Evaluate Supplier Contracts the Smart Way
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Much of what fleet managers do today is governed by contracts and other similar agreements. Contracts with suppliers can cover everything from acquisition to disposal, from maintenance to accident reporting, even simple administrative tasks such as paying parking tickets and renewing vehicle registrations.
Many companies have purchasing rules that require rebidding all contracts when they expire. Others allow a manager to extend existing contracts. Still others don’t have any hard and fast rules, leaving it to the manager of the supplier to decide. But, smart fleet managers will review all existing contracts regularly; the goal being to make them more cost efficient for the company and more effective for both the company and the supplier.
Making the Best Deal
Beyond the standard, boilerplate language in all fleet-related contracts there are several areas where key, direct elements of the program(s) are found (See Sidebar, “Defining the Contract Basics”). It is within these sections that a smart fleet manager can evaluate existing contracts, to the company’s advantage:
Pricing: The foundation of any contract. is pricing. In a fleet-related contract, this can include (in a leasing scenario) capitalized cost schedules for factory orders as well as out-of-stock orders, lease rate elements including funding and administrative fees, or, if the agreement is for a buy/sell program, any fees for both the purchase and disposal of vehicles. Added to these would be any fees for services such as maintenance management (most often a per-vehicle, per-month fee), accident management (per occurrence for reporting and repair management and a contingency fee for subrogation), and either per-occurrence or per-vehicle, per-month fees for administrative programs such as tag renewals and parking ticket payment.
Implementation: Once any fleet program has been chosen, there is nothing more critical to its success than implementation. This process will usually be outlined in the contract. If it isn’t, it should be.
Performance metrics: Suppliers should be held accountable for their performance under the contract. This is defined in a performance agreement. Such agreements can be entered into the contract itself or as an addendum. In order to be effective, performance agreements must contain specific metrics by which performance can be measured, and a regular reporting mechanism to track it.
Payment terms: The payment terms for a fleet leasing agreement should include how billing for new units commences (e.g., is there interim rent, or does the lessor use the “rule of the 15th” to determine when billing starts), and when it stops. Also, if the lease is a TRAC lease the timing of the application of resale proceeds should be outlined. If the lease is a closed-end lease, mileage penalties, and a definition of “excess wear and tear” should be included.
Negotiating the best deal for a company’s fleet with a supplier involves defining pricing, implementation, performance metrics, and payment terms. Re-evaluate the contract every six months or so.
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Choosing the Right Time
Even if a supplier contract is just a few months old, the environment in which it was originally signed has inevitably changed. For that reason, effective fleet management should include not only bidding out products and services, but continually evaluating existing contracts.
There really isn’t any fixed schedule for such evaluation. It has been said that contract negotiation is an ongoing process, which does not end with signatures on the last page, and fleet contracts are no exception. But, it is smart to allow a contract relationship with a supplier to “settle in” for some period of time before evaluating the document and seeking changes.
It’s a good idea to wait at least six months to a year before embarking on an evaluation of any existing contract, to allow for everyone involved (drivers, their managers, the fleet department, and the supplier) to become comfortable with the program. After that, again there is no set schedule a fleet manager can depend on to determine when the evaluation of existing contracts should occur. One trigger of the evaluation might be a major change in the industry, e.g., new regulations or pricing changes that might impact the capitalization schedule in a lease agreement, even an acquisition or merger involving the supplier (or the fleet’s company). An exception to this is in the implementation, if it is covered in the agreement. Most suppliers are well aware that the first implementation of a program will seldom end up being fully effective; there are always small changes in processes that replace those that don’t pan out in the initial stages.
It isn’t a good idea to evaluate an existing contract if the relationship with the supplier involved is on the rocks. Renegotiating contract terms when there exists the possibility of one party or the other terminating the relationship will only increase any tension between the two. Because changing a fleet supplier can’t be done overnight, making a difficult relationship worse can only cause problems for a fleet manager, and the drivers he or she serves.
Logically, the single most important section of any fleet contract is pricing. Whether it is for a lease, a buy/sell agreement, or for fleet management services it is the pricing that will make up the bulk of any costs associated with the relationship. Let’s begin with a leasing contract:
Capitalized Cost: If the lease is a typical, fleet TRAC lease, the agreement will outline four capitalization schedules: first, for the “big three” OEMs (and possibly for one or more of the major import brands), factory orders will be some dollar amount below or under factory invoice cost. Next, for the smaller import brands, it would be closer to straight factory invoice. Emergency orders from dealer stock will carry some markup on the negotiated price, either a percentage, or a straight dollar markup.
