Why leasing option is good for country and counties too

Some of the ambulances bought by Kisumu last month. The government’s equipment leasing programme is a great idea. PHOTO | TONNY OMONDI

On February 23, governors, in an open letter to the Health secretary, expressed reservations over the proposed managed equipment services promised to counties by the national government.

They said the deal was opaque and hence a few issues needed clarification. Granted, I don’t hold brief for the CS.

Further, although I am a professional with a Kenyan leasing firm, our firm did not participate in the said tender because we were technically side-lined in favour of international companies.

While I share some of the reservations raised by the governors, I am not well placed to respond to the concerns before the office addressed does so.

However, the letter has underlying tones that create the impression that leasing is not a financially viable model for asset acquisition and should only be embraced “where the public sector comparator proves that this service cannot be accessed through the normal government purchase system.”

Leasing is a novel concept in Kenya with corporates being early adopters of what is globally a popular phenomenon.

Still, to many it remains a mystery, an enigma. Here is the reason why – leasing loosely translates to “renting”. We live in a society which has historically believed that “owning” makes more sense than renting.

Hence, it makes more sense to own a house than to rent one and to buy a piece of land than to rent it. Such reasoning is not out of place.
Both houses and land are assets that increase in value and hence they are good stores of value. Thus, buying them today makes sense because you can be assured that the value of the assets will beat inflation.

If one bought a car or refrigerator today, it will depreciate in value in future. This makes poor storage of value. What makes such assets to depreciate in value is the fact that they have a limited life cycle.

Also, new variations and improvements are generated often, hence the asset becomes obsolete in time. Many people make the mistake of simply looking at the initial capital outlay when buying an asset. This is a small portion of the cost of the asset in its long term use.

To better understand how to make a better financial decision on asset acquisition, it is important to adopt a tool called Life Cycle Costing. This is the valuation of the total real cost of an asset over its useful life, or, during a lease, over the tenure of economic viability.

The operating lease, which is a pure rental, should have basic cost and accounting principles. I will mention only two key principles.

First, outside the cost of finance, you should not bear more than 90 per cent of the purchase value of the equipment in the primary rental period.

The primary rental period is the period in which after the lease ends, you can walk away without any obligation. However, the purchase value is not always the purchase price.

An item imported for you will have a lower purchase price to value should it be valued locally. This is the principle behind why a directly imported ex-Japan car is cheaper than a similar locally purchased one.

Secondly, the lease period should not exceed 75 per cent of the useful economic life of the asset. Here again there exists differences of application.

A useful life of a car is normally pegged to four years. However, this is because the maximum allowable wear and tear is 25 per cent. This does not mean it cannot be 15 per cent.

Majority of vehicles in Kenya are ex-Japan imported at eight years old. Hence the economic life is normally determined by both user and lessor and the general norm in the respective country.

Thus, a vehicle worth Sh9 million should be leased at not more than Sh200,000 per month over five years.

From a cashflow perspective, this is at least 10 per cent cheaper than a loan for the same equipment, with interest of eight per cent per annum. But what makes these leases much more expensive?

The costs relating strictly to the asset as outlined above is known as the dry lease. When insurance and maintenance are added to this, then value added services are combined forming a wet lease.

Different lease providers apply different costs. However, a lease payment is definitely less cash outflow than a leveraged acquisition.

Local content

It makes much more sense to lease and pay per use than to pay upfront during a direct acquisition, foregoing the opportunity cost of the money which you should be spending in other developmental sectors.

So the eventual cost boils down to how efficiently or capable you are at managing your assets.

It is clear that in such an analysis the costs involved could either be deterministic (such as acquisition and disposal costs) or probabilistic (such as cost of failures, repairs, spares and downtime).

Most of the probabilistic costs are related to the reliability and maintainability characteristics of the asset in question.

Enter Kenyan private companies. They normally manage their leased assets so efficiently that in over 50 per cent of the leases they take direct management of maintenance.

However, when management leases are charged at three times more than the actual lease cost of the asset questions are bound to be raised.

The government, after opting to use the leasing option for both police cars and medical equipment acquisition, is falling into the global best practice and will benefit in the long term.

Not to mention that the move will boost the leasing industry and ensure better service provision to citizens.

My only plea is that the government should seek to put in place measures to protect local leasing companies. It should ensure that it does not export too many jobs abroad when locals have capacity to undertake huge leasing transactions at home.

This was cleverly executed in the standard gauge railway project which has 40 per cent local content. This was privately effected in the police car leasing project as Toyota got a local partner with a 40 per cent share.

Why not for the medical asset management programme? Still, we can’t throw out the baby with the bath water. The government’s equipment leasing programme is, overall, a great idea.

Njeru is the regional managing director of Vehicle and Equipment Leasing Ltd.

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