The Answer Is Transaction Costs

Parts is (Not) Parts: The Life Cycle Problem for Heavy Equipment

• Michael Munger

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We trace how Ales Schuessler, the once and once-again President of SmartEquip--also a scholar of expressive choice!--built a platform that makes machines more profitable by erasing the friction between parts, service, and uptime. The rental economy, Japan’s utilization model, and IoT diagnostics reveal why transaction costs, not price tags, decide who should own and who should rent.

• rental vs sharing and why property rights matter
• how serial-number specific data kills errors and downtime
• why parts discounts matter less than service speed
• Japan’s high saturation rental market and long lifecycles
• sensors, IoT, and AI for damage attribution and prevention
• decommoditizing parts through integrated workflows
• Coasean boundaries of the firm and renting incentives
• why RB Global acquired SmartEquip to span the lifecycle
• the back-office puzzle of bespoke systems vs SaaS

“Next week: Book 4, chapters 7–9 from The Wealth of Nations”



If you have questions or comments, or want to suggest a future topic, email the show at taitc.email@gmail.com !


You can follow Mike Munger on Twitter at @mungowitz


Michael Munger:

This is Mike Munger, the knower of important things from Duke University. This is a bonus end-of-year episode with Alex Schusler, the newly named president of Smartiquip. Smartiquip is also the subject of our conversation today, and Alex was just named president. So I moved the episode up in the queue. In fact, if you look at the news, it made international rental news. The first line says Alex Schusler has been appointed president of Smartiquip, the business he founded in 2000. He will take up that role on the first of January. End of quote. It's pretty interesting. The rental market in ways that I had haven't talked about but have never understood. So we'll try to go into that pretty deeply. A new twedge, this week's letter, the book of the month, and more. Straight out of Creedmore, this is Tidy C.

Speaker:

When there is no transaction called imaginary system. When it is costly to transact, institutions matter, and it is costly to transact.

Michael Munger:

Well, this week on The Answer Is Transaction Cost, a history-making moment. It is the first been doing this for almost three years, and it is the first live recording at the Munger Mansion East in Wilmington, North Carolina, is Alex Schussler, whom I have known for a long time, and as always I asked the guests to introduce themselves. So if you could say something about how we met and the journey that has led you to where you are now, for many people it's complicated. For you it's downright tortured.

Alex Schuessler:

Thanks first of all for for the invitation to your house. We've known each other, I think. We met uh we first met in 1995 at a Liberty Fund conference uh thereabouts, and I had just started as at NYU as an assistant professor back then, and in fact that was the dream job I always wanted and never expected I would leave. Before that, uh I had started my my I was raised by two parents who had never been close to academia. They didn't have a chance. My German father, Austrian-Bulgarian mother, both were very high on the idea of an academic career, neither of them had the chance to do it because of the war. And then I grew up in Southeast Asia, I was born in India, grew up in Singapore, and so it was quite the international race in a German school originally and so forth, but I really always wanted to become an academic and took that very seriously. And back in high school, that began with an interest in initially in literature, and then I stumbled on anthropology. All the anthropology books I liked came out of Cambridge. I kind of ignored the fact that they had been written about 40 years, 50 years earlier, but I thought that would be a great place to go. And I did, and then for the first time I became involved in social theory. And I felt a little bit like, in retrospect, I feel a little bit like a forest gump, in the sense that I changed feels many times, but by pure coincidence stumbled over many of the leaders in the field. So anthropology at Cambridge at the time had just been taken over by Ernest Gellner, who I don't know if you're familiar with him, but he was Popper's Karl Popper's successor at the London School of Economics. Through that I got to know Karl Popper and and immediately started reading everything I could on logical positivism. So there was a lot of back and forth in all of this. And then at the same time became very involved in social theory and um uh and the like. Um, Anthony Giddens was there, and so so it was a big deal. Um, and I was always fascinated by um what later, as you know, uh became a book, but I was always fascinated by um instances of mass behavior where there was some kind of symbolic or expressive attachment, um, which you saw much, much later. Um and then I went to uh so and and I usually applied that to voting behavior and consumption behavior. And I thought it was very original that you could actually treat markets and electorates in the same way, but of course you had been doing this for a long time in a very sophisticated way, and and and and so were some others. And it's actually through that angle, and I think that's the roundabout, that it was really in that uh in that whole movement uh that we met. Um when I was at Harvard, I got to know people like and the work of uh Ken Shepsley and uh and a lot of the um rational choice, public choice, social choice schools at the time. That's also when I first became involved, or became aware of your work. Um, and I worked there with then Tom Shelling became my advisor, so game theory was big. So I really got an amazing tour. Uh, and it was a very undirected tour because starting with my parents, I had nobody to really tell me this is what academia is about. Uh Harvard at the time was a huge candy store, so I got to try so many things. Ended up turning writing this dissertation and then what became the book, A Logic of Expressive Choice, uh, which in the end was really about taking all the things that had been motivated by the early interests in um literature and in anthropology, of this whole expressive attachment, and then using some of the tools out of game theory and rational choice and so forth as aggregation mechanisms, saying, hey, if individuals are symbolically or expressively motivated, this is how you would expect groups to behave, and this is how you would expect candidates and um electoral candidates and producers in the mass markets to manipulate information to get more and more of them to either vote this way or consume this way. So it was a very, very roundabout way of uh um of going through academia.

Michael Munger:

Uh when did you start at NYU?

Speaker 1:

I was at NYU. I started there in 1994. Russell Hardin had just been brought in to start the department. It was a very exciting time. You had um George Downs later on, you had Steve Bramster forever. So uh I had great junior colleagues.

Michael Munger:

Well, and it was in the NYU was in the process of becoming one of the great political science departments in the world.

Speaker 1:

Yeah, and and uh uh two, three years earlier they had declared receivership and just completely restructured it, got a bunch of people from the University of Chicago in, and Russell recruited me into that group. It was alongside Statsis Kalivas, Anna Harvey, and some others. But it was a it was an amazingly um exciting time to go in there.

Michael Munger:

But like many stories that end with a butterfly, this man took a turn to caterpillar.

Speaker 1:

Yeah, it was a very strange moment. Um on the literally, I'd just been there for one, not even a semester here.

Michael Munger:

You know, let me interrupt for a second. Everybody says that this is true. This is really strange.

