Description
Funding the assets is a prominent challenge for PaaS businesses. Assets have to be prefinanced, as customers only pay a monthly few.
Generally, three partners can provide support: venture capital investors, banks, and strategic partners, such as manufacturers.
In this episode, Lennert van Mens provides a bank’s perspective on a PaaS business, including the overall business model, the cashflow design and the value generation.
This episode is the fifth in the series PaaS Decoded, 16 conversations about the fine details of product-as-a-service.
Video Impression
People
Lennert van Mens, Co-Lead ESG & Sustainable Finance Solutions Team, Commerzbank
Patrick Hypscher, Co-Founder of Green PO, Expert in Sustainable Business Models
Chapters
00:00 Intro
02:08 The right moment to contact a bank
07:25 The data a bank needs to assess the business
11:52 The specifics of circular businesses & leasing
22:05 Financing the assets
27:02 The PaaS valley of death
33:13 Cashflow design
36:45 Helpful financial instruments
39:41 The role of interest rates
43:42 The circular future is in B2B
About Commerzbank
Commerzbank is a prominent European banking institution based in Frankfurt am Main, Germany. Established in 1870, it is one of the oldest banks in Germany and operates as a public limited company (Aktiengesellschaft). The bank offers a comprehensive range of financial services to private, entrepreneurial, and corporate clients, making it a key player in the German banking sector.
Further Links
Transcript
[00:00:00] Intro
Lennert van Mens: You start at the business model. Why is the business model working? Why is the market working? And then you look at the cash flows and the timing of cash flows and the assets that are, you know, circulating. And those are the points on which you can develop a financing structure.
Patrick Hypscher: Welcome to the fifth episode of PaaS Decoded, 16 conversations about the fine details of Product as a Service. In the last episode, Boris Romero and Vincent van La Moën shared their learnings about refurbishment at Philips. In today’s episode, we look at Product as a Service from the perspective of a bank.
Patrick Hypscher: He has a background in political science, started his career at ING in Amsterdam, where he built up the Portfolio and Relationship Management program. Afterwards, he joined General Electric Capital as Executive Director Leveraged Finance. For over four years he is with Commerzbank, currently as Co-Lead of the ESG and sustainable finance solutions team. Welcome Lennert!
Lennert van Mens: Hi, good morning. Welcome, Patrick. How are you?
Patrick Hypscher: I’m fine. I’m fine. Lennert, let’s start with a private question. In private life, what’s your most preferred financial instrument you use?
Lennert van Mens: You know what? It’s probably my banking app. It’s where everything comes together and on my phone I’m in control of everything. Of, you know shares that I invest in and payment traffic. It’s all on my phone. I like that.
Patrick Hypscher: Okay, cool. All the good news on your phone.
Lennert van Mens: It depends, right?
Patrick Hypscher: Yeah,
Lennert van Mens: But at least I’m in control.
[00:02:08] The right moment to contact a bank
Patrick Hypscher: Okay, cool. Yeah. Let’s talk about financial instruments for product as a services and, and companies. You, I mean, you’re with Commerzbank as a, as a bank and you’re regularly approached by companies of different size and also from time to time, of course, when it comes to sustainability projects and product as a service.
At what stage of company development does it make sense to reach out to you, to a bank to provide financing?
Lennert van Mens: So, so in general, as a bank, we are responsible for the money of our customers, so we have to be very careful with this money and, and to borrow money from us directly, you need a certain level of maturity as opposed to earlier stage companies that are more equity or mezzanine risk. In our view, a company becomes bankable or financeable once you have an existing and proven market.
Your business model is up and running. So your customers and suppliers are there. The company is successfully producing stuff or services. And this also means you have a cash flow. So at least, you know, you can still do expansion investments or ramp up costs. But there needs to be an underlying positive cash flow.
Because as a bank, we love growth, but it needs, it needs to be profitable. And, and you have to repay the debt in time. Then other things we will look at is your management quality or investor quality. You need some track record on that. You need a decent financial reporting and you need a diet, a decent financial management.
So I’m part of the corporate client segment where we typically service very large customers from 100 million of, of sales up to several billions of sales. But overall, Commerzbank provides many different services also to smaller firms and to private clients. And it’s not just, it’s not just financing to get financing with us.
You have to be more, a more established client. We have a separate venture capital subsidiary, it’s called Neosfer, and they actually invest equity in young companies, many of them around ESG topics like recycling and circularity. Neosfer actually also organizes the largest B2B festival for sustainable innovation for ESG in, in Europe. It’s called the Impact Festival. So, so there’s a lot of interesting connections there also for us as a bank, and we learn from it. And it’s not just about the financing. We need to bring together the people and the ideas for the transformation. And we are part of an ecosystem in that sense, on, also on behalf of our business customer.
