Rising costs and a sluggish economy have forced fleets to rethink their budgets as they attempt to do more with less. An increasing number of companies are looking to cut costs by extending vehicle replacement cycles so cash flow can be diverted toward other expenditures. Whether extended cycling pans out for a company depends on factors such as fleet utilization, operating costs, and the length to which they're extending cycles. If there is life left in the existing fleet with minimal impact to maintenance, keeping vehicles in service longer may be a good cost-saving strategy.
Fleets in most business sectors are experimenting with extended cycling. For example, service fleets, which often have higher cap costs due to upfitting, tend to keep their vehicles in service longer than other fleets. These fleets are accustomed to paying more maintenance expenses near the end of the vehicle life, stretching out the lifecycle by as much as 15,000 miles over recommended replacement parameters if they feel the strategy will pay off in the end. More and more sales fleets are willing to embrace this philosophy as well, extending lifecycles by several thousand miles in some cases.
Budget constraints have encouraged more fleets to be creative with cost-cutting strategies, and nothing is off the table. Some companies have adopted a wait-and-see strategy, perhaps skipping an ordering cycle as they anticipate the economy to pick up. Individual vehicles are replaced only when necessary, when safety concerns arise, for example. A related strategy is "right-sizing" the fleet, or reducing the number of excess vehicles. Some companies are streamlining their fleets either by having drivers share vehicles when appropriate, downsizing their workforce, or redefining employee job functions to eliminate a portion of the fleet.
The economic downturn precipitated the adoption of many cost-saving suggestions, including extending vehicle lifecycle when appropriate, that fleet management companies typically recommend to their clients. Sometimes extending vehicle lifecycle when appropriate is a smart way to save money and to get as much life out of fleet vehicles as possible.
Current Industry Trends
Fleet managers are extending current replacement cycles for various reasons, primarily due to the economic environment and declining resale values.
Today's economic conditions make companies scrutinize cash flows. The past two years of the recession have strained companies' cash flows due to declining revenues and limited available credit in the financial markets. In addition, credit risk downgrades further impacted available credit lines and increased interest rates offered. As a result, capital expenditures have been significantly reduced, and fleet managers are under more pressure than ever to reduce total operating costs.
Since depreciation is the largest portion of fleet expense, some fleet managers and industry professionals believe extending the replacement cycle by a particular period of time lowers fleet operating costs. If the extension is longer-term (more than six months), uncertainty in resale markets, unscheduled maintenance, and subsequent downtime can more than offset the depreciation cost billed. Declining resale values largely contribute to extending vehicle cycling.
Several factors, from the economic environment to fuel prices, impacted resale values. Beginning in fourth quarter 2007, the resale market started to soften due to the economic slowdown. Demand for used vehicles declined as the typical buyers of these vehicles, the subprime segment, could not qualify for loans. In addition, vehicle owners found themselves "upside down" with respect to their auto loan situation, contributing to the decreased demand for used vehicles. To add insult to injury, the increase in fuel prices in the same time period stifled resale values for less fuel-efficient vehicles. Decreased demand, in combination with increased manufacturer supply and higher fuel prices, resulted in a significant drop - up to 8 percent per year in resale values for some asset types in 2007 and through the first part of 2009.
What is the outlook for future years? Fuel prices have remained relatively stable and resale values have improved, returning to 2007 levels. Future prices for fuel ultimately will rise with the improvement in the global economy; however, by how much prices will increase has yet to be determined.
Long-Term Cycling Trends
Within commercial fleets, the long-term trend in vehicle cycling has been a gradual increase in the service life of vehicles since 2007. Industry data indicates light-truck fleets (including those with cargo vans) have steadily pushed out their turn-in targets by about five months per year over 2007 averages. Sedan fleets increased at a similar average rate.
Economic pressures to realize short-term cost savings influenced decisions to control costs by deferring replacements and extending cycling parameters. However, the picture isn't as clear-cut as the numbers may indicate. Up to fall 2009, the increase in cycling timelines has been gradual, and only recently industry data has shown significant lengthening of cycles.
With the additional exposure to significant maintenance issues and declining gains on sale from extended cycles, the current trends in cycle extension are not expected to be sustainable. Indications already signal truck fleets are backing off somewhat from longer service lives, and sedan fleets' current push most likely represents an annual pattern that will continue to decline as the year progresses. In the end, the industry may see moderate service life extensions of less than six months as replacements are deferred short-term, but this by no means is indicative of a large-scale shift in commercial fleets' approach to vehicle replacements.