Speaker 1:

Yeah, that's right.

Michael Munger:

This is not someone No, you know, it's really strange. This is really strange.

Speaker 1:

Well, since you put it this way, I'll tell you how strange it really was. So uh I mean it was really, really strange in the sense that um my first holiday break, Christmas time, I went to see my parents who were still living in Singapore, and they said, hey, we have this great neighbor, you need to meet him. Uh and we went to a Korean restaurant in Singapore, and I had just uh started setting up a data center for NYU, modeled after Gary King's data center that was at Harvard MIT uh uh data center at the time, uh, that I'd been a fellow um with him, and that was a great time too.

Michael Munger:

Still well within the bounds of political science so far. Yes, so far.

Speaker 1:

This is what any political Scientologist would want to do. So now we sit in a Korean restaurant in Singapore uh and drink beer, and he said, Listen, I used to work for this company, Caterpillar. I said, Of course I know Caterpillar, I know who that is. And he said, and ten years ago, I told him that the future of equipment distribution would be rental. People won't buy things, they will rent them. Which seemed absurd when he said that, especially it's one thing to rent a car, but not a massive excavator. So he said, the future is rental, and um and they asked me to do the study, I did it, and then somebody's feet got trodden on, and so I I left to do it myself and failed. And the reason I failed was because of systems. And he said, now you're building all these data centers, just come with me for a week uh while I tour these places because they just invited me to come back uh and do this. And uh and after a few beers, you always say yes to these things. And then uh four months later he called me and said, It's time to go. I said, Where are we going? And he said, We're gonna spend a week and crisscross the United States and uh and look at rental, equipment rental locations. And there was absolutely nothing I would have liked to have done less uh than leave New York City and my jazz bars to go into very hot, humid places and look at equipment rental, which I knew absolutely nothing about. Um, but I completely fell in love with this whole concept then. This was such a pre pre precursor of the shared economy. I understand much better today why why instinctively I fell in love with this thing then, but it was a most bizarre experience.

Michael Munger:

It was ten years before anything like the comprehensive idea of the sharing economy was possible. And now I have tried to when when someone asks and you sum up what the sharing economy is, um my claim is that it's the commodification of excess capacity. What you're trying to do is to sell off parts of some durable, and what that means is you're convexifying ownership. Yeah instead of I own this and you may need it, maybe I can rent it, but it may be that we're owning it more or less collectively with the set of rights and the amount of time that each of us use being shared.

Speaker 1:

Yeah, so there are two interesting things, though, uh, in this particular case. Um one is I'm always convinced, and I can I think I have a bunch of examples, that the way you step through a revolution like this is for the wrong reasons. Uh and what I mean by that is the reason Caterpillar asked him to come back is this was in those days Caterpillar was organized by geographic region, and it was the South American group uh that invited him uh to do this. Oh CACO, it was called Catamericas. And the reason was they were seeing hyperinflation, they were seeing all this stuff that was that meant people could not buy equipment anymore. They were just not capable. Uh, and so they said, what can we do? Well, we'll rent it and we'll sell it. The dealer would sell the equipment to themselves as a rental company and then just rent it out. Um, it was a purely defensive move. This was not a new norm, it was not a new model, it was just let's do this. Um, but the people within those organizations that got drawn into this, they felt something was different here and they had to think about it differently. Um, and there were a lot of other organizational shifts that happened there. So that's one thing. The other thing is it wasn't really a sharing economy because the property rights were still on one side and the usage was on the other, right? So that's usually what gets merged when it gets really exciting, but that wasn't the case there. Um instead, they said, look, um, utilization is what drives everything, physical utilization. You want to have this thing running all the time. That's not in itself uh sufficient. There has to be a financial utilization, which is really the relates to physical utilization through price. So pricing has to be done correctly. And then you want the highest possible financial utilization on the one hand, and that's on the top line. At the same time, you want to absolutely minimize the cost of ownership. Bring that down, which is where then later our developments uh initially came into play. It turned out they had a much broader reach than we thought. So that was an interesting, it was an interesting development. But uh back in those days, uh the percentage of uh by by equipment value, rental penetration in North America was less than 20%, right? Um at the same time, in countries like Spain, uh and especially in places like uh Japan, it was closer to 85 or 90. So they were far along and had far more of a sharing economy mindset around it uh than what we were used to back here.

Michael Munger:

Why is that? Was it that transactions cost were less or that the prices were higher? What made that better?

Speaker 1:

In Japan, it's uh I don't know the path very well. I do know the current uh situation quite well. I mean I'm in in Japan five, six times a year, um, which is one of the markets where we've grown uh tremendously, in spite of enormous transaction costs. Doing business in Japan, you cannot describe it without using that term, right? But um Japan has a very interesting other situation. They're highly and have been for a very, very long time, they're highly saturated uh in the equipment rental market. It's been uh, and they have something uh that people in the industry call either dry rental or wet rental. And what that is, is dry rental is you walk in and you get some equipment. Ret rental wet rental means you need an operator with it. So it's a it's a strange term. Um but in any event, if you combine the two, you you are pretty close to 90%. Um it's it's uh financing plays a big role in why rental. And some things they call rental, we don't necessarily might be closer to leasing and so forth. There's a whole spectrum. But what's interesting in Japan is the rates at rental are incredibly low, um the uh which means getting your money back, your investment back, you need a much, much longer equipment lifecycle. And quite often, even that, so they we we are used in our country in North America, we tend to keep equipment between three and six years. They often keep it for 10 to 12 years. It looks much better than ours does after three or six, but that's another cultural norm. Uh and then it may only be when they finally sell it as used equipment that it actually makes money across its life cycle. So, in some sense, rental sometimes there is a production of used equipment to really get the full envelope of the profitability. Um but they are it's it's just um such, there's such tight margins, meaning using equipment and having that activity with equipment be profitable, that rental quite often is the only way to get there, uh, unless you start uh doing major, major financing yourself, which just doesn't make sense.

