Introduction
The Equipment-as-a-Service (EaaS) model is an innovative approach that is reshaping the business landscape for Original Equipment Manufacturers (OEMs). While this transformational shift brings ample opportunities, it also presents a new set of challenges, one of which is asset utilisation risk. In this post, we'll dive deep into asset utilisation risk, examine its main drivers, explore its potential impact, and discuss effective management and mitigation strategies.
Definition Of Asset Utilisation Risk
In our previous blog post, we examined the implications of excessive equipment usage leading to higher-than-expected depreciation, also known as residual value risk. In this post, we switch gears and focus on the opposite end of the spectrum - asset utilisation risk.
Asset utilisation risk refers to the risk that equipment does not generate the expected revenue due to underutilization. This underutilization could result from a variety of reasons - lower-than-expected demand, operational inefficiencies, or even customer behaviour. When equipment is not used as frequently or intensively as anticipated, it can lead to revenue shortfalls for OEMs, given the fixed costs associated with owning and maintaining the equipment.
Thus, while overuse of equipment can lead to premature wear and tear and higher depreciation (residual value risk), underuse or inefficient use can result in inadequate returns on investment, presenting a different but equally significant challenge for OEMs in the EaaS model.
Drivers Of Asset Utilisation Risk
The primary drivers of asset utilisation risk are multi-faceted, often intertwining a range of factors. They can include:
Customer demand fluctuations The demand for specific equipment can vary significantly due to seasonal changes, market conditions, or shifts in customer preferences. If the demand for a certain piece of equipment wanes, it can lead to underutilization and subsequent revenue loss.
Inaccurate usage estimation
Just like with residual value risk, inaccurate forecasting of equipment usage can lead to asset utilisation risk. If an OEM overestimates how frequently a piece of equipment will be used, it can result in the equipment lying idle for extended periods, resulting in lost potential revenue.
Equipment mismatch Providing the wrong size or type of equipment can also significantly contribute to asset utilisation risk. If a piece of equipment is not appropriate for the tasks it's meant to perform, it may not be used as frequently or may not operate as efficiently as expected. This can lead to underutilization, or in some cases, non-utilization of the equipment, leading to lower revenues for the OEM. For instance, if an OEM provides a large construction crane for a job site where a smaller, more manoeuvrable crane would have been more suitable, the larger crane may not be used as often or perform tasks as efficiently. This can result in less revenue generated from that piece of equipment, amplifying asset utilisation risk.
Operational downtime
Unplanned maintenance or breakdowns can lead to significant operational downtime, during which the equipment is not generating revenue. Frequent or prolonged downtime can exacerbate asset utilisation risk.
Impact Of Asset Utilisation Risk
The implications of asset utilisation risk are primarily financial. If the equipment is underutilised, the revenue generated from the equipment will fall short of projections, potentially leading to financial losses. For instance, if an OEM based its pricing on the assumption that the equipment would be used for 20 hours a week, but it is only being used for 10 hours, the revenue generated will be significantly lower than expected. This can strain the OEM's financial health and disrupt its revenue forecasting.
In the EaaS model, OEMs often bundle multiple pieces of equipment and services into a single offering. Underutilization of any part of this bundled offering can lead to a mismatch between revenue and costs. Even though certain services within the bundle are fully delivered, the revenue generated may not cover the cost of delivering those services. This can lead to reduced profitability or even financial losses.
In addition to the immediate impact on revenue, underutilization can also affect the overall lifespan and depreciation schedule of the equipment. Less usage might lead to a slower depreciation rate, which can result in the equipment having a higher-than-expected residual value at the end of the service term. While this might seem like a positive outcome, it can actually present a challenge for the OEM. If the OEM has other equipment ready to be deployed but the existing equipment is still in service due to its slower depreciation, the situation can lead to an oversupply and inefficiencies in the operations.
However, this is not always the case, as obsolescence could lead to a decrease in the residual value, even without use. If there's a high risk of obsolescence due to rapid technological advancements or changes in market preferences, the equipment's residual value could decrease over time, regardless of its usage.
Obsolescence risk is a crucial aspect that can impact the residual value of the equipment, and we will explore it in more depth in a later post in this series.
Risk Management Strategies
Effective management of asset utilisation risk requires a comprehensive strategy that encompasses technological, operational, contractual, and financial approaches (mitigation potential in parentheses):
Technological strategies - High
Leverage the capabilities of predictive analytics, machine learning, and IoT devices to accurately forecast the utilisation rates of equipment. Regular monitoring and analysis of usage data can enable OEMs to adjust their pricing models or operational strategies in real time, mitigating the risk of underutilization.
