In a slow economy, it is normal for senior management to demand expense reductions by limiting capital expenditures. However, this may be a “penny-wise, pound-foolish” approach to managing a corporate fleet, especially in light of the fact that auction data shows wholesale prices for used fleet vehicles were at a record high during the first quarter of 2011.
“The average price of a mid-size car sold at auction by a commercial fleet reached a record high in March, topping the $10,000 mark,” said Tom Webb, chief economist for Manheim Consulting.
Today’s exceptionally strong used-vehicle market offers innovative commercial fleet managers an “out-of-the box opportunity” to short cycle vehicles. While attending the recent NAFA I&E conference, I had the opportunity to talk with a number of fleet managers, some of whom are pondering the opportunity to short cycle from a traditional 36-month service life to a 24-month cycle to decrease overall fleet depreciation, their largest expense.
Nearly all fleet-related costs, both fixed and operating expenses, are influenced by when a vehicle is replaced. A shorter 24-month replacement cycle can reduce a fleet’s operating costs. For instance, a short-cycling strategy allows a vehicle to remain covered under the OEM new-vehicle warranty for a greater percent-age of its service life. In addition, other operating cost savings occur by avoiding the significant maintenance costs for fleet vehicles that occur in year-three and year-four of vehicle service lives. There is also a parallel reduction in driver downtime due to less scheduled maintenance. During the first two years of service, most vehicle maintenance expenses are for oil, filter, lube, and other related preventive maintenance. Also, a newer fleet will help reduce overall fuel spend. Today’s vehicles have the highest-ever average fleet mpg, and an accelerated replacement strategy winnows the lower mpg vehicles with higher mpg replacements.
However, the greatest benefit to short cycling is higher resale values. Short cycling means a vehicle coming out of service will be newer, have fewer miles, and most likely be in better condition, all of which contribute to a higher resale value. The current low supply of used vehicles has caused buyer demand to exceed supply, resulting in a supply-demand imbalance in the wholesale market. This has created a “rising tide effect” of stronger demand for all used vehicles, resulting in across-the-board higher resale prices. However, this is a temporary phenomenon.
“The shortages (in used-vehicle inventory) we will experience in the near-term will influence used-vehicle valuations,” said Webb. “However, the reverse is also true. Nothing has done more to destroy the resale value of mid-size vehicles than excessive used inventory.”
Another benefit to short cycling is that new-vehicle order volume is maximized. A hypothetical 600-vehicle fleet on a 36-month cycle will order, on average, about 200 vehicles per year. If a fleet short cycles to 24 months, it will increase its orders by 300 vehicles. This increased order volume gives greater negotiating leverage with the OEMs. A corollary benefit is improved driver morale since more employees will be driving newer vehicles.
Ongoing Supply-Demand Imbalance
If you accept the truism that new-vehicle retail sales “manufacture” the used vehicles of tomorrow, then we should anticipate an ongoing smaller inventory of used vehicles in the wholesale market for the near future. In a nutshell, yesterday’s depressed new-vehicle market created today’s used-vehicle market. The dramatic decrease in new-vehicle sales over the past two years has resulted in a corresponding dramatic decrease in the number of used vehicles in today’s (and tomorrow’s) used-vehicle wholesale market. In the commercial fleet arena, calendar years 2008-2009 were highlighted by massive corporate headcount reductions and the downsizing of sales forces and territory realignments. Many of these laid-off workers had been assigned company vehicles, which put downward pressure on future new-vehicle acquisitions.
The forecast is for the continuation of an ongoing tight supply of used vehicles. There is a lag time in the “used-vehicle manufacturing” process. “The trough in new-vehicle sales is still about three years away,” said Webb. “We can expect the lack of wholesale supply will continue, which will continue to bolster resale prices in this segment for some time.”
Supply-and-demand dynamics in the wholesale market dictate that a smaller inventory of future used vehicles be the catalyst for ongoing higher resale values, especially as buyer demand increases. Demand for used commercial fleet vehicles promises to increase with the greater availability of subprime financing and growth in new-job creation.
“Employment growth creates the need and ability to buy a used vehicle,” said Webb. In the final analysis, inventory shortages inflate used-vehicle values. “The depreciation curve of a vehicle with a 15-day supply looks a lot different than the identical vehicle with a 70-day supply,” said Webb.
Let me know what you think.