To own an asset or not? How to know the best business model

[File]

To some, a business should limit outsourcing and instead acquire every crucial asset for its operations. On the other hand, others insist a business should be light on assets as a tactic to reduce overheads and remain “safe and reliable.”

The second group often has a stronger case.

Global consultancy firm Ernst Young (EY) points out that being asset-light was “once seen as just a defensive tactic used by underperforming companies.”

But is the narrative changing?

“Regardless of market position, an asset-light approach can help companies achieve higher total shareholder returns (TSR), among other financial benefits,” EY said.

According to EY, an asset-light strategy or business model involves transferring capabilities, such as people, process and technology, to “better owners” in order to enable companies to transition fixed costs to a variable cost structure, enhance agility, and facilitate a shift of resources that allows a focus on core capabilities.

Does it then suit small and medium enterprises (SMEs) to be light on assets?

“The leasing option does not work for SMEs,” says logistician James Kariuki, the chair of the over 75,000-member China Dubai Traders Association.

“Government institutions and big businesses can take lease options. For example, for vehicles, you will find that there are several drivers in a big company driving the same vehicle in shifts. The vehicle will depreciate very fast; within two years it will be an old vehicle.”

This is opposed to the SMEs, which are very personal and where only one person is handling a machine, he says.

“When you look at the leasing fees, such an agreement works for the government and some of these big corporations because they have multi-users of the asset as misuse of such an asset would be expected. If I am driving a car worth one million shillings and I am paying a leasing fee of Sh20,000, I would rather negotiate with the bank and pay higher than the Sh20,000 to own the vehicle; and since it is my vehicle I will take care of it,” he said.

Why SMEs should avoid leasing

Unless it is a car hire for a weekend, he says, SMEs should avoid leasing. They should sit back as long as they cannot afford an asset, unless in emergencies.

According to Kariuki, for SMEs, sometimes the best approach is to innovate, slowly and diligently, and learn to survive when you cannot afford the asset, and then make sure you secure it when you can afford it.

“MSMEs are very innovative. If I want to produce, say a brochure, the printer will charge me Sh100. I will not pay that money. I will go to the person who sells the paper and buy it, then go to the printer who will charge me for using the machine; I might end up using Sh40 or Sh50.”

This will not be the practice of a lifetime. Sooner than later, when the SME builds capital to afford the machine, they will buy it.

SMEs have to survive by thinking outside the box as lack of innovativeness leads to death.

“SMEs are just about keeping costs as low as possible,” he said, adding that falling back on leases would be a counter-action to this aim.

“A hawker will set up a box worth Sh50 and convert it into a mobile shop and with that simplicity could sell goods worth so much,” said Kariuki. 

Why it pays to be street smart 

He observes that some people who import commodities such as maize germ from Uganda used to take advantage of Uganda’s allowance of importation of “over-age” vehicles, 15 years, (a law banning this practice came into effect in 2018) which charged cheaper for transport. They could then get underpaid drivers to complement the business plan, and would then have the goods delivered to Nairobi cheaply.

“By being street-smart, a small businessman can compete with the big producers in the country, and can sell for cheaper and make a profit,” he said. 

EY observes that the current Covid-19 crisis has prompted companies to conduct a comprehensive review of business portfolios and make long-overdue operational changes. Companies are also adopting an asset-light model to navigate market conditions.

Chartered accountancy firm MASD says that capital assets could potentially weigh down a company, but investing in technology and talent allows entities to scale up faster and compete with existing players in record time. They advise that businesses go asset-light.

They also say that asset-light businesses get long term sustainability, and do not have to incur the high initial costs of procuring machinery, most of which is obtained through painful borrowing of money, or fear of spending a lot when plants break down.

Businesses going asset-heavy should, however, consider high predictability and low volatility of cash flows, relative stability and predictable value of the underlying asset and a liquid resale market, according to Christian A. Schröder Founder & CEO of 10x Value Partners, an angel investor