Operational Strategies - Mid
Optimise the sizing and configuration of the equipment based on customer needs and usage patterns. By ensuring the equipment aligns with the customer's operational requirements, the likelihood of underutilization can be reduced. Regular maintenance and quality checks can also ensure the equipment remains in optimal condition for use.
Contractual strategies - High
Incorporate utilisation clauses in EaaS contracts to ensure a minimum level of equipment usage. This can help guarantee a steady stream of revenue and mitigate the risk of underutilization. Enabled by technology, as written above, agreeing on adjustable pricing based on monitoring and analysis of usage data can help OEMs in mitigating the risk of underutilization.
Financial strategies - Low
To mitigate the financial impact of asset underutilization in the EaaS model, OEMs can explore the still rare and expensive flexible financing options out there. These specialised financing arrangements provide the necessary financial agility to adapt to changing utilisation patterns, albeit at a higher cost. While flexible financing options for asset underutilization are not widely available, they offer OEMs the ability to align their costs with the actual usage of the assets, reducing the risk of revenue losses. These options may include customizable payment structures, variable interest rates, or leasing arrangements that allow for adjustments based on the actual utilisation levels. However, due to their rarity and higher costs, OEMs need to carefully assess the feasibility and cost-benefit analysis of utilising these flexible financing options.
Usage-based pricing model - Very high
Adopting a usage-based pricing model is the most effective way to mitigate asset utilisation risk. This model aligns the revenue with the actual use of the equipment, which means that the income will naturally match with the wear and tear (depreciation) of the equipment. This not only ensures a consistent revenue stream but also reduces the financial impact of underutilisation. By charging based on how much the equipment is used, OEMs can protect their revenue and also encourage customers to make optimal use of the equipment. It's a win-win strategy that can significantly reduce the asset utilisation risk.
Remember, the mitigation potential of each strategy varies depending on a variety of factors, including the specific circumstances of the OEM, the nature of the equipment, and the broader market conditions. Therefore, these rankings are not absolute and could vary based on these factors.
Case Example
In the construction equipment industry, many manufacturers are actively addressing the challenges posed by asset utilisation risk in the EaaS model. Several construction equipment manufacturers has recognised the importance of mitigating underutilisation to enhance their revenue streams and overall profitability.
These manufacturers have taken a proactive approach to tackle asset utilisation risk by implementing a range of strategies.
Firstly, they have embraced advanced technology to monitor equipment utilisation in real-time. By integrating IoT sensors and leveraging data analytics capabilities, they can track equipment performance, usage patterns, and identify instances of underutilisation promptly. This actionable data enables them to proactively address underutilisation by offering training programs, operational guidance, or adjusting equipment deployment strategies.
To reinforce the commitment to utilisation, some manufacturers have also implemented minimum usage clauses in their EaaS contracts. By stipulating a baseline level of equipment utilisation that customers must meet, they ensure a consistent revenue stream and mitigate the risk of underutilisation. These contractual provisions incentivise customers to make the most of the equipment services, driving higher utilisation rates and reducing the financial impact of underutilisation.
Through the implementation of these strategies, construction equipment manufacturers are effectively managing asset utilisation risk and experiencing improved financial outcomes. They are not only mitigating revenue shortfalls but also fostering stronger customer relationships by aligning equipment offerings with customer needs and optimising equipment deployment.
Conclusion
Navigating the complexities of asset utilisation risk is a critical component of the successful operation of an Equipment-as-a-Service (EaaS) business model. The consequences of underutilization can significantly impact the financial health of Original Equipment Manufacturers (OEMs), affecting not only revenue but also the lifespan and depreciation of equipment.
However, with the right strategies in place, OEMs can manage and mitigate these risks effectively. Technological solutions leveraging predictive analytics and IoT, strategic contractual clauses, and the adoption of a usage-based pricing model can all play a significant role in addressing asset utilisation risk.
Remember, these strategies are not one-size-fits-all solutions. Each OEM will need to assess its own circumstances and consider the specific nature of its equipment and the broader market conditions to tailor these strategies effectively.
While the EaaS model presents new risks, it also offers immense potential for growth and innovation. By taking a proactive approach to risk management, OEMs can turn these challenges into opportunities, driving greater profitability and success in the EaaS landscape.
In our next post, we will delve into obsolescence risk, another critical factor affecting the EaaS model. Stay tuned to learn more about this risk and how to effectively manage it in the ever-evolving EaaS landscape.