Captives

Challenges

In their role as financing partners, industrial companies are increasingly setting up and expanding in-house leasing companies or banks, so-called captive finance companies, in order to focus more strongly on new developments in the market and the financial sector.

In today’s market environment, increased volatility and economic uncertainty are causing dramatic fluctuations in income. Globalization and price transparency are intensifying the pressure on product margins. Rapid technological change is accelerating product cycles and increasing the demand for digitalized solutions, while customers are expecting more and more services and one-stop shopping. In addition, customers are looking for ways to make their own cost structures more variable through usage-based transactions and are tending to move away from traditional asset ownership. 

At the same time, changes in the financial sector such as Basel IV, new consolidation rules for joint ventures and new accounting rules for lease transactions have increased the cost of equity for banks and put the advantages of traditional banks as sales finance providers into question. In addition, banks and leasing companies are having more and more difficulties in determining the realistic value of ever more complex objects and in realizing the market value of collaterals or residual values.Yet this is a fundamental prerequisite for offering competitive financial products.

Insights

These market developments are prompting many manufacturers to rethink their relationships with existing sales finance partners. More and more manufacturers are deciding to set up their own in-house financing units in the form of captive finance companies. These are organized as business units or independent organizations with permissions to provide leasing services (in rare cases even with banking licenses) for the relevant sales regions. In contrast to traditional forms of sales finance, e.g. cooperation with selected banks, white-label arrangements or joint ventures, captive finance companies do not depend on third-party banks and offer customized sales finance solutions.

Grafiken_Parallax_Captives

This business model has helped well-established captive finance companies to achieve strong growth and to generate considerable added value for their parent companies. Over the past five years, for example, the captive finance companies of the three major German automotive groups Volkswagen, Daimler and BMW contributed an average EBIT of more than 20% to the respective group’s earnings. 

These companies provide their parent companies with additional value by:

Supporting the industrial company’s revenue generation
  • Strengthening the service portfolio from a competitive perspective with attractive and innovative financing and service products, such as operating lease, rental or pay-per-use
  • Enhancing customer perception as a customer-oriented and reliable partner with positive impact on revenues and market share
  • Supporting strategically important customers or customers with limited creditworthiness  through targeted lending
Earning steady additional income
  • Obtaining net interest income from financing agreements that offer an attractive fixed-interest source of income in times of low interest rates
  • Generating revenues from the sale of profitable additional services such as insurance, maintenance and repair
  • Profitably marketing residual assets from operating leases/rentals
  • Reducing the group’s revenue volatility through consistent cash flows from installments
Strengthening customer loyalty and collecting customer data
  • Cementing customer relationships by providing financing solutions that require regular contact and the acquisition of a new asset after the contract expires
  • Strengthening customer loyalty through support in times of crisis
  • Gaining additional insights into customer behavior and needs through extended communication and regular contact

The key to success for captive finance companies: building the right business model
 

A captive finance company can operate successfully in markets in which it is possible to quickly build a critical volume. Experience has shown that—depending on product and country coverage as well as structure—the captive finance business can already be profitably operated with a business volume of ~ EUR 100 million. For internationally operating industrial companies with a broad product range, the key to captive finance is to determine the markets and business units or product lines that should be served. Licensing and regulatory requirements vary widely from country to country and not all products are suitable for sales finance through captive finance companies. 

Additionally, captive finance companies require an efficient organizational and operational structure: The distribution of financing and service products should be carried out in close cooperation with the parent company’s sales department. In contrast, the approval process for financing requests should be separate from the parent company’s sales department and organization in order to avoid conflicts of interest between sales and risk assumption. The structuring of financial products and credit risk management are an integral part of a captive finance unit and often represent a new skill for an industrial company. In this business, success strongly depends on the availability of reliable and attractive refinancing sources, whether through bank credit lines or on the capital market in the form of asset-backed securities.

 

Solutions

zeb has extensive experience in supporting captive finance clients in the automotive and truck manufacturing sectors as well as manufacturers of industrial goods. zeb assists companies both with little and with extensive experience of sales finance or captive finance in further developing their strategy or in optimizing their operating segments.

Strategically enhancing the business model
  • What comes next? 
  • How can the business model be expanded? 
  • What are significant opportunities and risks?
  • How can the strategy be implemented?
  • What do new technical developments in industrial products or in the financial services industry mean for the captive finance company’s business model?
  • How does COVID-19 impact the business model when revenue figures change?
Strengthening and optimizing the sales process of financial services
  • What sales channels should be used to address customers?
  • How effective is the sales process and how can it be improved? Is the process based on the right sales incentives and KPIs?
  • How can the FS products be enhanced? Is it possible to effectively distribute further products and services?
  • Are the FS products competitive and properly priced in relation to their risk?
  • Is the remuneration aligned with the objectives of the captive finance company and the parent company?
Reducing costs
  • What are the main cost drivers?
  • Which services should be provided by the company itself and which services should be purchased from third parties?
  • Which areas offer potential for savings through improved processes, digital solutions or outsourcing?
  • Have possible synergies with the parent company been fully exploited?
Minimizing regulatory complexity
  • Which financial products can be offered locally or even internationally in what country and with what license?
  • What licensing model can be used to save regulatory-driven costs, including equity, liquidity costs, regulatory-driven process costs, bank levies and compliance with reporting requirements?
  • Where can the number of independent legal entities be reduced?
Ensuring attractive funding
  • What is the right funding mix considering different funding sources, maturities and currencies?
  • How flexibly can financial resources be transferred between individual regions as well as regulated and non-regulated group units and what restrictions have to be taken into account?
  • What are the consequences for the balance sheet structure and the company rating?
  • How can funding be ensured even in times of crisis?
  • What are the funding costs and can the sales finance business still be operated profitably in light of such costs?

zeb has worked in project teams consisting of business experts, research and client teams at more than 20 captive finance companies to answer these and other questions, translate them into concrete and specific solutions and successfully implement them together with the clients.

Selected references

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