Michael Munger:

I in the 1970s worked in landscaping at Disney World. And what landscaping meant mostly was that we used chainsaws to cut down trees and swamps and then put it on trucks, or we would help with pretty major projects, Lang Sawd, uh doing the development of new parts of the Disney uh magic universe. Um they had a motor pool where they had a bunch of large pieces of equipment. Most of them they had exactly one. And a lot of these things had to be used in concert. If one of them lacked a heart, that meant it didn't work. And then none of the others worked either. And this was a gigantic expense because you have all these machines, you have all these people, and you're done. It's 10 o'clock in the morning, and the question is, how long is it going to be until this works? I had never thought about until I started reading about you, the life cycle management question. When I talk about a durable, something's either a durable or it's not. Well, it's durability is contingent on whether you can get the correct parts in a timely manner. And by timely, we mean right now, because this is a $250,000 piece of equipment and there's 20 guys waiting. And plus, there's something that's supposed to be done tomorrow, and we can't do it. So the the question of durability is just not one that I had ever thought about because it was a binary to me. And the idea of life cycle, you just said in Japan they last longer. Well, they only last longer because they do different things with them. How does that work?

Speaker 1:

The um there are a couple things. So service and maintenance is absolutely critical to any of these types of equipment. Um, not just that you are ready to repair them when they break down, but that you prevent the repair. And as equipment grows and age linearly, the complexity of what needs to happen to it goes up exponentially. So parts and service costs and all the knock-on effects that you just mentioned, they just grow dramatically uh over the life cycle. Um it is interesting, though, um what you mentioned. The uh we we never set out to start a technology company, which I guess I should have mentioned here as well in the introduction. We I ended up starting a technology company, Smart Equip, in the year 2000. Uh that was not our plan. Our plan was to continue the kind of activity we were doing, and there was this massive dot-com revolution happening around us and all these marketplaces and transactional platforms, and we thought this is great. Soon we can buy. And here you are as a rental company, you have hundreds of different manufacturers for equipment, literally thousands, if not ten thousands, of different suppliers for for the little parts. Uh, you consume, just to give you a sense of um dimension, you only consume for a typical US fleet owner, you consume about one and a half to two and a half percent of its original equipment value a year in parts. It's close to zero when it's new, it goes up. And then if you're in Japan, it goes up exponentially, you're approaching 10% when it gets older. But but that's the financial volume, so it's quite small. The number of transactions that entails is very high. The complexity of those transactions is astronomical. It's not just that you need to know the make, the model, you need to know the serial number, you need to know the context of other repairs, and it's incredibly complicated. And the problem at the dot-com, which we were all waiting, saying, okay, come solve this, and they weren't paying attention to any of it. And there are there are two reasons for that, I'm convinced. Number one, why pay attention to the one or two percent when we have the big stuff, the equipment itself? Now, the big equipment is easy to buy. You just say, I want that, and it shows up, and there are a few decisions you have to make. Buying a part for that thing, which is just as costly in terms of operating costs, because when you get that wrong or you can't find it, that big thing isn't working. So, uh, and that's maybe a $30 part. I have a friend met, actually, he's in the industry, Michael Stanley. He's a wonderful guy. And he used to interview his parts guy, and he would they would go through the parts apartment, and he says, How much do you think that thing is? He would point at a parts bin. He said, I don't know, $15. He said, if you ever say that again, you won't work here. No, it's a $15 reason that the $150,000 machine is not working, and and then he would go on. So so it's it's there's a lot to it. And it's it's it it it touches every part of a project. As you mentioned, it's not just that machine, it's a whole bunch of other machines. It also touches every part of the organization that owns the equipment. So people will say, well, you're solving parts, so I can maybe get them 10% cheaper through your system, which you can, 1015, because you make sure that people buy from the right place at the right price, but it's thoroughly uninteresting. What's far more interesting is uh far more interesting is the fact that parts are useless without service. Service technicians worldwide are becoming more and more impossible to come by, they're very expensive, and it takes two, three, four hours to do the repair, sometimes more, and they're constantly chasing information. Uh we take that away, they no longer chase that. That information comes to them, already serial number specific to the equipment that is fixing. And then finally, and this is the best part, it's a pyramid. That's the tip of the pyramid, is that part savings, fine. The next one, that middle layer, is service, which tends to be eight times the value. Of the tip of the pyramid. But where the real value comes in is, as you indicated with your example, is you can now run machines that you couldn't before. And that's the utilization side. And if you think about this, it's particularly potent because if you get one more use out of that machine, it's virtually all profit. It's like it's exactly the same as you walk into a hotel and say, look, I don't have a reservation. Do you have a room open? Here's a hundred bucks. And they say, fine, 99 of those hundred dollars go right to the bottom line. And so it's the same high profitability. And what's great, and what the most fulfilling parts when people started using this technology was they stopped paying attention to the parts, and they said, We've gone deep into the black because of this technology, because we're getting that additional marginal, highly profitable, high margin additional revenue opportunity.

Michael Munger:

Your description sounds a little bit at the top like orbits, but for parts. So I have to find parts, and orbits would also combine, you know, I'm looking for uh a flight, and I then it'll say, Do you also need a uh hotel? Do you also need to rent a car? So if I'm getting the maybe wet or dry use of equipment, um, I need this equipment, and then it also asks, Do you need an operator? Where is it? A lot of things, things is the nature of the use of this equipment that is often far away from a major airport. And in fact, it's far away from a minor airport. And so the coordination of this if if you're large enough, you might have some small inventory of the parts you're most likely to need. But there are any reasonably sized piece of equipment. There are thousands, thousands and thousands and thousands of things, all with some not just non-zero, but decent probability of breaking. So my impression is this is not orbits, but but for parts, it's quite a bit more.

Speaker 1:

Yeah, and that's actually, but let's and but let's do that comparison. So, what what uh orbits and those kinds of sites are essentially portals that have multiple suppliers. They're being compared uh in within the shopping experience, and people then go ahead and they know what they want and select it. So, one big difference already is our use, and and by the time they select it, the idea of actually delivering that good, whether it's orbits where it's really trivial because you're not shipping anything in the mail, but even when it's shipping in the mail, placing an order and getting confirmation is the trivial part. So we've taken a very different approach, which is we're actually um we're taking away the human element to a very large extent because it's just too complicated. So I'll give you a very specific example of a workflow. Uh you're at United Rentals, Sunbelt Rentals, or in Japan at ACTO, it doesn't matter. And every and you've got tens of thousands of machines, every single one of them has a unique number. And all you do as a machine comes in for service, repair, maintenance, whatever it is, um, is you type in your asset number. So you don't have to know anything else but the number that your company puts on an individual asset to identify it.

