The Car and Truck Fleet and Leasing Management Magazine

Forecasting the Future of the Closed-End Lease

February 2007, by Bryan Calloway

While you shouldn’t expect the closed-end lease to become the preferred U.S. lease option in the near future, don’t discount its impact on the fleet industry in 2007. Fleets, large and small, are giving the closed-end lease another look with surprising findings.

A desire for predictable budgeted payments and fewer surprises at resale has prompted a renewed interest in the closed-end lease. Continued fleet conversion is expected in 2007; however, the reasons are varied. Some common reasons for conversion include compliance with international accounting standards (for the moment) and eliminating residual risk exposure. Still, other fleets have found they can drive costs from their bottom line by converting to a closed-end lease.

Simply put, the closed-end lease is not right for everyone. Every fleet and company has unique needs, pressures, and expectations. Remarkably, though, the greatest influence the closed-end lease may have on the fleet industry in 2007 is as a model for fleet efficiency.

Lessons from Closed-End Leasing
First, do not miss the forest for the trees by focusing on the monthly payment. Fleet management companies have teams of experts dedicated to examining and forecasting vehicle lifecycle costs to create closed-end payments. They must consider acquisition cost, vehicle condition, resale value, interest rates, and other factors. For a fleet management company, the goal of creating a closed-end payment should be to provide the lowest payment based on a company’s vehicle needs and driving habits, then matching mileage and months in service to those needs. This means setting realistic residual values based on market data and economic factors. Fleet management company attempts to underestimate residual values should become apparent in higher-than-market monthly payments.

This also raises transparency issues and the market’s distaste for the “closed” closed-end lease construction. Some closed-end products allow transparency, so it is inaccurate that all closed-end lease constructions hide something.

A fleet manager often must be the expert when evaluating the factors of a company’s lease payments. When reviewing open-versus closed-end leasing, do not focus solely on the payment. Also, educate financial officers who may try to establish a low open-end payment by selecting a very low depreciation rate. While this may be a short-term business objective to help meet certain company goals, major costs often result two to four years later when big resale losses must be taken.

Open-End Lease Can Be Misused
Let’s be clear, the open-end lease is not a bad lease structure in itself. Difficulties occur when companies abuse its flexibility and ignore expert advice on potential costs from major resale losses or additional cost as vehicles are extended past optimal lifecycles. The lesson is not that closed-end leasing is better, but that the construction can, in many cases, force a better discipline in managing company vehicles.

Another example concerns vehicle condition. Many companies have stayed away from closed-end leases due to a past reputation of lessors applying unfair wear-and-tear charges at lease-end. Many see this practice as the lessor’s way of recouping potential losses from over-estimating residuals. Some would call it a “bait-and-switch” strategy to create competitive payments up-front with an alternate avenue to recoup money later. While lessors may have conducted business differently in the past, today, more process-driven approaches in the marketplace allow companies greater input in unfair wear-and-tear discussions.

In addition, the biggest misconception concerning open-end leasing is that assessing unfair wear and tear does not occur. It absolutely does, and while the magnitude it has on resale values can be debated, the impact can be seen at auction lanes. Despite the availability of detailed data, few companies take recourse against drivers who have clearly abused a vehicle.

Under the closed-end process, an independent party should conduct a condition report. The report should be provided in advance so certain wear-and-tear infractions can be fixed, reducing issues at lease-end. The information should allow fleet managers to pass the responsibility to the proper party — the driver — helping a company enforce its damage policy and to charge drivers for unreasonable excess wear and tear.

Once again, this process is not exclusively tied to a closed-end lease; it can easily be established in the open-end lease scenario as well. As a fleet manager, you choose how to enforce the policy and whether your company will accept charging drivers for abuse. One big plus under the closed-end lease policy is that this process will be followed every time. Have an independent report conducted, tied neither to the lessor nor your company, that allows a fair assessment of a vehicle’s condition.

While a company car often doubles as an office and can feel like a home, that is no excuse for causing excess vehicle wear and tear. Drivers should be held accountable for their vehicle’s condition no matter the lease type. Fleet policies should be clearly defined to discourage and even penalize drivers for abusing their vehicles.

Educating Fleet Committees
As the fleet advocate within your company, you are often tasked with educating others on the fleet industry and the vast array of products and services available. This often means working with cross-sectional committees looking at cutting fleet budget costs. Use this situation to share the realities of total cost of ownership and the pitfalls associated with purchasing based off the lowest capital cost or monthly payment.

Our industry is changing in many exciting ways. Technology is paving the way for fleet managers and their partners to gain access to critical vehicle data directly from the vehicle itself. Improved safety features of today’s vehicles and extended warranty coverage are helping enhance and improve fleet cost management. When selecting the best lease structure, make sure to take the time to learn what is available and don’t let past perceptions preclude an option that could be a viable alternative in the future. Presenting an “apples-to-apples” comparison of available options — after all — is the most important first step.

As Market Grows, So Does the Closed-End Product
The closed-end lease is not right for every fleet. But as the need for this lease type grows, the closed-end lease will adapt to meet changing fleet requirements. Creative new closed-end products will overcome a perceived inflexibility and higher cost. Fleet management companies already offer recalculation solutions to avoid under- and over-mileage penalties. Closed-end leases with complete transparency are out there, providing a unique way to “de-risk” your fleet while offering the comfort of knowing all your cost components. Even if a closed-end lease is not right for your company, the process of examining this option could shed light on ways to make your fleet more efficient and cost-effective. In the end, that is what most companies are looking for anyway.

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