So the idea is that we connect the large corporates that we are financing with innovative startups, with investors, with ESG experts like yourselves, and with meta actors like, like NGOs. And we may not be financing everyone directly, but we certainly support the business development in, in several ways.
And we have a cooperation with the tech criteria, the bonus initiative, impact investing, ESG investors like agri technology funds engineer firms for ESG technology consultants. Cause it’s only together that we can make the transformation work. But our part of the system, our role is to support the SMEs and the corporates.
And other parts of the system are financed by venture capital, business angels, private equity, family officers. So there’s different pockets of monies for, for, for different kinds of companies.
Patrick Hypscher: Okay. So if I get it right let’s separate it in three stages. So it would even make sense at the first stage if I’ve if I. I have an idea. I’m already refining it. I want to get, let’s say, some market feedback. It would make sense to reach out, especially if financial aspects are a key component, and reaching out would be more like, let’s say, a bit on sparing an ecosystem, knowing that this is not your core business.
And then the second stage you have the the fund for early stage startups. And once you have a established, a running business with more or less predictable revenue streams, it doesn’t have to be profitable yet, I guess, but it’s, it has to be clear that it becomes profitable also based on your financial support. Then in this third stage, it’s, it’s in let’s say in your core area of responsibility.
Lennert van Mens: So to get the financing, bank financing means you have to be more mature, but even as a fresh startup, you need a bank account and payment traffic, right? For many companies, that’s where it starts. So it’s always useful to have a discussion with your bank, I think. And, and then it moves. Once you start developing your business model, you know, venture capital is your first goal to address or business angels.
And then as you get more mature, you will get in, in, in contact with professional investors, long term investors, and then also with banks. And then increasingly can also use bank financing. It’s, it depends on the business model and what you do exactly. But, but I think in general to, to get bank financing, you know, you’re, you’re more progressed in your business model.
You have an existing cash flow, you have an upper running set of customers and, and, and suppliers and money going through your bank accounts. That’s, that’s where it starts when you start the conversation with the bank on, on the financing.
[00:07:25] The data a bank needs to assess the business
Patrick Hypscher: Okay, cool. So let’s dive a bit more deeper on that one. The bank financing with product as a service in mind. What data and information should I provide to you? And how should I have validated some assumptions when I reach out to you in order to discuss possible bank financing solutions.
Lennert van Mens: So it’s very, very strongly depends on the type and size of financing. If you’re looking at 500, 000 working capital you know, the questions are very different than if you’re looking for a 300 million financing to upgrade a large factory. But the organization of the customer is also very, very different. And Neosfer is expecting a different kind of reporting from a startup than our small enterprises desk will ask from a company that’s been around for, for five years.
And in, in some cases, we actually look at the value of the assets in the business as well to enable more larger financing. So you may be looking at, at inventory or commodities on the balance sheet that you can finance, or you may lease certain assets. Sometimes there’s a guarantee from a parent company or from the local state.
And if you have these elements in your financing, you need specific information and reporting on this, of course. Thank you very much. In most cases, we will look on the, on the cashflow of the business, which is very easy. If you have an existing business with 10 years track record, you go like, well, that’s what happened in 10 years. And I have an equity cushion.
But if you’re a growing company and the company scaling up and internationalizing, it becomes a lot more detailed and you need to prove out what you’re saying and you need to show, you know, forward looking, where are you heading with your business? What are your expectations and plans in the next five years? Is this congruent with the market that you’re in? How profitable are you? Are you actually generating cash and can you repay the debt? How certain is this and what, what does it depend on? What happens in a scenario where the, the, the legislation changes or if a recession hit the market. What happens to your business?
And then the other side of the equation is how much are you spending in your business plan and are you able to dial back the capital expenditure or the run up cost if the growth and the cash flow maybe take a bit longer than you thought?
So it’s very case specific. But I think a bank will always look for data and facts to support your assumptions.
And it’s our job to question this and analyze if the story is, is rounded and true. So numbers, data, facts have to support all of the story and, and ideas that you have because again, we have to take good care of customer money. That’s our job.
Let’s look again on the growth aspect or the future aspect. Of course, ideally we think, we can validate the future with data from the past. But of course markets change. It might have been easy to reach a first adopters and then if you want to grow to, to Towards a larger market, you have different type of customers, so it’s not necessarily scalable what you did in the past.
Patrick Hypscher: Can you give some more insight, what kind of validation about the future and the growth plan can be provided by companies?