If the fleet has chosen to move from a domestic OEM to one of the import brands, it is reasonable to review the fleet’s existing contract and bring the lessor into negotiations to improve factory order pricing. Or if the company, for whatever reason, tends toward a great number of stock orders it might be time to negotiate a percentage markup to a fixed dollar amount, or a reduction in either case.
If the fleet has increased in size, organically or via a merger or acquisition, the increased number of new orders each model year would justify evaluating the overall capitalization schedule to better reflect the greater volume the fleet will be providing the contract holder.
Lease Rate Factors: Most TRAC lease contracts contain three elements: depreciation reserve, funding cost, and lease or administrative fees. It is usually left to the lessee to choose a depreciation reserve rate; most often, it will range from 36 months for very high-mileage or severe-use vehicles on up to as much as 72 months for low mileage or executive vehicles. Most lessors won’t mind if the fleet customer chooses an unusually short reserve rate, for example 24 months, but will contractually limit longer rates to that 72 month (6 year) figure. The large majority of fleets will be satisfied with some rate of less than 72 months. But, if the fleet has specialty vehicles, which can economically be kept in service longer, the fleet may be able to negotiate the existing contract limits a bit higher to better suit those needs.
Fleet lessors usually provide a proverbial market basket of funding options to their customers, including commercial paper (issued by the lessor or some other corporate entity), treasury issues, funding from the securitization of the lessors’ funds streams, even LIBOR (London Interbank Offering Rate) and the old standard of bank prime rate funding. And, they offer all of them as either fixed or floating rate funding. The contract will usually provide the customer with the option to choose any of the funding options at any point in time even to opt to fix existing floating rate leases, or float fixed rate leases.
A change in the fleet company’s financial position, however, might trigger the need to evaluate that existing contract, to add or access funding sources that it does not at present offer, for example, self-funding.
The third element of the TRAC lease rate factor is the lease or administrative fee. It is expressed as a percentage of the capitalized cost and included in the overall lease rate factor. Once again, if the fleet has grown in size, the administrative fee in the contract may not reflect the new volume, and most lessors will be willing to renegotiate it lower.
Evaluating Management Programs
Fleet management programs can be priced in the contract as separate fees, or even included in the overall rate factor. Fees for the most popular programs are expressed as follows:
Maintenance Management: Maintenance management fees are generally contracted as per-vehicle, per-month fees, and include all elements of the program. Depending on fleet size, they can be as low as $2 and as high as $8 per vehicle per month or higher. As with most fees, pricing maintenance management fees are based on fleet size. Unless there is a change in the size of the fleet, there is little that can be negotiated.
It is possible that, if it isn’t already part of the contract, a fleet manager can discuss sharing a portion of what is sometimes called a “rebill discount,” the volume discount the FMC receives from a maintenance provider for reselling its services to its fleet customers. Also, there is typically language in a contract for maintenance management providing for a surcharge for the use of a repair facility not in the suppliers network. The fleet’s circumstances might make using a local independent shop a better solution than using the typical national account chains most maintenance management providers use. The contract may have a process whereby such local shops can be brought into the network (if not, this should certainly be covered in overall implementation discussions); if the shop omplies, there won’t be a surcharge. But, if it agrees to become part of that network, but refuses to provide the supplier with that rebill discount, the surcharge may be negotiable.
Accident Management: Accident management programs consist of three primary elements: accident reporting, repair management, and subrogation recovery. Fees are generally rather simple, a per-occurrence fee for reporting and repair management, and a contingency fee for subrogation. There are ancillary services, such as replacement rentals, but usually there are no fees involved. The fleet manager presumably has negotiated all the above prior to signing the contract, and evaluating this portion of a contract is not likely to be viewed favorably by the supplier.
However, as with any contract, a change in the size of the company’s fleet would make it reasonable to ask the supplier to renegotiate fees more reflective of a larger fleet. Other than that, there isn’t much in an accident management program that is negotiable.
