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Rentals or Combo: Where Should You Put Your Money?

Can retailers earn higher returns on their capital by outsourcing their instrument rental program? The addition of an in-house instrument rental program should include careful consideration of the cost of capital. We believe an efficient combo retailer can earn much more with their capital dollars invested in standard retail inventory (high-turn instruments, sheet music/method books and related accessories) rather than band & orchestra (B&O) instruments to be rented on a month-to-month basis.

It’s All About Inventory Turn

The National Association of Music Merchants (NAMM) has reported that combo MI retailers typically have a 1.7 inventory turn. In other words, the retailer's entire inventory (dollar equivalent) is sold 1.7 times per year. NAMM also reports overall gross margins are approximately 37%. With this in mind while investing $50k into B&O rental inventory, 138 instruments could be purchased at an average cost of $365.00 and rented at an average monthly rate of $23.75 (including any maintenance fees). In a perfect world, where all 138 instruments are rented and bringing in $23.75 per month all year, the monthly gross revenue would be $3,277.50 or $39,330.00 annually. However, the gross profit would only be $21,631.50 (with a 55% gross margin and 43% gross return on capital). The same $50k invested into standard retail inventory could yield a gross profit of $49,920.63 or a 99.84% gross return on capital. Further, by outsourcing the retailer's instrument rental program, the profit potential continues to grow to a 115% gross return on capital as illustrated below (based only on $50k of investing dollars, not the entire retail operation):

Retailer Outsourcing Rental Program
Annual sales from $50K invested in inventory
$134,920.63
Cost of goods sold
$85,000.00
Gross profit on sales
$49,920.63

Commission from outsourced rental program
(138pcs=$39,330.00 with a commission rate of 20%)
$7866.00
Gross profit on rental program (no capital invested)
$7866.00
Total gross profit
$57,786.63

Retailer Maintaining Rental Program In-House
Annual rental income
$39,330.00
(138pcs rented at $23.75 for 12 months)
$39,330.00
Allocated cost (55% gross Margin)
$17,698.50
Gross profit
$21,631.50

With All Things Considered

VIR instrument return ratios vary from market to market. Most school music dealers would agree, however, that up to 50% of their rentals will be returned during the first year (10% within the first three months and 35-40% within the first 12 months). Add the cost of financing, payroll and collections to the equation and you'll see why many independent rental operations are looking to outsource.

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Additional Resources For Your Consideration