Measuring True Fleet Cost Savings
Image courtesy of iStockphoto.com.
There have been a number of attempts to point out that the company fleet is something other than an expense — “turn your fleet into a profit center” — but the fact of the matter is that no matter how you slice it, fleet is a cost center. It is unfortunate, also, that no matter what else a fleet manager accomplishes, his or her performance will be judged on the ability to control, and reduce costs. Thus, it is important that fleet managers know how to measure those reductions, and even make the case for holding the line.
The first step is a relatively simple one: laying out fleet cost categories.
Fortunately, fleet managers have had this done for them for decades; the NAFA Fleet Management Association set up standard cost categories a long time ago. In general, they are:
• Depreciation (or lease costs).
• Funding costs (if owned).
Fixed costs are those associated with “having” the vehicle, whether owned or leased. Operating (sometimes referred to as “variable”) costs are those associated with the use of the vehicle. The combination of the two, make up the total cost of ownership (TCO) of a fleet vehicle. Defining fleet costs is an important first step in measuring savings.
Fleet managers are smart to go where the dollars are: depreciation (fixed) and fuel (operating). Both can make up as much as 70% or more of their respective cost categories, and are the best first targets for savings.
Depreciation is simply the difference between the original cost of a vehicle and its resale proceeds after it is sold. Thus, it can only be calculated after the vehicle is out of service and sold.
For vehicles that are leased under a typical fleet open-end TRAC (Terminal Rental Adjustment Clause) lease, the major portion of the monthly lease payments is put into a “reserve” for depreciation.
At term, when the vehicle is sold, the proceeds are applied to the remaining book value of the unit; any excess is returned to the lessee, any shortfall is paid by the lessee.
Sometimes, fleet managers will adjust the depreciation reserve rate, that is, increase the reserve so the book value is lower than it was previously (but resulting in higher lease payments), increasing the possibility that there will be an excess of resale proceeds returned to the lessee. Conversely, sometimes the reverse is done, where the reserve for depreciation is made smaller, resulting in lower lease payments (but a greater chance of a shortfall vs. book value when the vehicle is sold).
Claiming that, in the first instance, lower lease payments are “savings,” or, in the second instance, that the increased resale proceeds are savings is patently wrong. Such adjustments are simply subject to a “pay me now or pay me later” rule. While one or the other, depending on the size of the adjustment, might result in a lower present value for the total lease payments (including any TRAC adjustment), such savings will be nominal.
One true measurement for depreciation savings is to determine the percentage of the original value retained after the vehicle is sold. This is simple, here’s an example:
The higher the percentage, the greater the savings; this method will take into consideration price differences from one model year to another, as well as seasonal used vehicle markets. Don’t get caught into the “timing trap,” where an adjustment to an arbitrary value (depreciation reserve) changes only the timing of payment.
Fuel costs dwarf any other operating expense category. But, what makes it different from depreciation is the volatility of its cost. While the used-vehicle market does impact depreciation, and there is some movement in used vehicle prices (much of it is seasonal, but can be impacted by weather and other events), the volatility in fuel pump prices can be dramatic, with prices sometimes changing by 100% or more within just a few months. Thus, it can be tricky to calculate true savings.
As with any variable cost, the key starting point in expressing fuel cost isn’t just dollars: It is how much use those expended dollars provide. The cost/use ratio for fuel can be either the universally accepted miles per gallon, and/or the more fleet-specific cents per mile ratio. Thus, the simple achievement of spending fewer dollars this year than were spent last year says nothing; any number of things could have impacted that number, starting with reductions in the fleet.
Cost per mile, as it relates to fleet variable expenses, is relatively simple arithmetic:
Make certain that the first formula —converting — is done. Not doing so can result in confusion, as the final number would be expressed in dollars per mile.
Do the calculations for the prior year, then for the current year. You will need to know how many total miles your fleet drives in a year, a reasonable estimate will do, provided that estimate is used for both years’ numbers.
These are two simple examples of how fleet managers can calculate and measure true savings, using the two largest fleet cost categories.
The most important point here is that mere changes in cost elements of cash flow, for example, a change in depreciation reserve, are not representative of true savings. All that does is to change the cash flows involved (i.e. reducing depreciation reserve will lower lease payments, but results in an increase in unamortized book value and a decrease in TRAC gains or creating TRAC “losses”).
Also, it is obvious that any savings should be calculated using a cost/use ratio: Total dollars reflect nothing as it pertains to fleet costs unless they relate to the vehicle use they permit.
It is sometimes tempting for a fleet manager who has been running a fleet for several years to allow themselves to slip into noting mere changes as savings. Fleet costs are, like many other costs, subject to the law of diminishing returns. Say, for example, that a fleet manager new to the job hits the above mentioned fleet costs (depreciation and fuel) hard, looking for ways to show true savings. Clearly that’s where the money is.
And, say that he or she finds ways to accomplish substantial true savings. As time goes by, and the fleet manager’s efforts squeeze more and more waste out of the fleet budget, finding true savings large enough to communicate to management will become more and more difficult. After all, the fleet manager’s efforts presumably result in a smooth running, efficient operation. It is at that point where the temptation to “find” savings moves over to things such as a change in the depreciation reserve rate. Indeed, a fleet manager with several years’ experience at the company who claims hundreds of thousands or millions of dollars in savings might as well be asked what he or she has been doing for the last few years, that such savings are even possible.
Finally, it is possible for a fleet manager to show as true savings efforts that result in a cost increase that is lower than what might have been expected.
Fuel costs are a perfect example of this. Because pump prices are so volatile, increases within a year’s time can be substantial, 100% or more. If a fleet manager, via downsizing, more efficient scheduling or routing, and elimination of fraud and other abuses, is able to keep increases (in the face of that 100% increase in pump prices) below the increase in prices at the pump, it is perfectly acceptable for a fleet manager, in such a case, to define a 70% increase when prices rise 100% as true savings, under the category of “cost avoidance.”
Management generally is not very well versed in fleet cost categories and what impacts them. But, senior managers don’t become senior managers unless they’re smart, and attempts to pass “savings” that aren’t really savings along will eventually be questioned.
Keep in mind:
- Mere changes in cash flow aren’t true savings.
- Maintain good cost history against which to measure current efforts.
- Keeping increases below what might be expected when elements that impact costs increase — cost avoidance — are indeed true savings.
Be accurate, know what defines true savings (or cost avoidance), and communicate them clearly and concisely to management. Doing so will help fleet managers along a rewarding career path.