Extending vehicle replacement cycles is a cost-cutting strategy explored by an increasing number of companies to divert cash flow 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 cycles are extended.
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 total costs. However, 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 saving.
Before making the decision to extend replacement cycles, consideration should be given to the impact on residual resale values; the potential costs and impacts of vehicle downtime and loss of productivity; the increased probability of safety-related issues; the impact deteriorated vehicles have on company image and driver morale; and the degradation of fuel economy. It is also significant to recognize that if replacement order delivery is slow, potential savings previously gained on paper may be mitigated by these unforeseen circumstances and may not be recovered in vehicle resale.
As senior management, it is critical to be aware of and fully understand the consequences of extending vehicle lifecycles.
Long-Term Cycling Trends
Since 2007, the long-term trend in vehicle cycling within commercial fleets has gradually increased due to economic pressures to realize short-term cost savings.
Initially, declining resale values largely contributed to extended vehicle cycling. Beginning in fourth quarter 2007, the resale market started to soften due to the economic slowdown. Used-vehicle demand 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.
Fuel price increases in the same time period also stifled resale values for less fuel-efficient vehicles.
However, the subsequent decreased supply of used vehicles has helped mitigate some of these resale concerns.
Reasons Against Extended Cycling
There are abundant reasons to avoid an extended fleet cycle: Maintenance costs increase, 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, preventive maintenance (PM), oil changes, and labor rates. It is also predicted future production changes will impact acqusition costs due to emissions mitigation technology. Repairs requiring more time, labor, and cost are also likely.
Replacing a vehicle in a typical cycle of 55,000-65,000 miles brings the lifecycle cost to its maximum efficiency, with nominal maintenance surprises and better fuel economy (especially in light of newly mandated CAFE standards).
Lack of proper cycling policies can result in catastrophic component failures - usually unbudgeted costs. An extended cycle route can lead to increased insurance costs, major mechanical failures, 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.
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.
Impact on Maintenance Budget
There are few benefits to the maintenance budget when extending replacement cycles - unless a company makes moderate adjustments to maintenance policy and manages the program very tightly.
Small shifts in replacement policy may be acceptable; PM expenditures may not increase, and the probability of catastrophic failure may not significantly increase. However, it is critical to establish and adhere to a policy that avoids additional sets of tires and brakes.
In most passenger vehicles, brakes are generally replaced every 30,000-45,000 miles, depending on the manufacturer and driving habits. Tires are typically replaced every 45,000-60,000 miles. Light-duty trucks, SUVs, and commercial vans may follow a significantly shorter cycle for brakes and tires depending on payload, application, driving conditions, and driving habits.
Increased PM expense for items such as timing belts, spark plugs, etc., ensues if cycles are not carefully planned and executed. If replacement cycles are extended beyond manufacturer new-vehicle warranty periods, unscheduled first-time maintenance repairs such as alternators, starters, suspension, and air conditioning become more probable and lead to thousands of dollars in unforeseen maintenance expense. With increased mileage, the frequency and probability of catastrophic failures (i.e., repairs in excess of $2,000) sharply increase.
Extended cycling parameters slightly below the next tire/brake/PM interval can minimize increased maintenance expense and reduce overall cost of ownership.
Budgeting for maintenance not under warranty is unpredictable, especially if routine maintenance does not follow recommendations.
Older vehicles may require more expensive repairs and face potentially catastrophic failures. Without proper routine maintenance, the timing of unscheduled repairs becomes even more unpredictable. More expensive brake repairs and repairs to heating, cooling, engine, transmission, and cab/sheet metal will increase disproportionately as vehicles age.
If senior management ultimately decides to extend vehicle cycling, fleet should implement a maintenance management program to handle the repair negotiations and post-warranty recovery.
Most fleet managers and industry professionals agree there is a cost to downtime. Lost business from a missed job, missed opportunity from a sales call - however a company defines downtime - can be a controversial topic, as it is difficult to calculate the rate and buy-in required to accept cost avoidance or missed opportunity value. 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.
Impact on Company Image & Driver Morale
Many companies view fleet vehicles as employee perks, and newer vehicles are seen as even bigger perks. When employees are provided older vehicles with higher mileages, morale can suffer, especially when vehicles are much older and experience frequent repairs.
If the driving force of vehicle change is unique to the company (i.e., drop in sales causing need to reduce expenses) and the change is not severe and expected to be temporary, most drivers likely will appreciate the situation and be happy to do their part to contribute. If the cause is more widespread (i.e., industrywide), again, drivers will tend to accept the change and for a longer duration.
The more severe the change and the greater the expected length of the policy change, the greater the likelihood of negative impacts. Vehicles can be very personal, and for some industries, an important influence on recruitment and employee retention. The cost can be significant if the company loses its top sales performer to competition that offers a driver-perceived better fleet vehicle and/or policy.
The cost will not hit the fleet's budget, but could have a dramatic impact on the company. Likewise, should the vehicle (or lack thereof due to breakdowns) impact the driver's ability to earn commissions or other compensation (e.g., route sales, services), clearly the situation would cause morale issues and again, the potential loss of valued employees -- not to mention the cost of hiring and training replacements.
In addition to internal morale, vehicles also contribute to consumer perception of the company. The condition of a company vehicle may be the first impression a customer or prospect gets. 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 repair quality.
A company's image could also suffer as vehicles age, wear out, break down, and at the extreme, appear unsafe. Such an appearance can be interpreted as the outward signs of a less-than-successful company.