Michael Munger:

So this this this is a shared identifier. They know it and you know it.

Speaker 1:

No, the only people that know it is the company that owns that equipment. And where did the number come from? They put it on. When a new machine arrives, they just slap on, it's like it's their own internal serial number. It has no logic to it typically. Some do, some don't. It's a name, not a number. It's a name, correct. And it's a name that is it a barcode? Can they read it? It can be, but that's in the at the end, that part is actually trivial, whether it's numeric or you're going to blip it or whatever else, they usually do have a barcode. It may even not be uh uh visual, it may be um uh a chip, it it could be a lot of things, but it's a unique identifier. It's a name. But it's a unique identifier that only exists in the world of that particular company. Um so it's not useful anywhere else. Except our system, our sort of worldwide network now, is fully integrated with your fleet management system. So when you type in 12345, because that's your asset number, our system watches you do that, reads uh your system in real time, and says, uh-huh. MongoRents 12345 is a uh is a uh scissor lift uh by a company called JLG. And the model number is a 1930 um E2, and it has a serial number 54321, and now dynamically it reaches into, in real time, into JLGs, it's one of 800 suppliers that are on the system, reaches into their technical documentation systems, brings in real time the parts catalog for that, and as you click on the part that you're looking at, it might be a valve assembly, it'll tell you, ah, you're gonna get the 20 volt, not the 24 volt valve assembly because of that serial number. And it used to be something else, but that's just been displaced. So there's an enormous amount of complexity. And by the way, every single one of your 800 or so suppliers has a different logic of how they read serial numbers. It is, it takes hours and has an extremely high error rate if it's done humanly. It the error rate goes away and everything else, and you literally save hours in effort. And then, of course, as you referred to earlier, uh you eliminate all the downtime that comes from these very common errors. So that's that's that's a big, big part of it. You then go ahead and say, okay, I need this part, this part, that part. Our system goes into your existing work order system where you normally would have to type for quite a while. It fills out everything you've just clicked on, it then goes into your purchase requisition system so your boss can say, Yep, you can order. And then it goes and generates in your ERP system, in your system of record, sorry, the enterprise resource. So it's your business system. Um, and it goes ahead and creates a purchase order and takes that information, gives it to supplier. That's something that usually takes one, two, three, four hours, uh, all in with searching and so forth. That's optimistic. It could easily take a day. And usually it the longer it takes, the more likely you have errors in it. That's another thing. So, but that's all gone. It's it's down to zero. It's virtually zero. And by the way, the guy who used to have to do all this, they didn't join their profession to become data entry people. They want to hold the wrench and go repair. So they're actually delighted by all this, right? Uh and so all the paperwork gets generated in the background, even though we're still in your company and we're not replacing your system records, we're starting to operate them for you. When all that is done, we go to your preferred supplier. We know if you're in this location, you prefer getting the part there and so forth. You know the pricing, we match it, and then we go ahead and fulfill that. So you can already tell by all this sort of overhead. I have a feeling the word term transaction cost is going to come up real soon, but you can tell by all that overhead that this is that the fact that the part may cost $12 instead of $20 is completely irrelevant when you're looking at hundreds and hundreds of dollars plus all that opportunity cost when something goes wrong. So that's what we just completely remove. Uh and it's and it's and it's starting to have that effect that people have stopped, have significantly reduced their price sensitivity to these parts. And instead, what they now think of, what used to be the manufacturers sending you a part, they are now sending you operational efficiency. They are making the equipment that they sold you have higher uptime and everything else. And that can be literally a thousand uh percent uh higher than than than the whatever the cost of the parts is. So fast access to cheap parts not necessarily. In fact, so one of the and and sorry to interrupt you, and one of the fears, uh now think think back, this all started during the dot-com. Everything in the dot-com thing, uh, back to transaction cost, was about disintermediating uh all the humans in the middle. They didn't they weren't needed anymore, and we can make this stuff cheap, right? Commoditize everything and so forth. And that's why we got a lot of resistance because they thought that's what we're doing, especially dealers. There's some equipment that they sell directly from the manufacturers. As soon as dealers were involved, they were petrified. That's what we were here to do, because everybody else in this B2B world did. We did quite the opposite. We said, no, we're the phone company, we're connecting, knowing that logic, we get the intelligence by being integrated on the buyer's side, we get intelligence on the other thing, and and the exact opposite happened. They thought everybody was going to use our technology to start cross-referencing to save that extra two, three dollars. And as soon as they realized we can focus on saving the two, three dollars, or the fact that we can reduce the repair time by five hours, who cares about the two, three dollars? So it actually decommoditized the parts, plus you get higher quality and all that stuff. So it really took the price sensitivity out of it quite a bit.

Michael Munger:

Well, so that my question was a different one that I was going to, and you actually skipped ahead and answered it. Because if it was Orbits, then all I'm going to do is search for a low price. Right. It could be that the company could say, just as part of its service, one of the things that we can offer you is fast, cheap parts. And we would compete on that basis. But that's hard because it's not integrated with the buyer, with the user company system. So that actually makes it possible to do that. It makes it easier for them to say fast, cheap parts.

Speaker 1:

So that's extremely interesting because that's in fact uh what we found out is that um there's there are quite a few companies that um, and they've been historically quite successful, that sell alternative parts cheaply, just like you described. Well, can you make the distinction then between OEM?

Michael Munger:

There's a bunch of acronyms here.

Speaker 1:

So OEM is original equipment manufacturer. That means that the part you buy is is is provided by the the the company that built your equipment. It may actually be the same at the end of the day, but that's a whole that's a number.

Michael Munger:

It is certified. It is authorized. It is certified. This is ours.

Speaker 1:

And there used to be, especially when there were industry roll-ups and all of a sudden these companies had a thousand locations or more and had uh up to 20 billion in fleet, where people would say, hey, if we can use alternative parts and say 5% on average, that's an enormous amount of money, right? Um and that's where this was going. When we started, these alternative providers started feeling threatened by us because we're taking away their case. Uh and it there are several cases where some of them would go to the same buyers that had were licensing our application for a lot of money because there was a high ROI on it still, and say, we can do this for you for free, and you get cheaper parts.

Michael Munger:

ROI.

Speaker 1:

Return on investment. Sorry.

Michael Munger:

That's yeah. There's a big bonus. Yeah. I can make more money if I do this.