Fleet Fuel Card: Fleet fuel card programs are among the fastest growing fleet service programs in the industry, and they help fleet managers manage by far the largest variable or operating cost they face.
Fuel card programs can be part of an overall bundled contract, or are incorporated under a separate contract. Either way, there is a level of negotiation involved that can actually be fairly lucrative for the fleet.
The contract (or section of the bundled services contract) will contain a number of items, most of them having to do with the issuance of cards, payment terms, cancellation of lost or stolen cards, and reporting. But, that key element involves revenue sharing between the fleet and the card provider. The credit or charge card industry operates primarily on what is called interchange; interchange is the fee charged by the card issuer to merchants that accept the card. Interchange is a very small number: for typical retail type credit cards (MasterCard or Visa, for example) it is roughly 1.5 percent of the transaction, give or take a few tenths of a percent. For fleet fuel cards (which are not credit cards; as with an American Express card, the full balance of the fuel card must be paid each month) interchange is in the area of a full percent higher, around 2.4-2.5 percent. The credit/charge card business is a very high-volume, low-margin industry.
That, however, does not mean that there isn’t room for a fleet manager to negotiate some level of revenue sharing with a supplier; this was, presumably, done at the time the contract was originally negotiated. If not, and the fleet’s fuel annual volume is at least $1 million per year (this isn’t as much as it may seem at first glance; a fleet of 300 vehicles can generate that much at current pump prices), evaluating that existing contract can result in negotiated revenue sharing that can bring tens of thousands of dollars per year back to the fleet.
Whatever the product or service, there are several basics that appear in most if not all contracts and service agreements. These include:
Definition of parties: Usually found in the opening paragraphs, this defines the participants, and how they will be referred to in the rest of the contract.
Dispute resolution: In the event there is a dispute between the parties, the contract will outline the process by which it must be addressed and remedied. Arbitration, mediation, legal processes are some of the ways that contract disputes can be resolved.
Choice of law: Nearly all contracts will indicate which state’s laws will govern the contract. Predictably, if the supplier and fleet are incorporated in different states, each will press for their own state to govern the agreement.
Indemnity: This is where both parties agree which of them will cover the cost of any disputes brought by third parties.
Force Majeure: Sometimes called “act of God,” this standard language holds that the contract can be suspended in the event of an unforeseen disaster, such as an earthquake, flood, hurricane, or other natural disaster.
Final Agreement: Or “integration,” this language states that the contract represents the final agreement of the parties; often, integration states that any prior discussions or interaction is replaced by the contract, and any changes must be in writing.
These are examples of what is often called boilerplate contract language, which appear in nearly every formal contract. Boilerplate does not generally address the product or service, pricing, or processes provided by the supplier, but are important to any legal review by either the fleet or the vendor.
Existing contracts are often only evaluated when they’re reaching the end of the contract term, as part of a regular rebid. But, smart fleet managers will consider the idea of evaluating those contracts regularly, on an ongoing basis, based on new information, changes in the industry, or changes in the fleet itself. But be careful when doing so. Doing it the wrong way can seriously upset an otherwise solid relationship with a supplier.
In order to take the evaluation to the next level — renegotiation of existing terms or pricing — have a good reason to do so. That is, don’t constantly hit suppliers up for further discounts or concessions. You and they have negotiated the existing contract in good faith, and you and your company have accepted the final offer; unless there is a significant change in circumstances, live up to the original agreement. But, if those circumstances have, indeed, changed, don’t hesitate to evaluate and approach the supplier(s) to renegotiate. If you do, lay out your case clearly and concisely. For example, your company has merged with another, or your volume has increased. This being the case, you are well within business ethics to ask that pricing be adjusted to be reflective of the fleet’s volume.
Don’t move from evaluation to new demands until you’ve given the new program some time to become established. Keep in mind how important the implementation process is to any program’s success. Adjust the implementation of processes and procedures as any flaws in the original plan become apparent. Let the program run for at least six months before evaluating the contract.
Keep in mind that most FMCs interact regularly, and you don’t want you or your company to get the reputation of constantly demanding concessions and price reductions without good reason.
Never think of, or treat, suppliers as adversaries. Treat them as partners, communicate regularly, work closely with them on making the product or service a success. But, keep in mind that, under the right circumstances, you will be acting in your company’s best interests to evaluate contracts and make any necessary or earned changes.