10 Ways to Optimize Depreciation Management

It has been said a fleet manager can do his or her job pretty well by managing just two costs associated with the provision of fleet vehicles: fuel (variable) and depreciation (fixed). Considering depreciation is more than half of fixed costs (fuel being the same for variable costs), this isn’t a far-fetched concept.

Managing depreciation has been at — or near — the top of fleet managers’ cost control/reduction lists for a long time, and continues to be today.

There are only two elements to depreciation: original cost and resale proceeds; however, there is much that happens in between fleet managers should focus on that will ultimately determine how large — or small — that cost will be.

1. Understanding Original Vehicle Costs

The depreciation puzzle begins, obviously, with the original cost of the vehicle. Both leased (under open-end, terminal rental adjustment clause [TRAC] leases) and owned fleets work at negotiating the lowest possible cost for new fleet vehicles. This includes factory orders as well as the occasional emergency order from dealer stock.

What is important is that fleet managers know what monies are available, what can be negotiated, and what cannot.

Keep in mind manufacturers and FMCs (where applicable), as well as the dealer if vehicles are purchased directly, are entitled to a fair profit on the vehicles they sell.

That said, available monies can include:

• Holdback: These are funds that the OEM “holds back” from the dealer until the vehicle is sold. Holdback can range from 2 percent of MSRP to as much as 4 percent, depending on the manufacturer.
• Floorplan: Support provided to a dealer by manufacturers to finance inventory.
• Dealer advertising allowance: While not available in all cases, OEM advertising support may also be negotiable from the vehicle price.

There may be other monies available, and it is the fleet manager’s job to know what they are and negotiate with the supplier for the lowest purchase or capitalized cost possible.

These monies can include a so-called competitive assistance program (CAP). These are programs offered by manufacturers to mid-sized and large fleets in return for a commitment to a minimum number of orders during the model-year.

Depending on the size of the fleet and number of orders pledged, CAPs can amount to as much as several thousand dollars per order, over and above published fleet incentives.

2. Overlooking Replacement Policies

A sometimes overlooked depreciation management tool is replacement policy. There are a number of considerations fleet managers must review when determining how long vehicles are to remain in service.
Clearly, though, replacement policy must be set at that point in service when the combination of fixed (depreciation) and variable costs are at their lowest. And, since depreciation is such a major element of total cost of ownership (TCO), replacement policy is critical in managing it.

Developing a strong replacement policy begins with a method of collecting and manipulating data; and, more importantly, having a record of resale proceeds. The data must include model-year, make/model, months-in-service, mileage, condition, and location of sale.

The ultimate goal, of course, is to replace vehicles at the point in time when the combination of fixed and variable costs are at their lowest, and a major part of that is maximizing resale proceeds. When a well-documented and structured replacement policy is in place, by definition, it will contribute to depreciation cost management.

3. Ensuring Proper Vehicle Specifications

Selecting the right vehicle for a job doesn’t end with a make and model; fleet managers should ensure vehicle specs not only are right for the mission, but also will maximize resale value.

That said, this doesn’t necessarily mean loading a car or truck up with options that won’t add to resale value; but, it does mean fleet managers need to research the used-vehicle market carefully to see what options are bringing additional resale, if those options are a reasonable addition to the vehicle, and what options might seem to bring additional value, but won’t.

This also goes for powertrain configurations, too, particularly for work trucks.

Often, it is a vehicle’s trim level that determines whether an option adds sufficient value to boost resale. For example, a moon roof or upgraded stereo won’t be of great value for a base trim, for which buyers’ interest is piqued by low price.

Choosing the right specs for the make, model, and trim level a fleet manager chooses is another element in overall depreciation management.

4. Performing Preventive Maintenance

There are six major elements that sellers, and buyers, of used vehicles consider when determining value:

1. Year.
2. Make.
3. Model.
4. Options.
5. Mileage.
6. Condition.

Within the last item, condition, both mechanical (operating) and physical (exterior/interior) condition are considered.

For operating condition, this is where preventive maintenance comes in. Most companies have a preventive maintenance schedule based on mileage for fleet vehicles. The issue is enforcing it, which requires some reporting capabilities based on reported mileage (generally, today, obtained from fuel purchases under a fleet fuel card program).

Preventive maintenance reports are an important element in enforcement.