Lennert van Mens: That’s a very different. Difficult question to answer genera in general or generic because it’s very company specific, but what we will always look for is validation on, you know, is the technology working? Is it proven? Is the market there? Is it proven? Is it something that is likely to continue? And then you work your way back way back in your analysis from the market and, and, and then the regulation, the regulatory framework that you operate in and then you go back in more detail in the business.
How dependent are you maybe on certain customers? How? Or, or suppliers, for instance, and then how profitable are you? How much control do you have over your profit margins? And, and that works back and then what’s your, your cost base, how fixed or flexible is your cost base. And, and we work through all of these aspects, which already shows that, you know, bank financing is.
We try to be very precise and very concrete about what we finance. And so there’s some work in it. And that also shows you the companies need to be a bit bigger to put in this much work.
[00:11:52] The specifics of circular businesses & leasing
Patrick Hypscher: I imagine you probably come across some challenges. What, what are the biggest challenges that determine the financing and how can these challenges be solved?
Lennert van Mens: So, well, let’s get specific on, on circulars or products as a service business models.
And, and I think the one thing, the first thing where we start is the reason to exist. So who will pay me for what I’m doing? And why? Okay. And as a private company, it’s not enough to want to help save the planet where I like these kinds of business models, but you, you also need to, to, to, to be profitable and make cash.
And in particular, you need to have the producer and the end customer on board. So somebody to make the service and somebody to buy the services. In some cases, you actually need to consider all of the further parts of the value chain, like the logistics. So if you develop a new textile. Somebody needs to weave it, cut it, make garments out of it before it ends in the shop.
And even if I convince a large chain of stores and their customers, it wouldn’t suffice to get my product running. I actually have to orchestrate all of the value chain in between. So that’s the first thing. Who makes it? Who buys it?
And then you need to think about the cash flows in the system. Who’s paying who when? Because it’s liquidity that kills companies, not profitability. I’ve, I’ve seen some very successful startups that run into major issues because their large corporate customer had a three months payment term. And they actually have to buy they have to pay their own suppliers before they get paid by their customer. And you can solve for this, but you need to think about it upfront. So you can do like reverse factoring on this. And it free up liquidity, but you need to have prepared for it.
And then the third point, I think for products as a services in very many cases, you need some kind of financing because what you’re typically doing is you’re creating an asset pool that you are providing to somebody else. And that you, you need to think about these things up front.
And I think we look in the financial sector a bit differently on these things, as many startups or Mittelstaendler do. But so it’s always a question is where, who pays, who, when specifically, and, and how do I bridge time gaps in, in, in sort of the flow of cash on that?
Patrick Hypscher: Could you elaborate a bit more on the aspect of who will pay me for this and why? I can imagine with your, let’s say, financial perspective you have a yeah, special twist to that question.
Lennert van Mens: Hey, thanks. Thanks for your question, Patrick. That’s a absolutely great question.
I, we actually had this challenge with payment methods as a bank, because at around 2004, I was working in business development for internet and phone payments on behalf of, of merchants. At, at point of sale and, and in the store and online.
And there were so many solutions and ideas. I’ve, I’ve must’ve looked at over a hundred payment methods, a lot of them startups, and, and most of them focused on consumers, mobilizing them to providing them a card or an e wallet, et cetera. And then a few focus on the merchant side. So what we call acquiring where the payment is accepted and they had to offer low cost and fast processing of high volumes, so already a bit Contradictory.
And then you have a platform issue because in a nutshell, the merchant wants to not too many different methods. And he wants to have offer the payment methods that consumers will actually use and that are not expensive. And the consumers, on the other hand, they only want payment methods that the merchants accept. You know, and many different merchants except they don’t want a different card for each shop. They don’t want to pay anything for making their payments. And they like to get benefits, like points or convenience or a nice looking card as a status symbol. And that actually costs money. So getting both sides right, it’s very difficult. It requires a lot of patience and investment.
And, and what is left, you know, of, of all those different payment, methods. I, I think in the Netherlands you have IDEAL, then you have PayPal. But there’s not so many left and, and some of them who are left actually are not a full payment method, but they cooperate with MasterCard or Visa to solve the acceptance issues.
And then you have payment processes. So there’s some very interesting parallels, I think, with products as a service services and, and circular value chains. Because money is also always, it’s a circulation, it’s a loop, it’s a platform. And, you always need both, both sides of, of of the equation.
To start with the obvious parallel, so if I want to lease out my product, I need to have enough customers who want to rent it and the customers, they want fair choice. They want a lot of choice at fair prices. So what you see that historically we had meat calves or lease constructions in, in Germany. This has always been around, but it was mostly for poor people who couldn’t afford a new television or washing machine in another way.
