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Strategic Timing of Investment over the Business Cycle: Machine Replacement in the US Rental Industry

Author

Listed:
  • McClelland John

    (American Rental Association, Washington, D.C., USA)

  • Rust John

    (Georgetown University, Washington, D.C., USA)

Abstract

We analyze a data set containing rental revenues, maintenance costs, and sale prices of five different types of rental machines to econometrically estimate key relationships needed to implement a dynamic programming model of the optimal timing of replacement of rental equipment owned by a large multi-location firm in the equipment rental industry. The model reveals significant potential to improve rental company profitability by improving the strategic timing of equipment replacement. The gains from the optimal replacement strategy come from exploiting seasonal variation in rental demand and the timing of the business cycle due to their effects on rental revenues and the cost of replacement. For some machines we find the optimal replacement strategy is procyclical, but for others we find that a countercyclical replacement strategy –- where replacements are concentrated in slow periods of the business cycle –- can significantly increase firm profits.

Suggested Citation

  • McClelland John & Rust John, 2018. "Strategic Timing of Investment over the Business Cycle: Machine Replacement in the US Rental Industry," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 238(3-4), pages 295-351, July.
    • Handle: RePEc:jns:jbstat:v:238:y:2018:i:3-4:p:295-351:n:4
    DOI: 10.1515/jbnst-2018-0023
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    References listed on IDEAS

    as
    1. Rust, John, 1987. "Optimal Replacement of GMC Bus Engines: An Empirical Model of Harold Zurcher," Econometrica, Econometric Society, vol. 55(5), pages 999-1033, September.
    2. John W. McClelland & Micheal E. Wetzstein & Richard K. Noles, 1989. "Optimal Replacement Policies for Rejuvenated Assets," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 71(1), pages 147-157.
    3. Sungjin Cho & John Rust, 2010. "The Flat Rental Puzzle," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 77(2), pages 560-594.
    4. Paarsch, Harry J. & Rust, John, 2009. "Valuing programs with deterministic and stochastic cycles," Journal of Economic Dynamics and Control, Elsevier, vol. 33(3), pages 614-623, March.
    5. John Rust, 1997. "Using Randomization to Break the Curse of Dimensionality," Econometrica, Econometric Society, vol. 65(3), pages 487-516, May.
    6. Paul A. Samuelson, 1937. "Some Aspects of the Pure Theory of Capital," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 51(3), pages 469-496.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    rental equipment; rental markets; optimal replacement;
    All these keywords.

    JEL classification:

    • D22 - Microeconomics - - Production and Organizations - - - Firm Behavior: Empirical Analysis
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • L64 - Industrial Organization - - Industry Studies: Manufacturing - - - Other Machinery; Business Equipment; Armaments
    • L74 - Industrial Organization - - Industry Studies: Primary Products and Construction - - - Construction

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