don’t have to tie up their capital going after it,” says Gayle Hoshino, General Manager, MBS Pricing, Microsoft Business Solutions. “The partners are ecstatic [about the promotion]. It gives them competitive edge, it helps them from a cash flow standpoint, because they get cash up front for the complete sale, for their services and the software too, and they don’t have to spend their administrative time doing collection.”

White, meanwhile, believes the emergence of 0% financing deals says more about the condition of the vendors than the demands of the customers. “Zero per cent financing is an instrument that can be used by any vendor of any product to drive incremental sales, to protect margins, to avoid discounting and to launch new products.”

“Buyers have to ask themselves whether the attraction is to the 0% finance, or to the ability to pay in payments over a period of time,” he adds.

Down to zero

SAP, the applications maker, is offering 0% financing for certain customers as part of its Best-Run NOW drive. But 0% is not a goal in itself, says Dave Keen, SAP’s VP of industry and competitive marketing. He says that, on their own, 0% deals are unlikely to stimulate much business.

“Throwing 0% finance offers [at customers] is the wrong thing to do,” says Keen. “People don’t just want get things for cheap; they want things that will help them succeed in the downturn, and that they can get up and running quickly.”

Far more than the cheap money, it is the ability to assess return on investment that – if anything – is driving companies toward financing packages for IT, says Keen.
“Return-on-investment cycles have changed; people aren’t willing to talk about a five-year investment,” he argues. “So we are not seeing greater demand for 0% finance deal per se. We are seeing greater demand for solutions that can help organisations see a faster return on investment, and finance is one part of that.”

Paul Sheeran, EMEA managing director for HP Financial Services, sees 0% financing deals as just one of a broad range of services that vendors are prepared to offer in order to help customers in all geographies and industries free up some buying power.

“Our intention is to offer a financial solution to help people buy, whether it’s a lease or a loan, 0% or otherwise,” he explains. “Every country is somewhat different, depending on what the law [covering finance], and what the convention is. And some customers prefer on-balance sheet loans, some off-balance sheet, depending on circumstances and industries.”

Furthermore, he continues, HP’s finance operations – which has a full international banking licence and finances about $5 billion worth of deals per year – is just another piece of its holistic customer management.

“The trend we are seeing is towards lifecycle asset management, where the vendor gets involved in the disposal of hardware, and data wiping, for example,” he explains. “Offering finance is just one more way to extend the relationship with our customers.”

Some observers see interest-free financing offers as a sign that the IT vendors are leveraging their creditworthy status and multibillion dollar cash reserves to giving back to their customers. Certainly, many of the big names in the sector are sitting on large piles of cash: Cisco has $26.8 billion, Microsoft $2.7 billion, Oracle $10.6 billion in cash and short-term investments.

But according to Smith, the former head of Cisco’s financing division, there is no chance that vendor’s will endanger these war chests of cash through liberal lending. “The reason why those large US manufacturers are cash rich is that they have very prudent financial accounting,” he explains. “It’s the same financial prudence that prevents them from lending that cash excessively.”

Managing change

What is becoming clear is that the most attractive aspect of IT procurement financing – from the customer’s point of view and, arguably, the vendors long-term benefit – is the shift to monthly payments. That being the case, this is yet another way in which the software-as-a-service (SaaS) model is proving disruptive: SaaS vendors, who charge customers on a monthly basis by default, are in a sense in competition with the IT financing providers.

But taken from another perspective, the finance operations of those vendors – whether internal or third party – are helping them to wean themselves off the front-loaded, cash-intensive deals of the sort that many their customers just can’t afford anymore.

SysCap’s White explains their predicament: “Software manufacturers have historically received 100% of a sale on day one. They use that to pay off their R&D debts and other costs, and they might make 20% as profit. If they switch to a subscription model, they will only get a small percentage of the sale on day one, but they still need to pay the wages.”

The business models of large software providers, therefore, prevent them
from wholeheartedly embracing the SaaS/cloud computing model of IT delivery.

Financing, however, offers them a middle way. “We can offer vendors a way to allow their customers to pay on a monthly basis, but receive 100% of the cash upfront, so we can help them to re-engineer their business model,” explains White. “And with some vendors, we might pay 100% of the buyers’ payment upfront in the first year, in the second year 80% up front and 20% on a monthly basis, then 60%/40% the next year.”

Unfortunately for White and his fellow independent IT financing providers, the increased demand from both customers and vendors comes at a time when their own ability to obtain funds is challenged.

“Capital is harder to come by. And while there may be a falling base rate on loans, extra costs such as compliance are preventing them from being passed on to the customer,” he explains. “So just as the credit crunch is driving demand for our services, it is also constraining supply.”

Those vendors with captive finance operations, such as IBM, HP, Dell and Microsoft, are therefore in a strong position to benefit from growing demand.

As a final note, it is worth mentioning that as cash becomes scarcer, its buying power increases. The more organisations that opt to pay for their IT using financing deals, the greater the bargaining power of those that can still afford to put up the cash.

“If you were out on the high street today looking to buy something with cash, you could probably negotiate a good deal,” says SAP’s Keen. And that now applies to both the cost of the product and the cost of the cash.