When PMs aren’t enforced, vehicle condition can deteriorate, sometimes substantially. Fuel efficiency declines; key vehicle systems, such as powertrain elements, suffer excessive wear-and-tear; tires wear more quickly, and unevenly; and brake pads/linings wear down past rivets, gouging into rotors or drums.

Most buyers or consignment sellers require, or at least request, maintenance history. What all this adds up to is, quite simply, a vehicle which is worth less, and, thus, greater ultimate depreciation expense. It isn’t enough to simply have a policy; that policy must be enforced for it to help maximize resale and manage depreciation.

5. Monitoring & Reviewing Condition Reports

Fleet managers, as often as not, must manage assets they never see. A national or regional fleet is dispersed across a wide geographical area. The result is that, rather than managing the vehicles themselves, fleet managers manage the data and information the operation of these vehicles produce.

One of the most important pieces of that information, vis-a-vis depreciation management, is the vehicle condition report. Clearly, for fleet managers who must manage fleet expense, knowing what condition vehicles are in at any point in time — and, more importantly, following up on items that require attention — has a substantial impact on what those vehicles will be worth when they are taken out of service and sold.

There are several keys to an effective condition-reporting policy:

• Timing: In a perfect fleet management world, fleet managers would have access to condition reports as often as possible. Realistically, their time and resources are limited, so reports — say, quarterly — will have to suffice. 
• Content: Drivers should be expected to provide reasonable detail on the condition of their assigned vehicle — mechanical, tires, glass, interior, and exterior. Any issues, for example physical damage beyond what common sense would call normal wear-and-tear, should be noted. Mechanical conditions, such as hard starting, stalling, bad fuel efficiency, and unusual noises, should also be described.
• Documentation: Not only should the aforementioned issues be noted, but photos should also be provided wherever possible for visual confirmation. This will help fleet managers to decide what, if any, action to authorize.
• Signoff: In addition to the driver signing off on condition reports, the driver’s manager should also be required to endorse them. 

In addition to the reports themselves, fleet managers must have a process for follow up on conditions that require it, such as the replacement of worn tires, repair of body or interior damage, and repair or replacement of damaged glass.

All-in-all, a well-structured and strictly enforced condition reporting policy might be as important a means of managing depreciation expense.

6. Maintaining a Driver/Employee Purchase Program

There are a number of venues through which fleet vehicles can be, and are, sold. Leased fleets’ out-of-service vehicles are usually run down the auction lane. Some fleets use used-car wholesalers, while others use brokers. It is generally a wise move for fleet managers to use more than one method of selling vehicles; different venues bring different advantages to the seller.

It is no surprise that, for many years, fleets of all sizes and types have, at the very least, attempted to sell vehicles to their own drivers and/or other employees. Why? What does an employee sale program bring to the table versus more traditional auction and wholesale markets?

Put simply: money.

Resale proceeds, and the resulting depreciation when applied to the TCO, are, for the most part, dependent on the criteria previously described. But, because fleets can purchase vehicles at substantial discounts, using volume and other incentives, the “starting cost” of the asset is lower than it might be for a retail buyer. Thus, depreciation as a percentage of retained value is greater.

The best market of all, though, is a strong, well-marketed employee/driver purchase program. Rather than selling at any of the pure wholesale markets, an employee purchase program will return so-called “wholetail” dollars. Pricing is made available to employees, which is higher than any reseller’s market price and lower than what the employee can find in a retail market for the same vehicle.

Simply offering drivers, at their request, a price on a vehicle won’t take full advantage of the potential market. Fleet managers should actively market an employee purchase program. Offer a formal price on every vehicle coming out of service; first to the driver, with a time limit on a response, and then to the entire employee base should the driver decline.

Fleet managers can also consider suppliers who can provide funding for the purchase of fleet vehicles, along with warranties and even insurance. As with any other method of managing depreciation, if it is done well, an employee purchase program can bring hundreds or even thousands of dollars in additional proceeds into the depreciation calculation.

7. Determining Replacement Timing

We’ve already treated the replacement policy issue, but there is an additional consideration which enters into the replacement mix, and that is replacement timing. Replacement timing is at the same time apart and separate from replacement policy, and an integral part of it.

Remember, “year” (or model-year) is an important element in the market’s pricing of used vehicles. This is where replacement timing enters the picture.

Most fleet managers will try to time replacements to take full advantage of the model-year. For example, a fleet has a number of 2013 model-year vehicles that are, at varying points, coming due for replacement. Imagine that it is the middle of June. If the fleet manager replaces the vehicle with an upcoming 2016 model-year vehicle, which would be delivered in perhaps September or October, the company will receive the full 2016 model-year’s credit for the new vehicle when it is ultimately sold.

