In 2002, the average contract manufacturing agreement had a 60 month term. For 5 years, you could build a business model based on the supply, packaging or distribution goods. And those were clearly the good old days. Increases in automation, something called “big data” around customer preferences and margin compression across the board have led to a very different business climate. One in which the average contract these days is less than 3 years…and getting shorter.
How can you equip your company to meet the rapidly changing demands of tier 1 manufacturers and customer needs in the “new normal” of short term contracts that require significant capital to execute?
A CFO of an international food packaging company recently said, “The trend of short term contracts to follow consumer fads severely limits our ability to plan, forecast and manage risk. And those things leave big questions for growth and profitability.” With a number of shorter term contracts, providers have to be more nimble. The same CFO said, “ramping up with major capital expenditures to support short term contracts has left us in situations with surplus staff, equipment and even square footage, while draining cash and credit capacity.”
Equipment can be one of the biggest challenges you face with the shorter term contract. On average, manufacturing equipment has a life cycle of 7 years. Contracts can require capital investments of $100,000 to $10,000,000 just to begin meeting the conditions of an agreement. Gambling six to eight figures of capital or your bank credit capacity on long term equipment for the hopes that the 24 month contract reminds us that…hoping is not a strategy.
Improvise. Overcome. Adapt.
It is unlikely that the industry will return to the 5 to 6 year production agreement. It is also unlikely that the pressure on capital to ramp up for new projects will lessen. Unless you do a little improvisation with your approach to equipment acquisition. What if you could have an 24 month lease for the custom equipment you need to meet the 24 month contract while offering flexible extension terms–only activated if the contract renews? Imagine, only paying for the portion of the equipment that is correlated to the contract term. Then…only if you need it…renew for another 24 months or other customized term. And after that…only if you need it…renew for another customized term.
With this solution, if there is a change in or abandonment of the contract, you simply return the equipment to the equipment finance provider. You preserve maximum flexibility, enhance cash flows, preserve capital and position your business to win more contracts with a real plan to equip your business for success in a rapidly changing manufacturing climate.
About Nexseer
As a direct lender throughout the United States and abroad, the deal structuring experts at Nexseer Capital solve for the equipment and project finance needs of mid-sized and large companies. We leverage our decades of experience as dealmakers across a range of asset classes, financing structures, and economic cycles to solve problems and deliver execution confidence. In other words, we help you move from complexity to clarity.