The impact, of course, is greater when clients, customers, partners, vendors, etc., are exposed to the fleet as passengers or when the vehicle is on the road or parked in their facilities. Oftentimes, the driver and company vehicle may be the only tangible exposure someone has to the company, and as such, can have a significant impact on how the company is viewed by the outside world. It is important the vehicle's general perception is aligned with the desired perception of the company.
As the frequency in repairs increase, drivers tend to care less about the vehicle's internal and external condition than they would a newer model. The direct result is a lower resale value due to below-average condition status.
Further, if extended cycling gets to the point where vehicles are unreliable and proven unsafe, the liability exposure to the company is immeasurable.
Each company and fleet is different, so there can be no one answer to the question of the optimum cycle policy, and the impact of extending a policy will vary. Solicit input from all those who might be affected, directly or indirectly, including sales, service, HR, risk management, and any other stake-holding departments. This change should not be considered solely on the basis of bottom-line impact on fleet cost.
Lower Resale Values & Irregular Ordering
Keeping vehicles in service 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 vehicle purchased has zero miles, negatively impacts the older vehicle. For example, if a 2011 model-year vehicle is purchased new with no miles when the 2012 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 powertrain warranty versus the older model.
In addition, extending cycling based on current cash flow requirements upsets future cash flow budgeting for subsequent years.
Getting back on track once the budget has been disrupted may be difficult, 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 cost to downtime.
Cash flow shift to maintenance and fuel expense would also occur, as well as lost customer-negotiated volume incentives from OEMs. If fleet executives decrease the annual order, OEM volume incentives may be impacted. 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.
Impact on Fuel Efficiency
When a fleet manager extends replacement cycles, he or she gives up cost savings associated with a more fuel-efficient vehicle, whether for another make and model or with a similar replacement model.
The impact on fuel efficiency created by extended vehicle replacement cycles is two-fold:
■ New model-year vehicles continuously achieve better fuel economy.
■ As a vehicle ages, the performance of the vehicle deteriorates, decreasing fuel economy.
Some industry data suggests vehicles can lose up to 1 percent or more fuel economy per year. Future fuel price increases will exacerbate the cost of the additional fuel expense.
According to the U.S. Environmental Protection Agency (EPA) website (www.epa.gov), large sedans have been realizing better average fuel economy year-over-year for the past five years due to a variety of factors, including lighter-weight vehicles and vehicles designed to run more efficiently. In addition, OEM manufacturers are continuously developing and introducing new configurations, including more hybrid vehicles, to add to their vehicle lineups.
Compliance with the changing CAFE standards will continue this trend.[PAGEBREAK]
Leveraging New Technology
When examining vehicle replacement cycles, consider the benefits of newer engine technology. With fuel the largest fleet operating cost, advanced engine technologies offer opportunities to reduce fuel spend through better mpg.
As fuel prices increase, the impact becomes greater. With CAFE standards rising by 30 percent over the next five years, the effect of vehicle replacement acquisition costs will continue to increase.
(CAFE data is the sales-weighted average fuel economy, expressed in miles per gallon, of a manufacturer's fleet of passenger cars or light trucks with a gross vehicle weight rating (GVWR) of 8,500 lbs. or less, manufactured for sale in the U.S., for any given model-year.)
To combat rising fuel prices, combining a right-sized model with an increased focus on mpg can aid with selector list evaluation.
Fleets taking advantage of new engine technologies by timely replacement and moving to a smaller class of vehicle have, on average, realized a 10-percent reduction in both fuel spend and carbon emissions resulting from mpg improvements.
Safety and Ergonomics
As computer technology has increased exponentially, innovations regarding vehicle safety have come along with it. Pioneering features (such as traction and stability control, side air bags, etc.) on the most high-end vehicles just five or 10 years ago are now standard on even the most basic vehicles and across all vehicle classes.
The list of benefits from increased vehicle safety in newer vehicles includes side air bags, anti-lock brakes, stability control, tire pressure monitoring systems, etc.
Operating fleet vehicles for longer cycles means drivers operate vehicles without the advanced safety features of current model-year counterparts.
Even in vehicles without a system integrating all the entertainment functions, significant improvements have been made to features such as navigation systems. These include capabilities such as real-time traffic alerts and touch-screen monitors, all designed with the intent of keeping the drivers' eyes on the road.
Alternatives to Extending Vehicle Lifecycle
When facing a limited budget for vehicle replacements, alternatives are available to simply extending the lifecycle of the vehicle.
Dollars can be stretched further by:
■ Leveraging remarketing opportunities. There are opportunities for leveraging the current slow economy as part of the cycling plan. With the decrease in new vehicle sales, the result is a shortfall of used vehicles. This decreased supply presents a rare opportunity for fleet managers to take advantage of a stronger-than-expected used-vehicle resale market.
■ Body transfers and refurbs. Some fleets refurbish specific types of chassis to improve overall lifecycle expenses. Body swaps are more common and necessary when the upfit is more customized than the chassis. This strategy can decrease capital expenditures.
■ Route optimization. When applicable, fleets may reduce miles driven by reassigning vehicles with remaining life as replacements for aged units.
■ Long-term rentals. Vehicles without extensive upfitting can be substituted with long-term rentals -- at least until the next year's budget allows replacement. This tactic reduces major maintenance expenses on vehicles that have reached the end of their lifecycle.
Proper financial analysis will allow you to identify the specific circumstances when these options make fiscal sense and are appropriate to your fleet operation.