Speaker 1:

But as soon as people and it took a long time to persuade them, and we were, again, to be perfectly candid, we never, when we first conceived of this, we didn't and we didn't think about transaction costs, right? This is all about redu eliminating the transaction cost. We had no idea how large the potential was there. That was not by design that there was a lot of luck involved. Um and but once that was became more widely known, it it did take away from from these sort of um alternative part suppliers. Even though, by the way, they're also suppliers through a network. So you can still buy from them. We're not competing, we're not selling anything, we're just connecting buyer and seller. We're also, by the way, the other big difference, I should have mentioned this first, to orbits. We're not a marketplace, we're not a website where you shop around. You are the buyer and you tell me these are my preferred vendors and this is what I want. And by the way, when I buy a filter, I'm not going to buy it from a manufacturer, I'm going to buy it from Baldwin or some somebody down the street. And we can say, fine, your user doesn't even need to know that. If you have that rule and you select 10 parts, eight of them go to the manufacturer, the tires go to your tire guy, the filter to your filter guy. That's fine. They don't have to know. We can set those rules and then generate several purchase orders rather than just one.

Michael Munger:

So a question that I had um in looking through all of this, because now you're able to articulate what it is that you do. Uh, there's a famous story, maybe partly, maybe entirely apocryphal. Uh Harvard Business School. Um the guy's teaching the class, he's a famous entrepreneur, and he says, I want each of you to tell me, and these are all in-service mid-career MBAs, I want you to tell me what business you're in. And the the guy who was the head of sanitary fish restaurants um answered the question and said, Well, you know, we have a restaurant, we have a thousand things that we do, we provide service, we make people happy, and the entrepreneur interrupts him and said, Okay, that's stupid. Two weeks from now, come back, and next time we meet, tell me what business you're in. And two weeks later he comes back, asks again, and the guy says, I sell fish. And what he really did was have the best way of the freshest, best, not cheapest, fish. And people would pay a premium if all the other things just were were add-ons. And once they see he started to focus on the main value proposition, so your main value proposition, you have now said, in retrospect, is the ability to use this equipment and make a much higher rate of return on the equipment, not to get cheap parts. When did you realize that that was your business?

Speaker 1:

Um We really there were a few moments. By the way, if I had to answer the fish question, I would say we uh we sell asset productivity. That's really what it is. We do it in multiple ways. We do it by so so and we thought we would make that parts selection side easier. We didn't realize that it would have our knock-on effect to all of this, but it was that's that's how it started. Then we realized when you make that part stuff more efficient, you also automatically make the service guys more efficient. That's a direct consequence, and then we fine-tuned it to do even more for the service people. And then we realized this was not all upfront. Then we realized when we make those guys more efficient, your uptime improves while lowering a total cost of ownership. And the minute you improve uptime, you're no longer on the cost savings side, you're now also on the revenue side, which was fascinating. So we're really it we're touching much more. And then we thought, okay, now we have it, until we went to a conference, and one of our largest customers, the second largest rental company in the world called Sunbelt Rentals, out of Charlotte here, but they're also in the UK, that they got up and spoke at the conference and they said uh once we started using SmartEquip, over the last four or five years, I don't remember, it was something like that, but we doubled the size of the company and we reduced the size of our accounts payable group by 35%. And everybody turned around, looked at us, and I was sort of nodding, smiling, being very proud, having no clue why we should do that. And so I asked afterwards. And the idea, and they said, well, because you're integrated on both sides, there is uh pricing uh coordination. And by the way, when there isn't, which is very frequent, especially with parts, because you have new prices, you have new part ID numbers coming all the time, they call it super session. When you have the prices coordinated, that takes away pain for the seller and the buyer. It no longer has delay in settling. So they were just able, in spite of doubling the company, reducing 35% out of that. So then we realized we're really in all of this, but then we took a step back and said, we're not creating this. We're now permitting the seller, whether it's a manufacturer, whether it's another type of supplier, we're enabling them to deliver that asset productivity. And that now knocks on to the whole rental world because they can start guaranteeing with greater comfort certain levels of fleet availability because of this whole logistics chain that we took over.

Michael Munger:

I have always admired Ronald Coase. He's one of the heroes of this podcast. And Coase asked this great question in his 1937 paper, but he actually quite naively went over to the United States because he'd heard all this great stuff about how prices and markets organize resources and asked CEOs if markets are so great, if prices are so great, where are their firms? And a big part of the answer may be to secure your upstream market, your supplier, and it may be to secure your downstream retail outlet to make sure that you have a place to sell and you can buy the things that you need. If Coast were alive today, he might very well ask a different question, and that is why do we own so much when we could rent? And the the Coast's answer to this, how big should a firm be had to do with, well, unsurprisingly, transaction costs. Well, the line between owning and renting is probably going to be based on transaction costs. If I own something, I'm paying for it twice. I have the entire purchase price of this capital tied up, and I have to pay to store it. If I can avoid those costs, I will rent more. It had not struck me that from the owner's perspective, making this asset more productive makes it more valuable to rent from the perspective of the user. And so, does that blur the line between ownership and rental? Let me ask it in a different way. Somebody now might own an asset that they could rent out. And the analogy that I'm thinking of is Airbnb, and it may be too extreme, but several times we have rented Airbnbs in New York, and the owner said, I live in a much bigger apartment than I would otherwise, because all of every August, and this happens in Paris also, right? All of every August, they get the equivalent of six months of the rental for the entire year. Yeah. And they have a much nicer place as a result. So if I can rent a backhoe, if I can rent a piece of equipment, it'll be way better, more powerful, more efficient piece of equipment than what I could own and then store. Now, it is true that it would solve the three problems of triangulation, transfer, and trust. I know where my backhoe is. Yeah. It's in the shed. It may not start because I haven't used it for three months. I'm going to have to work on it to get it to start. Whereas if I can get it rented and have it delivered, and maybe even with an operator, that'll be a whole lot better. So it isn't exactly sharing. Preparation for this, I went and looked at Sunbelt and United, and the the size, the the amount, the diversity of things that are being rented is shocking.