Now, imagine it isn’t the middle of June, but the middle of February: If an order is placed and the vehicle is delivered in perhaps early to mid-April, and it’s a 2015 model-year vehicle, in only a few months (April to September or so, for example) the new vehicle will be a full model-year old, as by then the 2016 models have begun to be produced — and the resale market will punish that 2015-MY vehicle with a value penalty even though it was in service, for only a few months, reducing proceeds.

Of course, there is a reductio ad absurdum to this, where all vehicles are replaced at the beginning of the model-year, no matter where they stand within replacement criteria. Indeed, if this was the case there would be no need for a policy. But, replacing vehicles slightly early, or keeping them in service a few months or thousand miles past normal replacement, can help fleet managers to get the benefit of a full model-year when they ultimately come up for sale.

8. Avoiding Out-of-Stock Purchases Whenever Possible

The logic behind avoiding stock purchases is simple: Most fleet acquisition deals, whether for leased or owned fleets, provide maximum advantage when vehicles are factory-ordered, rather than purchased from dealer stock. And, fleet managers nearly universally try to avoid stock purchases.

Unfortunately, sometimes circumstances require the emergency replacement of an existing vehicle, usually in the event of a total loss or major mechanical failure.

Most, if not all, lessors will, at the very least, have the resources to search for and negotiate pricing that fleet managers (lacking staff) don’t have. But, many lessors will, after negotiating the price, apply a premium to the ultimate capitalized cost or purchase price of the vehicle to the fleet.

If time permits, fleet managers can survey dealers themselves and negotiate the price as well. When this is possible, the premium can sometimes be avoided, or at least mitigated, as the fleet has absorbed the administrative costs of the search.

Sometimes, the fleet manager may also have a surplus fleet vehicle that can be transferred to the driver until a factory order is built and delivered.

The bottom line is that fleets can help manage the front end of the depreciation equation by avoiding emergency orders wherever possible, and, when unavoidable, using existing resources to mitigate the price premium.

9. Managing through Strategic Sourcing

Strategic sourcing has become “all the rage” in companies for the acquisition of assets of all sizes, shapes, and uses. Fleet vehicles are no exception.

Some fleets are a monolithic entity — that is, all of the vehicles are managed from a single point in the company. But, others have more than one business unit with a fleet of vehicles, and too often they are managed separately — different selectors, different suppliers, even some leased and some owned.

Strategic sourcing won’t necessarily change how vehicles are managed on a day-to-day basis, but will provide the company with maximum leverage when selectors can be developed for all business units within a single or two OEMs.

Common sense dictates that combining the purchasing power of all of the company’s fleet purchases will result in stronger pricing up front than if business units do so in a vacuum, independently.

Indeed, some companies have operations overseas, and, without impacting the day-to-day management of individual business units, vehicles can be sourced from one or two manufacturers globally.

10. Shortening vs. Extending Cycling

As with any other commodity market, the market for used vehicles is rapidly changing and volatile, with highs and lows popping up for various reasons all the time. If fleet managers are to successfully manage depreciation, they must keep up-to-date on any and all markets they use to sell out-of-service vehicles.

Occasions exist where markets are very strong (stronger than typical during a particular time of year). It may be advantageous in the face of such a market for a fleet manager to consider choosing some portion of the fleet to “short cycle,” or replace them before they’ve reached normal policy guidelines.

On the other end of the spectrum, markets might well be unusually weak, with vehicles bringing much lower proceeds than they would under normal circumstances. In these situations, the same consideration could be made to keep vehicles in service longer, until markets recover.

Neither decision should ever be made lightly — if either decision backfires, the consequences could be substantial. For that reason, if deciding to either shorten or extend cycles, it is best to do so only partially, choosing only a portion of the overall replacement lot.

Either way, the fleet manager’s knowledge and understanding of the various markets, along with the ability to be flexible and nimble in moving forward, could result in either receiving many thousands of dollars in additional proceeds or preventing the same thousands in lost value.

Know Where the Money Is

It has been said that, if a fleet manager does nothing else, he or she should spend his or her time and resources managing the two biggest costs — fuel (variable) and depreciation (fixed). Both are rapidly changing, and, particularly as it pertains to depreciation, fleet managers can do a great deal to impact the outcome.