not match reality
Over the years, I have had the opportunity to read a variety of
articles about the trials and tribulations of captive finance
subsidiaries. It would be interesting to know if others have, like
me, experienced disappointment with the observations.
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Almost without exception, the articles have been able to name
names when discussing the merits and advantages of having a captive
– IBM, HP, CAT etc – but, when discussing the negative aspects, I
have seen no references to real companies and the concentration is
moved towards general comments such as capital being tight and
changes to ratios not being appreciated by the rating agencies. It
makes me wonder from where the writers of these articles get their
information.
One of the most negative and inconclusive articles I have seen
on the subject was written by two people from the ‘industrial
goods’ practice of a major consulting group. Just in case anyone
has seen the article – or still remembers it – I am going to use it
as a basis for trying to put the record straight.
Treasure chest or time bomb?
The article states: “The traditional advantages of
do-it-yourself financing have largely become obsolete and the costs
and risks of ownership now often outweigh the benefits.” It goes on
to say Caterpillar,
Harley-Davidson and John
Deere have continued to make healthy contributions to their
parent companies. However, the article then turns vague and states
“many subs have become financial burdens”, without actually naming
any that have become a problem.
If we look at these three companies and consider their position
in the ‘captives’ market, we see three excellent businesses, well
run and that take their place alongside the best in the market. I
am still looking for the failures. The heading of the article,
‘Time Bomb’, completely confuses me because I have yet to see any
captives that should carry this health warning.
The new competitive terrain for financing
Under this heading, the attack of the article seems to be a
mixture of what is called “a compelling reason for industrial
companies to extend credit to their customers”, coupled with
“disguising their true earnings” – presumably the suggestion being
that the manufacturing company profits are being shored up by the
profits from the financing arrangements. This is aligned with a
suggestion that traditional lenders have somehow regained centre
stage.
Having worked with many of these captive finance companies, I
see the main reason for industrial companies wishing to extend
credit to their customers as being more about customer retention
and control of both the primary and secondary markets for their
equipment.
Also, the bundling together of services and supplies is very
much more convenient if a customer wants to see the ‘whole supply’
on one invoice – granted, they need the skill sets that protect
them in the conferring of credit. A quality credit function, plus a
first-rate billing and collection process, are a prerequisite, but
that has never been just the prerogative of banks or finance
companies. Looking at many of the office equipment manufacturers
and their finance subsidiaries, it is difficult to see how, today,
they could do without their sales mixture of ‘cost justification’
for their equipment and an ‘over time’ payment plan.
The suggestion that this can be achieved by linking with a
specialist financial institution is, of course, indisputable, but
it is so much more convenient if there is a first-rate ‘in-house’
solution. It is no surprise that many industrial companies are
starting to shift from ‘relationship’ funding to ‘captive’
funding.
Does owning a financing sub still make
sense?
This section, which I have borrowed from the article,
concentrates on the profit generation of a financing subsidiary
and, what the authors call, “value creation” – as if they are not
connected. They also suggest some of the services to the subsidiary
would be provided by the parent and, perhaps, not costed properly –
and that, in some way, this would distort the results.
It is my experience that finance subsidiaries of manufacturers
are generally very well run and that control of the essential
processes are under the supervision of individuals who have been in
the leasing or lending business for many years. In fact, the real
‘added value’ or ‘shareholder value’ has been the saviour of
several large industrials in recent years.
The market value of some captives has been put to the test over
time – not always in good times or convenient circumstances – and,
nevertheless, has brought relief at a critical time in the life of
several industrials. If I stand back and look at the current market
value of many of the ‘captives’, it is, in any language,
substantial.
Attacks on any part of our industry are always disappointing. To
look at and, perhaps, even criticise from the inside is the
greatest contribution our profession can make to this great
industry of ours.
The author is a principal at The Alta Group
