Equipment Acquisition

Cover Story

As a laboratory-and business-manager, decisions regarding equipment and reagents are not taken lightly. Whether you should purchase these tools outright or consider a leasing or reagent rental option is worth investigating.

Pros and cons of each option and financial advantages of one method versus another are explored. Considerations such as how volume and growth may impact your decision also are addressed.

The selection and acquisition of equipment and consumables for the laboratory is one of your major responsibilities. Although the means of acquisition is not always left to the manager to decide, it is still necessary to know the options available:

• cash purchase

• lease and

• reagent rental.

All have advantages and disadvantages attached to them, but to determine which might best suit the laboratory’s needs, it is necessary to understand each.

Purchase Details

Purchase is accomplished by offering money and obtaining ownership of the product. The money can be from liquid cash assets of the lab or practice, or by borrowing money from a financial institution, whether by a loan or line of credit. The end result is outright ownership of the goods after all loans have been repaid.

Outright purchase usually carries the lowest interest rate for a loan, but the capital equipment must be depreciated over a period of time (generally five years for laboratory equipment) and appears on the balance sheet as a long-term debt. If assets are liquidated to purchase capital equipment, the interest opportunity for those assets must be factored in against the lower interest rate available for a loan versus a lease.

Lease Details

A lease can be one of two types: Fair Market Value (FMV) or capital. In a FMV lease, ownership at the end of the lease is dependent on the lessee paying a “fair market value” for the commodity, generally 10% – 15% of the retail price of the goods. A capital lease is also sometimes referred to as a “dollar buy-out lease” because at the end of the term of the lease, the lessee can purchase the commodity for $1.00.

As one would expect, the interest rate on a FMV lease is less than on a capital lease. Ownership is optional at the end of the lease period, but is generally a given for a capital lease because there would be no reason to opt for a capital lease with the higher interest rate if ownership at the end of the lease was not desired. Capital leases can be deducted for tax purposes like purchases.

One of the most attractive options for leasing capital equipment is there is no capital outlay required to acquire the equipment. Another is that service can be added to the lease payment as an interest-free “pass through,” whereby the leasing agency passes the service payment on to the contracted service provider on a monthly basis, eliminating the large service contract that would otherwise come due annually after the warranty has elapsed. And, unlike a purchase, a lease can be considered a tax-deductible overhead expense.

Reagent Rental

A reagent rental agreement is arranged by the manufacturer or distributor of the equipment being acquired. The cost is usually based on a cost per reportable test (CPR), but sometimes is based on total test count. In a CPR arrangement, calibrations and controls are not counted in the pricing structure, while in a total test count arrangement, all tests are counted and charged.

The price paid per test covers the cost of the instrument, service, reagents and consumables for the term of the agreement, but there is no ownership at the end of the agreement. This option, like leasing, offers the use of capital equipment, reagents and consumables without capital outlay. It also eliminates the need to contract for service annually after the warranty has elapsed because service is covered in the CPR.

For labs with very large volumes, highly competitive CPR rates can be negotiated, making this an attractive option for reference labs. However, the CPR is calculated to cover the cost of the equipment and service in addition to reagents and consumables, so at the end of the term of the agreement, the instrument has essentially been paid for but there is no ownership. If the reagent rental agreement is renewed without renegotiating the terms, the equipment could be paid for more than once without ever achieving ownership.

Successful reagent rental arrangements require the lab operator to have an accurate estimate of test volumes over the length of the agreement. Failure to estimate correctly could mean paying for tests that are never run, or losing the lower cost per test advantage that generally accompanies growth. If the manager’s estimate of tests performed over the term of the agreement is too low, the organization will pay much more than they need to for their tests.

However, for small labs with no capital funds available for instrument purchases, this option might allow the lab to do in-house testing that otherwise might not be available.

Selecting the Right Option

Selecting the right option to acquire capital equipment is always a financial decision. Although the final decision may be made by the lab administrator, hospital or reference lab CFO, the lab manager can add significant insight into the selection of financial methods. The information that should directly affect the decision and is best provided by the lab manager is whether ownership is desired (a function of how rapidly the technology is changing) and if service should be included or charged in addition.