And it was actually a bit often a bit shady business financing at high margins and then repossessing goods. And it has never become a mass phenomena. And then you also have paper use like washing centers that are used as a student but where products as a service or leasing and, and the fact has really worked.
Is in some business to business environments. So leasing buildings, leasing cars it has become the norm and to free up capital. And some of the buildings are even purpose built or in single use like rehab clinics. There’s no real alternative use. And it’s nothing else, but buying a project and, and paying a monthly subscription for it instead of actually paying in cash.
And lately what we’ve seen is private leases on e cars. Which that’s, that’s taking off. And why is it taking off? Because it’s de risking the consumer for the residual value of the e car at a comparatively moderate rate. And why is this happening? Because for the producers, for the OEMs, it’s the only way they get the cars in circulation because people are reluctant to buy and take the risk of, of owning the car.
But it shows that the model works fundamentally if the risk and reward and cost makes sense. It’s and I think this, this is partly still an issue. For instance, if you look at leasing heat pumps or solar cells, which are also products as a service models, which are already successful but also there, I think the, the better the risk reward and cost becomes to the, to the user.
I think there’s, there’s a lot more potential there. An interesting example that we saw was leasing out lights rather than buying armatures for offices. So this is something that makes a lot of sense from an environmental point of view. But it’s not, it hasn’t grown that strongly and it’s not that easy because the question is what’s the benefit for the customer given that it’s a relatively small investment within, you know, setting up a whole building and it’s quite a long life with led lighting.
So does the cost of coordination on this maybe outweigh the actual benefits for the, for the user? But there are some great examples that do work. Like there’s a German manufacturer of forklifts that I worked with in the past. And, and they discovered that the Chinese were undercutting the prices of their fork, forklifts, they were half as expensive, but they they discovered that their, their product life was at least three times that of the Chinese competitors, because all the components, everything was higher value was better built.
And it actually ended up that they lease out more of their trucks instead of selling them because with the leasing reg, if I have three times product life, I can actually undercut my Chinese competitors and offer a better product at a reasonable price. And that’s only, you know, vendor leasing is one form.
But if you know the green crates for the supermarkets. You know, in the, where the fruits and the vegetables are in. This is a great example of, of products as a surface because it’s a, it’s multi use circular crates that are leased for usage fee backed by deposit. And these have completely substituted the wood and cardboard boxes that I remember from I was when I was a kid fruits and vegetables were all in wood and cardboard.
And I think in Germany, the Netherlands, other European countries, you don’t, you don’t even see them anymore. And this company covers the value chain from South America to Africa, Europe, and, and back and has grown tremendously. So that’s a great example for me, how, how a product business model works.
And we see actually quite a lot in, in kind of the circular packaging solutions. Also, you know, shipping glass jars from glass factories to marmalade factories with reusable packaging. We’re seeing some startups like providing Amazon with pouches instead of card, cardboard boxes. And I, I think financing these kind of asset pulls, it’s, it’s one of the key challenges for the financial sector on, on ESG.
Something, how we can contribute to, to sort of closing Closing the loop and being more careful about resources.
Patrick Hypscher: so would it be fair to say, if we look at the question you raised, who will pay me for this and why would it be fair to say that you look at this question on three different layers? The first one is, The you mentioned like the reward risk relationship. So what’s the value proposition? What’s the benefit for, for the customer? The second one is the cashflow design. Can I make sure that I get money at the right point in time to make sure that I cover my expenses. And the third layer is the payment methods that support, let’s say the previous two layers.
Lennert van Mens: I’d say you start at the business model. Why is the business model working? Why is the market working? And then you look at the cash flows and the timing of cash flows and the assets that are, you know, circulating. And those are the points on which you can develop a financing structure.
It’s always the combination between sustainability, strategy and financing and it’s always those three, how do they connect and how do I make a working structure out of it.
[00:22:05] Financing the assets
Patrick Hypscher: I have one more question in mind, but I’m want to park it and this is about cashflow design because you mentioned before the asset pools and the challenge to finance these asset pools. And I imagine asset pool financing and cashflow is a bit related. So let’s maybe First, look a bit at the key challenges you see when it comes to financing these asset pools. And then yeah, let’s, let’s look at that question again from the cashflow perspective.
Where are the key challenges especially, product as a service is a lot about asset pools. In many cases they’re with the provider and not with the customer anymore. So what are the challenges here?
Lennert van Mens: I think the example we had with the green crates and these are not even owned by any producer. It’s a separate provider of, of a service that puts the crates in circulation, cleans them and does the logistics. But I think that the model it’s easy to, to understand. And fundamentally this works also outside of logistics and packaging.