Reasons Favoring Extended Cycling
Extended cycling can be a preferable replacement policy for the right company and for the right reasons. Over the past few years, manufacturers have improved quality, warranties, and vehicle dependability, thus making some decisions to extend less-risky fleet assets, especially light-duty trucks. Many fleets are now moving to the 75K-85K mileage replacement parameters as they encounter more pressure from management to hold on capital expenditures. With manufacturers reducing fleet incentives, cap costs may increase with shorter-term cycles, and that can play into holding and extending.
Annual mileage may also be a condition of extension since a lower mileage vehicle will be less susceptible to major mechanical or beyond warranty claims if maintained according to manufacturer recommendations. Telematics has maximized asset life. Diagnostic information and driver behavior habits can predict or control a vehicle's overall health and whether the company asset is being driven abusively or within policy. It is no different than any appliance in the home; if well-maintained and used correctly, the appliance enjoys long life.
Today's 65,000-mile vehicle is tomorrow's 75,000-vehicle in terms of quality perception due to telematics information and data. A secondary buyer will pay top price if he/she perceives the vehicle has been driven carefully and maintained well.
Corporate image is another factor to consider. What image does the fleet project to companies or vendors every day?
Overall, how fleet managers determine their fleets can be extended should always consider lifecycle costing (which includes depreciation and financing), driver behavior/effective training, how fleet affects and is viewed by other departments in the organization, and the ability to measure risk factors such as downtime, warranty coverage, and budget considerations.
Reasons Against Extended Cycling
Reasons to remain in a typical fleet cycle are abundant as well. Maintenance costs are rising, older vehicles present more risk, and remarketing efforts are more difficult with higher-mileage vehicles.
Maintenance costs rose in 2009 due to higher cost of replacement tires, PM oil changes, and labor rates. OEMs are also predicting production changes in 2011 will impact operating costs due to emissions mitigation, fuel economy, and telematics technology. We may begin to see repairs that require more time, labor, and cost.
Replacing a vehicle in a typical cycle of 55,000-65,000 miles brings the lifecycle cost to its maximum efficiency. No maintenance surprises, better fuel economy (especially in light of newly mandated CAFE standards with fuel engineering), tire pressure monitoring systems, navigation, and sensors can all help extend or maximize vehicle lifecycle.
Without proper cycling policies, catastrophic component failures happen, usually unbudgeted costs. Those who choose an extended cycle route may see increased insurance cost and major mechanical and downtime due to unpredictability factors. Driver productivity, more-attractive resale opportunity maximization, and increased safety are other strong reasons that present advantages when benchmarked against extended cycling.
Additional Reasons Against Extended Cycling
The most significant, and uncertain, expense to control when extending vehicle cycles is the impact on the maintenance budget. However, there is one certainty: maintenance expense will go up. If it didn't, OEMs would not offer limited warranties. The question is, by how much will maintenance costs rise?
Other arguments against extended replacement include:
1. Loss of OEM volume incentives. OEM volume incentives may be impacted by decreasing the annual order. For example, if a 1,200-unit fleet with a 36-month/75,000-mile cycle extended the cycle to 48 months/100,000 miles, and the difference in the volume tiers reduced the incentive from $2,000 to $1,500, the impact for the new four-year cycle could be $600,000. The loss of $600,000 would equal depreciation for 30 vehicles. Note: incentive refers to customer-negotiated OEM incentives.
2. Increased maintenance costs. Maintenance expense becomes unpredictable and more expensive.
3. Increase in downtime costs (including loss of driver productivity). Lost business from a missed job, missed opportunity from a sales call - however a company defines downtime - can be a controversial topic due to the difficulty involved with calculating the rate and buy-in required to accept cost avoidance or missed opportunity value. Most fleet managers and industry professionals agree there is a cost to downtime, so here the value as assumed to have for the fleet in the previous example had calculated a downtime cost of $100 per hour.
Downtime directly correlates with maintenance, specifically, the hours involved with a vehicle and driver out of production due to maintenance occurrences. Critical repairs tend to see higher downtime costs per repair due to complexity of the repair, and the time required to complete is longer than more routine repairs.
4. Decreased employee morale. Many companies view fleet vehicles as employee perks, and newer vehicles are seen as even bigger perks, especially vehicles employees can order themselves online through a driver order management application. When employees are given older vehicles with higher mileages, employee morale can suffer, especially when the vehicles are much older and experience frequent repairs.
As the frequency in repairs increase, many employees perceive the vehicle as more a nuisance and do not care for the vehicle's internal and external condition the same as they would a newer model. The direct result is a lower resale value due to below-average condition status.