Ownership can be a two-sided coin. Where technology is volatile and rapidly changing, ownership of highly technical equipment can be a burden. If the technology is going to evolve and change to the extent that the equipment is out of date by the end of the term of the loan or lease, ownership is not always desirable, unless the dated equipment could be used as a backup instrument.

That being said, if the technological changes are not going to affect the way the lab operates or the tests that can be offered, volatility is not a factor and ownership would be preferable. For example, computer technology changes so rapidly that a new computer is almost out of date by the time it reaches the checkout counter in the store, but if the only thing that computer is going to be used for is surfing the Internet and emailing, it doesn’t matter how quickly the changes are occurring because they won’t affect the way the computer is being used. For technologically stable equipment such as refrigerators or centrifuges, ownership is desirable because they will be used for much longer than the standard 60-month term of a lease. Knowing whether ownership of the equipment is a desirable outcome should be one of the key factors in selecting the method used to acquire it.

Service contracts are expensive (generally about 10% of the retail purchase price of the instrument) so if leasing provides additional warranties or field service offered by the lessor, a lease can be a more attractive option than purchase. In reagent rental agreements, service is provided as part of the cost per reportable test. Service costs must be paid one way or the other, but having it included in the cost per test in a reagent rental or as a pass through in the lease can eliminate receiving a large bill each year for the next year’s service.

Click to view Table.

Other considerations that will affect the choice of purchase, lease or reagent rental are:

• cash flow and the need to achieve the lowest outflow of cash,

• the flexibility of leasing terms and their ability to meet the lessee’s needs and

• whether the balance sheet for the organization strongly prefers not showing debt (an operating lease is not considered a long term debt).

Industry Insight

Ken Lee, a partner in Hatteras Venture Capital, believes the message should be that leasing is a better choice in some circumstances, especially where cash flow is an issue, technological advances are rapid and constant upgrading is necessary, extended warranties are offered, and the balance sheet strongly prefers showing no debt.

Dan Melamedorf, Baytree Leasing, adds that leasing offers a number of advantages over a loan for purchase, including being tax deductible as an overhead expense, not showing up as a long-term debt on the balance sheet, an immediate write-off of the dollars spent (eliminating the need to depreciate the equipment over five years or more), flexibility, virtual 100% financing options available, and the variety of leasing products available that offer customized solutions to the needs of the corporation. The Table illustrates an example of cash versus lease.

Emmett Kane, Kane Healthcare Solutions, LLC, notes that reagent rental is the best option if the platform is a closed system where the reagents, parts and consumables are proprietary and alternatives are not available or possible.

“Know the component cost breakdown for equipment, service, reagents, parts, consumables and the cost of money,” he cautions, “and include language in the agreement that protects your costs in the event any component or individual test on the platform menu either temporarily or permanently cannot be performed.”

Kane suggests that language be included in the agreement to renegotiate the cost per test once the volume commitment has been met so equipment and service costs (which have already been met) can be removed and only the reagents and consumables be priced from that point on. On leasing, Kane says the lab should know what the component costs are for leasing equipment and should know whether they want to own the equipment at the end of the lease term. The financial department should work up any purchase options regardless of lease or buy, he adds, because they will best understand how the organization depreciates equipment and their cost of money. “You don’t want to be in a position where you need to trade out a piece of equipment and discover that the organization is still holding half the capital cost on the books, requiring a write-off.”

Look at ROI

Mary Pat Whaley, practice administrator for a bariatric surgery clinic in Cary, NC, says that her ideas of how best to obtain capital equipment have changed over time. Where ownership was once her primary goal, her goal now is to acquire equipment “with the least amount of pain,” whether the “pain” is cash outlay or maintenance and service. “Put all the pieces together to determine the return on investment (ROI) before making the decision as to how a piece of equipment is to be acquired,” she recommends.

The informed laboratory manager can assist in the selection of an option for acquiring capital equipment by providing valuable information as to the rate of change in the technology involved, accurate estimation of test volumes and comparison of the options presented to her by the vendors.

Libby Knollmeyer owns and consults for Laboratory Management Resources, Greensboro, NC. Kerry Foster is director of Marketing, Orchard Software.