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4. Two wrongs do(n‘t) make a right... Understanding the Interplay of Risks in Equipment-as-a-Service

Opdateret: 12. jun. 2023

Introduction

In the world of the Equipment-as-a-Service (EaaS) model, businesses grapple with multiple risks that can have profound impacts on their revenue streams and overall operational efficiency. In previous posts, we have delved deep into three key risks: residual value risk, asset utilisation risk, and obsolescence risk. Each of these presents unique challenges, yet they don't exist in isolation. In fact, they influence and often amplify one another. In this post, we will explore the interconnections between these risks and discuss how mitigating one may affect the others.


Overview Of Each Risk

Let's quickly recap each risk:

  • Residual value risk refers to the potential for the market value of equipment to be lower than its anticipated value at the end of the service term.

  • Asset utilisation risk is the risk of underutilisation of the equipment, leading to lower-than-expected revenues.

  • Obsolescence risk is the risk of equipment becoming outdated or less desirable before the end of its expected service term.

Interactions Between Risks

The interplay between these risks is complex and nuanced. For instance, obsolescence risk can lead to increased residual value risk. As equipment becomes outdated, its market value is likely to drop, leading to a higher residual value risk. Similarly, if equipment becomes obsolete, it may be underutilised, leading to asset utilisation risk.


However, the mitigation of one risk does not necessarily exclude the others. High asset utilisation does not mean that obsolescence risk is low. Even heavily used equipment can become obsolete if new technologies emerge that offer greater efficiency or other benefits.


Furthermore, these risks can compound. For example, a piece of equipment that is underutilised (asset utilisation risk) and becomes obsolete (obsolescence risk) is likely to have a significantly lower residual value (residual value risk).


Risk Mitigation Strategies and Their Impacts

Mitigating one risk can potentially increase another. For example, to mitigate obsolescence risk, a company might decide to upgrade their equipment frequently. However, if the upgraded equipment does not align with customer usage patterns, it could lead to increased asset utilisation risk.


On the other hand, some mitigation strategies can address multiple risks. Flexible EaaS contracts, for instance, can manage both obsolescence risk and asset utilisation risk by allowing equipment upgrades and aligning service terms with customer usage patterns.


These dynamics highlight the importance of a balanced and holistic risk management strategy. It's crucial to consider all risks in tandem rather than trying to manage each in isolation.



Balancing Risks in EaaS: The Pivotal Role of Equipment Data

The strategies for mitigating these three risks often involve a trade-off between one type of risk and another, with equipment data playing a central role.


Using data to balance residual value risk and asset utilisation risk

Employing IoT devices and advanced analytics can help OEMs accurately predict asset utilisation and assess the residual value of equipment. By leveraging this data, OEMs can balance between these two risks. For example, equipment that is underutilised might have a higher residual value since it experiences less wear and tear. On the other hand, highly utilised equipment might have a lower residual value due to increased wear and tear, but brings in more revenue through higher utilisation. By effectively monitoring and managing this trade-off using data, OEMs can strike an optimal balance between these two risks.


Leveraging data to mitigate obsolescence risk

Equipment data can also be instrumental in mitigating obsolescence risk. Predictive analytics can help OEMs forecast technological trends and potential obsolescence, enabling them to plan for equipment upgrades or replacements. However, a proactive approach to mitigating obsolescence risk might increase asset utilisation risk. For instance, if an OEM replaces equipment frequently to prevent obsolescence, the replaced equipment might end up underutilised, leading to increased asset utilisation risk.


Data-driven contractual strategies

Contractual strategies can also be informed by equipment data. Dynamic contracts that allow for adjustments based on equipment utilisation and performance can help mitigate both asset utilisation risk and residual value risk. However, these strategies might inadvertently increase obsolescence risk if not carefully managed. For example, a contract that allows for early termination in case of underutilisation might leave the OEM with obsolete equipment that has little to no market demand.


In each of these scenarios, it's clear that equipment data can provide invaluable insights to OEMs, helping them understand and effectively manage the complex interplay between these risks. However, it's crucial for OEMs to carefully consider the potential impacts of each mitigation strategy on all risks, not just the one it's primarily intended to address. Only by doing so can they ensure a balanced and effective risk management approach.


The Impact of Risk Mitigation on Other Business Risks

Understanding the interplay between residual value risk, asset utilisation risk, and obsolescence risk, and their respective mitigation strategies, is key. However, it's also important to note that these risks and strategies can have implications for other business risks.



Credit risk

Mitigating asset utilisation risk by ensuring high equipment usage can inadvertently increase the credit risk, as the customers who heavily use the equipment might face difficulties in fulfilling payment obligations, especially during economic downturns. Similarly, a strategy to mitigate obsolescence risk by offering flexible EaaS contracts can potentially heighten credit risk if it involves offering the equipment to less creditworthy customers in order to ensure a wider market reach and higher usage.


Market risk

Efforts to mitigate residual value risk by ensuring high-quality maintenance of the equipment can lead to an increase in market risk. The increased cost of maintenance could raise the pricing of the service, making it less competitive in the market. Additionally, a strategy to manage obsolescence risk by staying ahead of technological trends could also increase market risk if the adoption of new technology doesn't align with market demand.


Operational risk

While managing asset utilisation risk by optimising operational efficiency can lead to a decrease in operational risk, other strategies might have the opposite effect. For example, an approach to mitigate obsolescence risk by constantly upgrading or replacing equipment could increase operational risk due to the challenges, and costs, associated with integrating new technology into the operational process.


Regulatory and compliance risk

Efforts to manage obsolescence risk by keeping abreast of regulatory changes can decrease regulatory and compliance risk. However, a strategy to mitigate residual value risk by extending the service life of the equipment might increase this risk if older equipment falls short of updated regulatory standards.


Each of these examples illustrates the far-reaching implications of risk management strategies in the EaaS model. It's critical for OEMs to not only understand the interplay of risks within the EaaS model but also their potential impact on other business risks. A comprehensive risk management approach that takes into account the entire risk landscape can lead to more sustainable and profitable operations.


Conclusion

In conclusion, the Equipment-as-a-Service model, while offering a compelling value proposition, presents a unique set of risks. Residual value risk, asset utilisation risk, and obsolescence risk are all significant concerns that intertwine in complex ways. Their mitigation strategies can sometimes be a balancing act, potentially exacerbating one risk while reducing another.


However, through the intelligent use of equipment data and a careful, holistic approach to risk management, these risks can be effectively balanced. This involves not only understanding the interplay between these risks but also considering their impacts on other business risks such as credit risk, market risk, operational risk, and regulatory and compliance risk.


The EaaS model, despite its inherent complexities, offers tremendous opportunities for businesses willing to navigate its risk landscape. By comprehending the intricate dynamics of these risks and employing data-informed strategies, OEMs can ensure a sustainable, efficient, and profitable operation in the evolving EaaS landscape.

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