So it, it, it vendor a vendor providing his products as, as, as a lease, instead of selling it like the forklift trucks, that’s the base case. But I think a lot of things we have a common pool of assets that different players can use. So maybe even a factory could be pool owned that produces different kind of plastic products and.
Gets a better utilization in a way, and in a way this is actually a very old model because it goes back to the 19th century when contractors owned large agricultural vehicles and rented them out to farmers on a daily basis. And this is still in operation today, this model, because it just makes sense as a farm not to own a vehicle that I’m only using a week a year.
And the same happens for cranes and constructions. So these tend to be owned by leasing companies rather than individual building companies. Because, because it makes share to, to it made, it makes sense to share these assets. You also see it at butleries that mix and fill drinks for Coca Cola as well as Pepsi as private label.
These are all existing examples. And when I, when I follow this up. If I have a steady state recycling, I could theoretically even finance the raw materials, so the copper in the electro motor, and only lease them out for the usage of X years and the idea was actually proposed and, and executed for batteries in electric vehicles, so Renault Tried it, the French auto, auto manufacturer.
I’m not sure why it hasn’t worked. I think part of the issue may have been that it was only one car producer. So again, it wasn’t the choice and I would get tied in with one producer. It might have been different if several large manufacturers would cooperate and there’s an independent provider. You know, competing for the service of leasing the battery packs at, at fair prices, but it makes a lot of sense from environmental point of view, and it’s, it’s nearer to the model that we know where the fuel is a separate cost item from, from owning the car. What I heard there, there’s also been some technical issues, so I’m not, I’m not sure where it is.
But I think that the line of thought, where does the asset pool, and this can be the vendor, but also as a vendor, if I lease out my assets, I create an asset pool on the balance sheet. And, and so how do I finance this? How, how much is the metal holding dust worth, which comes as waste out of a blast furnace, but I can actually still extract metal from? How much is the used cotton worth that I can recycle, make new clothes from again? And in some cases, like I mentioned before, we, we can finance the flow of goods and inventories, for instance, metal scrap or the asset pool of the products that we circulate, such as, you know, the boring base for the crates that I mentioned before, where I have a fleet of assets, but it’s very much, it’s always a question of mature maturity.
So the, the example of the plastic crates. They were quite volatile at first. It only became bankable when it covered more products, more customers, more regions. You start with a huge concentration risk, with a single customer, a single product, single region and you know, the harvest is good or it’s not good, and your faith depends on it.
And at that, at that stage, these are investments by strategic corporates who have a long term interest or it’s venture capital, and the bank comes in later. But also as a bank we are thinking about these business models and we are having some very interesting discussions with corporate clients on this lately.
Because it’s not just startups taking initiatives here. Actually, a lot of these kinds of initiatives sort of setting up logistics, circular packaging, et cetera. It comes from large companies and vendor leasing as well. You Patrick know that better than, than anyone. I think that corporates are thinking about this and looking for ways, how to set it up.
[00:27:02] The PaaS valley of death
Patrick Hypscher: Mm-Hmm. . Yeah, when you mentioned the starting point, which is about one product in one region with one customer, yeah, that’s, that’s could be based on a big company running that with having, let’s say, a decent cash flow and some, some equity cushion and so on, but it could also be a startup.
And what I see, I mean, there’s some valleys of death out there and I see a valley of death also in that case, yeah, that you start with a few dozens, a few hundreds of assets you might be able to finance that yourself maybe with some support from friends and family, some first business angels and to keep growing you need to fund these assets. And on the other end of the side of the valley there’s a bank, yeah, that naturally also requires to have more validation, yeah that you don’t have yet, yeah, and I, I, I
I know at least half a dozen of startups from Europe that didn’t manage to reach these let’s say 1,000, 5,000 subscriptions to be eligible and reliable enough to start serious talks with the banks.
Coming to the question, you’re sitting, let’s say, on the other end of the valley, yeah, do you see any patterns of those providers that reach your territory and managed to validate that preposition in comparison to those who, who didn’t make it.
Maybe there is no answer because I don’t see, I don’t necessarily see a pattern. I have some clues about it, but yeah, how is it from your perspective?
Lennert van Mens: That’s Yeah that’s a very good question. So this is exactly what I’m saying. This is the key challenge also for us as a bank. You know, it’s a big piece of the puzzle is how do I finance these new asset pools that I need to build up, which are capital intensive. And the answer is I can do some of it as a bank. And we are thinking about, you know, what can we do to support more of it? This, this is our responsibility that we want to take.
