Interface’s Evergreen Services Business Model

1. Regarding the conventional economic arguments for providing services (i.e., leasing) rather than simply selling a product, which of these is most important in the carpet industry?

The main view-points for selling services rather than product are higher margins, stable revenue streams, and long-term customer relationships. For the carpet industry, the long-term customer relationship argument is most important. The industry is unique such that the each customer (owner of the building) has to continue availing the product and services of the industry for a long time, until the building ceases to exist. Thus, this business is a repeat business. In traditional product selling approach, the carpet manufacturer would get the next sale from the same customer after a large gap of 7 years on an average, due to which it may not be possible for the manufacturer to maintain the relations with the customers and secure that repeat business leading to a high churn rate. The long-term customer relationship aspect of the services model enables the seller of the service to maintain the relationship with the customer due to the lease contract as well as maintenance and replacement services and get the repeat business after expiry of the lease thereby increasing the retention rate.

2. What is your assessment of Interface’s Evergreen Services business model? Why is Interface having difficulty in selling Evergreen Service Agreements?

The business model for Evergreen Services includes offering the material and services for two types of charges: one monthly lease payment and second maintenance of the carpets. At the end of the lease, Interface will remove the carpets for further processing at no charge. With the Evergreen Services business model, Interface’s approach has been to provide a complete end-to-end solution for floor-covering needs of its customers. In order to achieve the goal, Interface tried to make the offering financially appealing to the customers by offering ESA as an operating lease, wherein Interface will maintain the ownership of the material and the customers don’t have to include the asset in their balance sheets, having a positive impact on customer’s return on assets (ROA) and debt-to-equity ratio.

The major difficulty in selling the Evergreen services is that the pricing of the services highlights the high cost of maintenance for the carpet. To comply with FASB’s statement No. 13’s standards, Interface had to decrease the lease charges leading to the annual maintenance and other associated services as the key earning aspects of the service. The maintenance services availed during the traditional offering are limited to cleaning and are part of larger cost pool of janitorial services. Thus the customers are not aware of the actual costs being incurred for carpet cleaning. This thought bias of the customers poses a roadblock in success of the ESA model. Further, as the lease is being offered at lower cost to keep it as an operating lease, Interface also has limited room to lower the prices for maintenance services, which may be considered as the key to maintain the profitability. Due to these reasons, Interface is having difficulty in selling Evergreen Service Agreements.

3. Provide a financial analysis (i.e., compute NPV; use yearly time buckets) of both leasing and selling alternatives from the University of Texas’ perspective. Consider a 9% discount rate for computing NPV, and a 7-year leasing term. Here are the cash flow streams:

Buying: initial cost (plus installation), 5% yearly carpet tile replacement starting in year 3, disposal at the end of year 7, and maintenance.

Leasing: Annual leasing expense, maintenance.

As per the data given in the case, the PV from University of Texas’ perspective is calculated in Appendix A. Following are the cash outflow values for University of Texas in both the scenarios.

PV of cash outflows while buying: $2,112,655

PV of cash outflows while leasing: $2,824,875

Clearly, as the PV of future cash outflows is less in case of buying, the UT had rejected the Evergreen Services leasing option offered by Interface.

4. Conduct a financial analysis of leasing vs. buying from Interface's perspective.

From Interface’s perspective the detailed financial analysis is as per Appendix B. Following are the NPVs for Interface in both the scenarios.

NPV while selling: $322,375

NPV while leasing: $504,895

As the NPV while leasing is more, the option of selling the ESA is better for Interface.

How should Interface change its business model?

Currently, the PV of cash outflows for customers is more while leasing the carpet, making it difficult for Interface to execute the sales of ESA. Even though being environment friendly is a big selling point for ESA, customers might not want to pay more than their current practices.

In order for the customers to prefer the leasing option over the traditional buying option, the difference between the outflows of buying and leasing should be minimum. To successfully sell the ESA, Interface has to modify the ESA business model such that the ESA package should appeal to the customers financially. This can be done by 1) reducing the maintenance charges and/or 2) integrating the lease and maintenance in the agreement.

Even though lowering the price of maintenance is a less profitable option for Interface, the same can be implemented as strategy to get the customers on-board with the idea of a comprehensive solution for the first lease cycle. Once the customers are engaged and they realize the intangible value of the offering, the prices can be adjusted to suit both - Interface and its customers.

Appendix A: University of Texas’s Cost