Speaker 1:

Yeah. No, it's remarkable, and then there are a lot of specialty rentals, sometimes they exist uh by the side. And then there are re-rentals, which sort of fits into your world where it may not make sense for United rentals to have specialized 135-foot booms and so forth. But then there are specialty rentals that don't rent to the end user, but they only rent to United. Uh, and then the question is who maintains the equipment? Is it the end user, is it United, or is it the owner? And there's usually their agreements uh with for different types of equipment. So it's really, it's it's really quite remarkable how this is all um coming together. There are movements and have been several attempts to go more into an equipment sharing world. Um it's had some stumbles. Where it's worked quite well is actually with power generation. And what's interesting is um there is a network of dealers uh across Europe. Uh and there's something nicely commodifiable by power. At the end of the day, it's kilowatts, right? There's nothing. And so it's it's much more fluid than saying, how good is this backhoe? Is it damaged? Does it produce it how productive is it? And what these uh what this network has done, they've just all invested in generators that are all over Europe. They pool them, so they're collectively owned, basically, and at the end they they uh they share the revenues uh out of what what what that pool generates uh in a way that's um proportional to the amount of the equipment that they they've invested in. So I think the more fluid, the more there's an external, almost money-like metric that allows you to do that, the more successful it is. And on the other end of the spectrum, renting a crane is incredibly hard. It's really, let alone sharing one. And starting with safety and complexity and everything else, there are crane rental specialty places. That's different, but that's not the share model that you just asked about or talked about.

Michael Munger:

Well, that raises so many questions. One of the things I gave a talk uh two weeks ago in Sheboygan, Wisconsin, to the famous Sheboygan Economics Club. I don't know why there's a famous club in Sheboygan, Wisconsin, but Milton Friedman and a number of actual competent people have given talks there. And I made the claim that there was going to be a change in the nature of equipment that could be rented to make it easier to say what the cause and fault of damage was. And so something like trying to imagine 20 years out, I have a piece of equipment and it has in it something like the black box that we put in an airliner. And this black box tells me the speed, how was it used, was there a sharp blow to it, from what did it come, did it get wet? And there's a timestamp. And I can use that to say, all right, that was your fault. And so I know exactly when it happened, and that knowing that I know that, it means you, the user, are more likely to take care. Because the problem with uh rental equipment, people never say, um, I I beat it like a mule I owned, I beat it like a rented mule. Be gentle, it's a rental. People don't do things like that. If we had some way of being able to attribute blame even just better than we did, is there a move towards having a special because that's an additional expense for most equipment. But if it were a dedicated production for rental equipment, then I could rent it more frequently and at lower costs. Is there anything like that in the works?

Speaker 1:

Well, it's actually in uh it's very interesting. So one part of the the three parts to the answer. Um the first one is there's there's quite a bit, it's it's quite easy nowadays to see uh how something got damaged. Um because of sensors, because of um uh faults showing. Uh most equipment now has what we used to call telematics, and then that became smart, so now it's IoT, Internet of Things. Um there is quite a bit of it. There's also, um, this is already a few years ago now, but I visited a very sophisticated uh German equipment manufacturer called Wacker Neussen, and they showed me, they have a wonderful RD lab in Munich, and they showed me a mini excavator, tiny mini excavator that had a shovel. Um and as it was approaching, it could feel what it was digging. So if there was a power line, which is can be very dangerous, not just to the equipment, but the operator, it would stop and then graphically show, since they didn't know what language the operator spoke, what was going on. So there are a lot of the sensor technology is pretty stunning. The other thing that's becoming stunning, it used to be that you would then always have codes that were hardwired in. Now with the IoT side of things, uh and with AI really stepping in, uh, there's certain vibration signatures and other things where you don't have to know to teach the um uh equipment this means this is happening, but because in the aggregate uh people are starting to monitor it, they realize that certain vibration signatures mean you're within 50 hours of a so-and-so uh fault. That's the other one. The third one, uh, getting back to damage, and I didn't answer a question you asked earlier. You asked why is Japanese equipment looking better. Um I don't know if you ever saw uh during the Olympics, um, and this is I I I always dislike uh cultural explanations because at the end of the day they're more descriptions than any form of explanation. Exactly. That's right. That's right. We would like variables, not names. That's right. Um but what is was very striking when I happened to see this after just having come back from yet another trip to Osaka this time, where I saw this equipment facility where everything looked brand new, is uh when the Olympic team, the Japanese Olympic team, left the Olympic village, their rooms were absolutely immaculate. Uh when all the Europeans and the Americans did, it looked like they had partied until right before leaving. So and and there is this pride, and if it's and and there is a cultural norm. Again, it's a generalization, but there is a cultural norm. It's a central tendency, a statistical central tendency. It's right, it's descriptively right, but there's also it's been described to me many, many times. When I ask about this, there's a cultural norm that if the equipment belongs to someone else, you'll be twice as careful with it. So it's the it's the opposite of what you do what you just described, what we would expect. Yeah. It's just there.

Michael Munger:

I the the setting in which I had this experience, this argument, was that I was describing the potential for Turo. So you go to Heathrow Airport and you can park, and it's 40 pounds a day to park your car. Half a kilometer away, there's another parking lot, and it has a big orange Hertz sign on it. Yeah. And I can pay to have my to park my car, and I can pay to rent a car. It makes far more sense not to park, but to rent my car. But I would need to have something in the car to be able to say what caused the damage. Was it the fault of the person? And this is something more intrusive than just having a dash cam. But if we had if we were able to solve those problems, the ability to share even things that I own would be it would it would dramatically change the way that we think about, particularly storing automobiles. Do you know of anything about renting or using cars? Or and what do you think of Turo?

Speaker 1:

Is there some chance of that working? Um, from what I I don't know very much about this. I know people who actually work there and so forth. They certainly seem to think it's working. I also know that they're having a much harder time in Europe for the very reasons you mentioned, and that is, and the example that sticks to my mind, which is now quite a maybe ten years ago or so, it was a um a more advanced version of rental, more in the direction that you're describing, and a uh a very expensive car was stolen. They recovered it because it had an IoT device, a tracker on it. Um, but then the company that owned the car was sued uh a multiple of what the car was worth because they were violating GDPR regulations, privacy uh laws. So so it is very tricky there to do that kind of monitoring, uh far more so than it is, for example, in North America.