But then again, the role of a bank is still also to protect the money of our customers, so we, we can only do so much of it and, and to answer your question, if I look at the example with the plastic crates you know, they had a long term strategic investor and who, who believed in this business model and financed it through some dips and cycles.
Which is exactly what, you know, a strategic investor is, is for. So this was a large company doing a different business, but adjacent business who believes in this business model and put in money several times again. It, and it paid off for them, right? It paid off, you know, 20 times or, or more in what they invested.
They, they had a it, it’s been very successful. But. Before they became bankable, that was really you need to, and you need to, to, to, to invest and reach a certain size and stability to, to get to that point. That’s, that’s the truth. And, and I think if you look at startups who made it, they typically have a strong anchor investor at the start, and then they have several rounds of money where, you know, they grow and need further money.
And then the question becomes at what point can I start supporting this as a bank because obviously the initial high risk money is also expensive money for corporate share capital and I need to show high return on that. And if I build up a, a bigger asset base, I cannot pay, you know, 20 plus percent on every plastic crate that I’m making.
So, so I need to get access to more affordable capital and, and, and, you know, it starts with venture debt and then you get to, to bank financing, et cetera. And it’s probably combinations of, of different financial instruments, but you need, you need somebody who will. Who has a long breath to actually support you before, you know, this, this becomes a self running system.
Patrick Hypscher: Yeah. I, I definitely would agree. It’s really hard for a n independent startup without a strategic investor to, to I mean, starting it is not that difficult, but reaching the next level of growth without a strategic investor is hard, especially since most investment funds don’t necessarily want to invest in, in the assets. Yeah. They want to invest in the growth.
Lennert van Mens: Yeah.
Patrick Hypscher: One exception to me is a Grover. They managed to design a special purpose vehicle which is a bit like a asset fund. So they somehow managed to make their products investable, so to say and opened a new asset class. But that seems to be the exception.
Lennert van Mens: Yeah. Well, and what you have to remember is that the corporate also as corporates are having challenges as well that they need to solve for. So they do need to think about, under a European regulation, they need to think about how they make more circular use of resources, how they make more efficient use of energy.
So I think there’s a lot of potential in the next few years for what we call corporate venturing, how startups. You know, cooperate on a longer term basis with corporates, how you connect both. And this is part of, of what I’m very interesting on right now, because it’s a win win situation for the corporate and the startup.
That’s part of, of what the ecosystem that we are part of should, should be doing for our customers because it’s, there’s something in it for both sides. And actually startups tend to be a lot more efficient use of money then for instance, internal R&D. So there’s some good reasons for corporate to, to start this cooperation.
But it’s a fairly new subject and we need to get more people interested in it.
Patrick Hypscher: Yeah, yeah, definitely.
[00:33:13] Cashflow design
Patrick Hypscher: I want to come back to the question I mentioned before. So now we talked a bit about asset pools and I want to come back to the cash flow design. Are there any patterns, successful patterns, you see, when it comes to product as a service, cashflow design with the asset pool in mind?
Lennert van Mens: Well, there’s one major thing to consider also from a financing perspective, which is that products as a service, thinking from the situation of an existing provider of products or services, products as a service will dramatically change the structure of your cash flows.
So one industry where products as a service is very successful is software, software as a service. And I do not know if this is because people have less trouble renting instead of owning something that they can drop on their feet or cannot drop on their feet and, and that they don’t see anyway. Maybe it’s just because software is a less emotional asset category.
When I was doing leverage buyouts for ERP payroll software and other software providers in the late 2010s. These were starting to move to cloud based and software subscription models. the B2B customers were often quite open to this. But what happens is the long term effect is positive for the producer seller because he gets higher and more stable revenues with improved profitability. Because you also include some service component, but we had quite some covenant and liquidity issues in, in certain cases, because. Initially, my sales, my profit, and my cashflow, they go down. So if I have an average five year product life and I used to sell my software package up front, then now, if I start a subscription, I have a five year transition period, where initially, in year one, I only get 20 percent of the revenue, and my revenue goes down 80 percent in year one. Theoretically, I switch all my contracts at once, and it takes five years to be back at the same revenue and cashflow where I started. And in the meantime, I’m building up this big pool of, of contracts with a future value.
And depending on your shareholder and management situation, and also how you how your accounting strategy is on this, but it needs to be very well explained and manage is really going through a massive transformation with your company.
And it conflicts with your short term targets. You know, for a certain quarterly revenue and, and profit. So at the end of the day, it’s a question just of the revenue recognition shifting in time or the cash shifting in time. But it becomes quite difficult to, to, to explain to your investors, if you’re publishing quarterly earnings as a listed company, it’s just, it’s too detailed. So you have to, to think about how you temporize the change.