5. Company image. Body damage, rust, peeling decals, and breakdowns on the road occur with older vehicles. The condition of a company's vehicle may be the first impression a customer or prospect may get when they see the vehicle. If a company markets itself as a high-quality repair business and the service van shows up with body damage and rust, the customer may relate the presentation of the vehicle to a lower quality of repair.
6. Lower resale values. Keeping vehicles longer results in higher-mileage vehicles sold at auction and subsequent lowering of resale values. In addition, competition with newer model-year vehicles being released, even if the older model-year purchased has zero miles, negatively impacts the older vehicle. For example, if a 2010 model-year vehicle is purchased new with no miles when the 2011 model-year vehicles are introduced, the older model-year vehicle will realize a lower resale value (approximately $2,000 for common sedans) if both model-year vehicles are sold at the same time in the future with the same mileage. The reasoning is the newer-model vehicle's technology and fuel economy may be better, and the vehicle may still be covered under the OEM warranty versus the older model.
7. Unbalanced cash flows from irregular ordering. Extending cycling based on current cash flow requirements upsets future cash flow budgeting for subsequent years. Chart 5 illustrates the impact on depreciation expense with a 1,200-unit fleet when the fleet manager simply defers the current vehicle cycle to the following year. The fleet will see an increase in depreciation of 44 percent or more than $200,000 in the second year, provided the fleet manager reverted to prior established replacement parameters.
In short, it is difficult to get back on track once the budget has been disrupted, as budgets are typically set based on prior years' expenses. In addition, if the economy worsens the following year, the problem would be exacerbated to the point the fleet manager may defer the second-year cycle. Thus, in the third year of the cycle, a much larger number of vehicles would need to be ordered at higher capitalized costs. Cash flow shift to maintenance and fuel expense would occur as well as lost volume incentives from OEMs.
Impact on Acquisition Budget
Budgeting for vehicle acquisitions varies according to whether fleet vehicles are leased or owned.
Under ownership, most companies must establish a capital budget for acquiring assets. The capital budget is for the total acquisition cost of the vehicles planned for replacement. Thus, a critical step in preparing the budget is accurately forecasting the number of vehicles requiring replacement. Once the budget is in place, acquisitions are made using a capital expense authorization request. Because of the nature of the budgeting process under ownership, oftentimes vehicle acquisitions are made at a less-than-optimal time of year, for fear of losing the capital budget later that year.
In companies that own vehicles, deferring replacement to save money on the capital budget is easy. For that reason, oftentimes poor replacement practices are seen in which short-term capital expenditure savings are sacrificed for longer-term expenses and productivity impacts. The net result can be a very old fleet with a high incidence of spare vehicles, as spares accrued are no longer depreciated on the books.
There are many examples of companies that own their vehicles and have educated their business planners on the needs of fleet and best practices that allow fleet performance optimization. They have convinced their business of the need for regular replacements, total cost of ownership (TCO) management, the impact of driver productivity, optimal fleet sizing, etc.
Acquisition budgeting for leased vehicles is a bit easier. Generally speaking, one lease payment is traded for another, plus or minus residual gains and losses, and any impacts from new-vehicle price changes. In the leasing example, the critical factor becomes optimizing the TCO. Here, all the cost factors such as depreciation, maintenance, fuel, driver downtime, etc. are all accounted for in the replacement decision.
When everything is accounted for, the fleet manager is left with a net impact to the budget based on the change in TCO for the combined factors that drive operating cost. Typically, the fleet budget will fluctuate plus or minus 5 percent annually, depending on the outlook for fuel prices, interest rates, and over-inflation for new and used vehicles.
Sources contributing to this White Paper:
● Trudi Beardsley, manager, strategic consulting & financial modeling, GE Capital Fleet Services
● Mark Conroy, vice president sales & marketing, Union Leasing Inc.
● Greg Corrigan, vice president, strategic business services, PHH Arval
● Paul Fortin, vice president, asset risk management & analytics, LeasePlan USA
● Dan Hannan, senior vice president, strategic consulting & environmental solutions, Donlen Corp.
● Brad Jacobs, client consultant, Donlen Corp.
● Les Lynott, remarketing manager, Emkay Inc.
● Joe McDonald, senior director, account management, Wheels Inc.
● Evan McKerns, strategic consulting services manager, Donlen Corp.
● Anthony Foursha, manager, strategic consulting, ARI - Automotive Resources International
● Gary Scanlon, national sales manager, Merchants Leasing
● Chris Tepas, executive vice president, Emkay Inc.
● Scott Tepas, client service & fleet analytics manager, Emkay Inc.