Michael Munger:

It would require it is more intrusive. Yeah. So the the my sort of optimistic story of about how we might be able to save on storage is going to start to run up against privacy laws. Well, the the last question that I had for you, and you may have had some other things that you wanted to say, but there was a uh case not too long ago, uh a court case with a company called RealPage, and the allegation was that landowners, people who landlords, people who rented out flats were using the software to coordinate on price. And anytime you have one of these, maybe if it were if it's Turo, um if I look on orbits, orbits might be used to coordinate price on rental cars. Amazon has been accused of using uh coordination on prices and charging different prices for different customers based on um willingness to pay. So you have both the price discrimination, if there's a single place, if if an app is successful, everyone starts to go to it. That means that the ability to quote a price almost automatically runs afoul of at least the temptation to use it as a way to violate antitrust laws. And so I I was I was wondering what you thought of the the problem of uh real page or the accusations that have been made to Amazon is i i i as far as I can tell, even the claims that have been made, the alternative is you have to compare this to a world where it's just chaotic, you don't have any ability to find things and be able to coordinate on price, that price is going to be still higher. So imagining that we can have this app and then yet somehow have an intrusive government regulation system that prevents coordination, that third alternative just may not be available.

Speaker 1:

It that that always struck me as such an interesting case, right? I mean, when you become really obsessive about wanting to remove transaction costs, and then you suddenly describe, I think what you're describing are settings where the removal of transaction costs promotes the potential of collusion, right? Which is because it's successful, but there's just one. Right.

Michael Munger:

Yeah, it's so much cheaper that everyone goes to it.

Speaker 1:

Yeah. Um and and the more the product is a commodity, the the more it lends itself to that. Um, I'm familiar with a few such platforms, and typically the ones I know well, typically those are the ones that have um there are provisions on what needs to be added. There may be a time delay to the pricing signal, right? There may have to be a um there will be sufficient participants in a market uh so that you're not identifying what any individual is doing. And that there's sort of a lot of these things. Um it's it's and and and this has been on our mind, especially when people say, well, you guys are just a marketplace, um, and it's starting to hint in that direction. You're there to bring the price down. Well, in our case, no, because these are parallel transactions. There is no market aggregation as such, right? There's no information aggregation, but it's also very interesting, and it's a highly fluid area right now in terms of what the government is doing regulation-wise. Um and and as soon as, yeah, so it's it's uh I I I honestly don't know where that will go. Um, but it's it's again, if if you're any way, well, why am I saying this to you? If you're in any way sentimental about the notion of removing transaction costs, it's like such a disappointing uh notion that it actually can in this is one case where it where it's a market failure of sorts almost.

Michael Munger:

Well, it it ends up being a market failure, but only if you compare it to a non-existent world of zero transaction costs. If you compare it to the world of real transaction costs, we're way better off.

Speaker 1:

Well, and that's uh and so I don't know, it's I I I always get uh upset when people say, I can't believe Amazon is charging this, right? Well, first of all, there are two problems with that. Number one is it's easy, so they're charging less in that sense, right? They're taking some cost away from you. But the other is also you you don't have to buy it there. It's at the end of the day. It's so it's interesting. I mean, there still is an equilibrium at work somewhere in this, right?

Michael Munger:

But it is easy to imagine an alternative. So what you said raises an interesting question. Um the the company was acquired by is it Ritchie Brothers. Yes. And what they had operated was an auction company. Yeah, that the world So an auction is you have a bunch of buyers bidding against each other for a one thing.

Speaker 1:

So that that's that's a good good question. Um so Ritchie Brothers is the largest auctioneer of, and they're now called RB Global because of all the companies they own, including ours. Uh they acquired us in 2021. Um and they are and it and by the way, if ever you want to go to an auction, come with me. It is really amazing to see, and the amount of equipment that they move through and the combination of physical and virtual. I mean, the whole world is there.

Michael Munger:

Three more zeros than I expected.

Speaker 1:

Yeah, I have no idea. It is stunning, and the efficiency. I mean, if you ever want to see a market work, that's the place to go. Um it's really, it's uh it's incredibly impressive. And uh, and I try to take every opportunity to go see them just for that. The um but the interesting thing is so they were the dominant player of being the ones where you sell used equipment. And then ideally, if they make you really happy in that experience, you'll also be selling it again at the end of your ownership lifecycle. So there are several ownership life cycles across the equipment lifecycle. Um, the reason they bought us is they said, you know, we kind of own these customers, um, but it's more of a loyalty and we keep having to serve. How about we also serve them while they own the equipment? And so it made perfect sense to start uh filling the space between the two book.

Michael Munger:

It's obvious it had completely evaded me.

Speaker 1:

Yes. It is and now, it is obvious. It's also very difficult because the mindset of somebody who is an auctioneer and lives for that nanosecond with the highest prices and already on to the next deal is very different from the mindset, our mindset, where I come and try to province uh convince you that if you use our technology, you're gonna raise your financial return on asset by 2.8% over the next three years. It's it's so so it's a comp and you say and I would speak to a different employee of yours with our stuff than others, but when you abstract it or when you step back far enough, it it belongs together uh very, very much. Fish. It's still selling fish.

Michael Munger:

So that that's right. That is spiritual. That's right.

Speaker 1:

Yeah.

Michael Munger:

Well, those are the questions I had that I, as I had said, have you a summing up or something that people should look at a few years from now that will be uh maybe go out on a limb a little bit?

Speaker 1:

Yeah, I have a puzzle for you actually. Um and and I thought about this, I'm obsessed about this one, and I thought about it quite a bit more knowing we were going to have this conversation. So all we focused on, or primarily what we focused on so far, is this move into the rental side, historically how it happened here, where it was in Japan and so forth. And and and there's usually, when you go back to the beginning of these caterpillar dealers, uh it was a younger generation that really understood the rental side, and the older generation was all about that sale. And by the way, some of the fascinating stories there, uh selling parts is very hard. It's very hard to be profitable. So the older generation, what they did is they spoiled you with the parts and service. They would lose money quite often with it, especially the parts side, but to gain your next sale. Okay, so that was the idea.

Michael Munger:

So we offer fast, cheap parts. That it seemed like that was in the old system. Yeah. That's a company by itself could say that.