And it’s also more difficult if your lender or investor lacks sector know how. If you’re financed by a local bank in Germany, they may not have a full understanding of products as a service and software as a services. And then always what happens is the short term cash level goes down you’re ramping up the asset base of close contracts with underlying service agreements. And And I actually need a financing strategy and clarify with my banks when switching this. And, and how do I how do I finance this pool of contracts that I’m building up?
So it brings us straight back to the financing question that I mentioned before. It’s always, yes, sustainability and strategy and a good product and business model. But I also always have to think about the financing and, and these factors are inseparable.
[00:36:45] Helpful financial instruments
Patrick Hypscher: And do you see then also classical leasing instruments as bridge solution, but sometimes maybe also ultimate solutions from the perspective of the provider, so that actually the bank covers this cashflow risks , and based on some criteria, immediately pays the provider manufacturer the product value. Which makes it a bit easier, maybe also a bit more affordable for, for the provider. It’s closer to the core business, to traditional sales business, but you can still offer such a model to your customers. Okay.
Lennert van Mens: Yes , leasing is certainly one of the solutions you may use, and then there’s reverse factory if you have large customers, then you could use reverse factory. And then there’s you know, boring base and inventory finance that I might be able to use in some cases. And then there’s securitization solution.
So it very much depends on your product and on your size. Like for the forklift benefactor, you start setting up separate leasing companies, which are part of your group, but have their own financing and can actually emit bonds or securitized loans. To finance the fleet of assets that you’re creating.
That’s like the biggest case. And on a very small basis, I might just be cooperating with a bank to make certain leasing constructions for the products that I sell. If I think about manufacturing side that makes a use hydrogen and CO2 to make alcohol. That will be something that you could do a, a leasing construction on because it’s a 20, 30 million facility or a heat pump, maybe. Those are things that you could think about efficient leasing solutions in a quite standardized way. So it depends, liquidity flowing in the system once you’ve reached a certain size.
Patrick Hypscher: One tiny question. I never heard of reverse factoring. Uh, Can you shortly explain it?
Lennert van Mens: Also, this is where my customer is a big, well known company, like, maybe I’m providing services to Commerzbank, and I have a large number of invoices on them, and then somebody else may say, well, Commerzbank is a good risk. You’re only a small company, But I’m happy to buy your invoices to Commerzbank from you because I know that they pay slowly, but they will pay you after two months or, or whatever the term is.
And in the meantime, so I’d buy them from you at a slight discount and then I get the money once, you know, Commerzbank pays. So this is quite frequently used. It’s a good good system. And you can do it,
Patrick Hypscher: that’s factoring,
Lennert van Mens: and then the reverse factoring would be to also pay up from my suppliers and then I only need to pay the factoring for uh, firm once I got paid by my customer.
Patrick Hypscher: Okay, gotcha.
[00:39:41] The role of interest rates
Patrick Hypscher: And let’s say last question on the asset pool and cash flow perspective is about interest rates.
When we started BlueMovement now about six years ago, interest rates were at about, let’s say 1% and we know over the last year’s interest rates grew, which make it a bit more difficult to reach profitability. Especially when it comes to longterm contracts.
Keep in mind home appliances last many years. That might be different for let’s say shoes. If you want to rent those shoes like ON does it with running shoes, , that might be just 6 to 12 months. But we also talked about forklifts and other um, B2B services that may be easily go beyond 10 years.
Rising interest rates are a risk. Is it in any way different for product as a service or did you observe something here or is it just like, yeah, it’s a risk and you have to account for that.
Lennert van Mens: So I think I, so the one point is that. If I offer this at a certain price, I need to make sure I lock in the interest rate. So I need to hedge or have a long term financing. I always need to match sort of the life of my assets with the life of my financing and, and, and fix the interest. That’s just good housekeeping. That’s something you need to, to think about .
In general, you know, why do interest rates go up? It’s because the central bank is saying we need to invest a little bit less because we’re causing too much inflation. So this is actually what it’s supposed to do is make it a little bit more difficult to invest.
And some of the investments are no longer profitable. I think if you’re, if you’re truly in a growing business model It becomes less of an issue because in a, you know, if you’re expanding properly and, and, and, and are successful at this, then your margins and your growth makes up for the interest that you pay.
I think it gets tougher on this kind of lead phaser questions because it simply becomes more expensive to set them up, to create the pool of assets and it pushes up the price of, of these business models. So yes, not every, not every idea, not every business model will work as well in a in a high interest environment as in the low interest environment.
It’s part of, of, you know, the world we live in.
Patrick Hypscher: Yeah, yeah. Okay.