Speaker 1:

And we will give you the free coffee, of course it's not free, and we'll give you all this other stuff, of course that's not free either. But but that's what we do, we tied goods. But there was also yes, but there was also a high margin to this. Now, these margins sort of coming down, especially with smaller equipment. Now, the younger guy said, um, wait, if I can make this profitable, this whole parts business, then we're thinking about this the wrong way. Every time I sell a machine, I get a permanent income stream across its life. Let's seed the world with these permanent income streams. It becomes an annuity of sorts, right? So it's a completely different mindset.

Michael Munger:

And that means we can charge less the equipment. Exactly. For 20 years, we're going to be selling. It's a razor.

Speaker 1:

You know, we're now digital. Yeah, it's just analyzed. We're now selling razor blades, or the promise of razor blades to ourselves. So it's a version of that. But that goes somewhat mentality-wise, goes with that whole rental, uh it's a different transaction cost world, right? So I get all that, and that's quote unquote the front of the house. That's what the rent how the rental company thinks about the world that they're saving. Now, if you turn to the back of the house where we usually sit, with this parts, service, and everything else, you suddenly stumble over the strangest things. For example, in we are in the five largest equipment rental companies in the world. So we really are the standard in North America, in Europe, and we're kind of it now too as of a couple months ago in Japan, and that's the window into the rest of Asia Pacific, so we'll probably become all of that. So, but especially in when you're in Japan, with these four, the four the 2,000 rental companies, the four largest ones own 58% of the market, which means they're tiny, tiny, tiny little regional ones and many, many of them, right? But it's rental in their blood. But now with the large ones that are the sophisticated ones, the front of the house, they're phenomenal. Service and everything else looks phenomenal, and then you turn back and you realize they wrote from scratch, each of them, their own rental management system, which is an enormous software package, right? And you say, how can you simultaneously, and by the way, many companies here do as well, how can you simultaneously think of this rental world, but when it comes to maintaining it, you actually have a bunch of coders that you hire and do this, and it's a one-off, and you do this, as opposed to not even buying it, but just rent it through SaaS. And so there are all these contradictions on the back, and it's almost as if the back of the house hasn't adopted the mindset to support the front of the house. And I keep stumbling over this and I can't figure out why.

Michael Munger:

My generic answer, and I'll just trot it out and see if it actually if it makes sense to you here, there are so many things that we don't think of as being a business activity. We think of it as being an accounting activity, something that we have to do as part of the way that we do business. And I'm sorry I keep coming back to the fish. If you think that your business is to organize, deliver, and process rentals, that's very different than I'm in the business of providing assets that are really valuable to my customers.

Speaker 1:

But you see, that part, the latter, uh, is so sophisticated that if you ask a skilled rental operator what is it that you're doing or selling, they will never say I'm renting equipment. And that's why they don't, in the back end, why they don't integrate it. No, but what what what what would your sense be? If I ask a rental operator, what is it that you're selling? Their answer usually is, I'm not renting a drill, I'm not renting out a drill, I'm selling a hole, right? And the ideal world that they will describe to you is I want so so here's a nice example. There used to be a company called Nation's Rent, it's now part of Sunbelt Rentals, they were out of Fort Lauderdale, and they would um, and and this is many, many years ago. I would go there, I would work there, and then we would drive by their largest yard, uh, and then we would uh buy their largest customer, and there were all these nations rent machines that weren't being used, and they said, Hey, look at this, um, free money. They're paying and they're not using it, right? Then a year or two later, there was such a cultural shift, they started calling the customer, say, hey, look, this thing has been sitting there, why don't we take it off your hands so you don't pay us for it, and we'll take it to another customer. And now they don't exist anymore, but now you often hear from them, I want that machine to show up one nanosecond before that hole gets drilled and then disappear again. And I want to integrate into your whole job management side and everything else, right? And I want to build the systems around it that we can really do this, and we can charge more. You don't charge by the length of time, you charge by the output, and we want the whole world to be this way. Um, and yet the system to do that, I may build. So that is the interesting part. It makes sense when you unite rentals because you're the size of, you know, you have GDP level uh size. It is um unbelievable. But it is very yeah, it is remarkable, but it is it is uh it's it's one of those puzzles. Why does that gene that makes you go into the rental, why does it seem to switch off when it goes into running your own company?

Michael Munger:

So I think that is a terrific puzzle, and I would be interested in the comments of some of our listeners. So I I want to thank. Alex Schusler for having appeared on The Answer Is Transaction Cost. It's been a pleasure. Thank you, Mike. Whoa, that sound means it's time for the twedge. Since this episode was long, I just have one short joke here. What brand of counterbalance fork can raise the biggest load? The answer is a rented one. The letter is from DP in Perth WA, that's in Western Australia. One of my very favorite places, it's just not easy to get to. DP says Greetings from Perth. We have parklets too. Similar to the San Francisco ones, and we talked about that in the episode two weeks ago. Similar to the San Francisco ones, they are provided by the local council outside popular coffee shops and cafes. Similar to San Francisco, they are technically public spaces, but their location tends to make people believe they belong to the nearby coffee shop. Not surprisingly, they are not used by non-patrons. I've always assumed they were a public good provided to increase the ambiance and amenity of the high street vibe in an attempt to attract visitors to local businesses. They are prevalent where quote cappuccino strips, unquote, are. Ours vary from recycled timber to posh aluminum structures such as you described. Happy to provide photos. Love your work, by the way. P.S. There's a book in this Parklets of the World. Regards DP End of letter. Well thanks DP. That really is great. You do put posh in quotes there. It's a little hard to imagine, but I've never thought of a cappuccino strip. I understand that Australians are very concerned with coffee. I've had people basically threaten to fight me when I doubted that well, the claim was that Melbourne has the best coffee shops in the world. I I've been a number of places that have good coffee shops, and they never say, you know, we wish we could be more like Melbourne. But still, I understand that if you have a cappuccino strip, you may need an aluminum posh parklet. So anyway, thanks for your letter, DP. The book of the month is Isaac Asimov's Treasury of Humor. It's published in 1992 by Houghton Mifflin. Isimov has a theory of jokes, and it's actually quite interesting to that the theory is it's not a mathematical theory, but it is a set of claims about what makes a joke work and the circumstances under which telling a joke may succeed or fail. He also has six hundred and forty jokes organized by category. About a third of those jokes are funny, which is a pretty good ratio. Well, the next episode is next week, December 30th. We'll have episode 8, which is book 4, chapters 7, 8, and 9 from The Wealth of Nations. I look forward to talking to you then.