Lennert van Mens: but I, I, I think generally if you, if you have, You know, the most successful ideas, like, like the plastic crates, there’s a lot more value add to that. It adds value also on protecting the stuff which is in the crate. It has, it offers the bananas better protection than the cardboard boxes do.
So if you have this kind of value add for your customer, for your value check, then the, the level of interest, or, you know, if I pay a Euro or one Euro, 10 for using for one of use of this product, it becomes less, less relevant.
Patrick Hypscher: Yeah, yeah, good one. Yeah. And I think also what I mentioned before, it really depends on the, let’s say, product lifetime and the cycles, the length of your contracts, and the longer the contracts, um, the higher the impact of change in interest rates you know.
Lennert, let’s, let’s zoom out a bit.
And let’s look at product as a service in general. I’ve three generic questions for everyone who’s part of that series. And the first one is what’s the main thing you need to make sure as a brand or manufacturer before you want to start a circular product as a service
Lennert van Mens: I think the devising perspective is that what we’ve been discussing. It’s think about the cash flow, who’s paying who, when, who’s building up a pool of assets. Remember that products as a service will dramatically change the structure of your cash flows as compared to selling products previously. Those are the two things. If you think about that, that I think is half of the, of the work from a financing perspective.
[00:43:42] The circular future is in B2B
Patrick Hypscher: Let’s look into the future. What are the significant trends you see for circular renting in the next five years?
Lennert van Mens: So as a bank, I think we’re a bit more remote on this because we come in at a later stage, once the business models are more established. So I follow the trend. I don’t , I don’t create the trend, but I think in general, I think software as a service is opening the door for products as a service in a B2B environment.
And I think the B2B environment is more open than consumers, you? know, keyword capital efficiency and, and focus on core business.
So we saw this in company premises. I thinkw companies nowadays own their offices. And, you know, we’re, we’re seeing it now with renting work clothing for cooks and safety clothes and hospital personnel. And this is already getting quite normal and it makes a lot of sense. So I, I think we’re still a bit further off with consumers on this.
But what I see overall is that circularity is getting importance as a topic and my corporate customers are rethinking how they can close, close the loop. And you know, recycling is one part of it, but products as a service is also a very important solution for this.
It’s all about preventing down cycling and, and using the same product for longer. So, for instance, offering modular upgrades for products, refurbishing it. Or at least use the raw materials for longer and recycling it. So it’s a huge opportunity here. For instance the availability of certain bio based raw materials is going to change fundamentally over the next few years.
If you think about cotton, there’s only so much cotton that we produce worldwide and it’s not so easy to expand the production of cotton. But if I start recycling this or reusing it in a different way, it’s I can have a much larger share of clothes made from this fiber, because I’m using it four times.
So there’s four times as much bio based fiber available in the market. So I think we will see major changes in new, new business models in the, in the next five and 10 years. And I think we As a bank we will be seeking to support some of this where we can.
Patrick Hypscher: Nice. At the beginning, you mentioned the ecosystem you’re also part of and you are, you’re building and supporting. And here again circularity is about sharing knowledge and connecting people. You, you probably have certain topics you work on right now. Who, who should reach out to you these days?
Whom do you want to talk to?
Lennert van Mens: So, so we are cooperating with many players and, and I love exchanging thoughts with investors, startups, other banks and, and corporates especially. But in practice it’s, it’s too much for cooperating. Just me or just a few colleagues in that ESG and sustainable finance team.
So, so this gets channeled a little bit through platforms and organizations, Neosfer for startups, then we are cooperating with Tech Criteria for impact investors, we are cooperating with the Bundesinitiative for Impact Investing for corporates, we have, you know, their relationship manager at Commerzbank, and we are cooperating in the Zühlke sustainability circle.
So, so we are getting joined up on specific topics like recycling and product as a services. Or at specific events like the Impact Festival. And what happens is, the more complex and challenging the questions become. You know, a lot of it gets done by relationship managers and, and financial engineering specialists or financing specialists.
And they involve the ESG and sustainable finance team of which I’m part in a, in a targeted way. But that’s, that’s how it works.
Patrick Hypscher: yeah. Okay, cool. There’s a touch point literally for everyone who’s working on circular business models. It’s great that you cover such a wide range of people and services.
Thanks a lot, Lennert, for providing some insights into financing circular business models, in particular product as a services.
Lennert van Mens: Thank you, Patrick.
Patrick Hypscher: This was another episode of PaaS Decoded, 16 conversations about the fine details of Product as a Service. If you liked it, share this episode with colleagues or on social media. If you missed a question or topic, please send me an email so I can improve the conversations for you. If you learned something from this episode, please provide a review via Spotify or Apple Podcasts.
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