Fleet managers are a resilient and pragmatic group of professionals. They will find a way or make a way, no matter the obstacles placed in their path.
By Maria Neve, Manager, Mercury Associates
So here we are—6 months deep into a pandemic that has changed the way we work at the most basic level. Trying to predict what will happen next month, let alone next year, feels about as scientific as asking the Magic 8-Ball sitting on your desk. Despite all of this, the work continues, especially in our industry. 73% of fleet operations overall were deemed an essential service by government officials. Government itself is an essential service. State and local government fleets do not have the option of pausing their operations, and by all accounts they continue to rise to the challenge.
A recent survey found that a majority of fleets are worried that their budgets will be reduced by more than 10% over the next three months. Almost a quarter of fleets have said they are acquiring fewer vehicles right now. That may be short-sighted in the long run. Immediate capital expenditures are reduced, but operational expenditures will rise as assets age and require more unscheduled maintenance. The short-term gain does not outweigh the long-term pain.
Educating the decision-makers is part of a fleet manager’s job. Their instinctive reaction will be to address the immediate issues caused by decreased tax revenues, which only kicks the can down the street for someone else to deal with later. This is a prime opportunity for government fleet managers to showcase their strategic capabilities and correct false impressions. Solid data showing exactly how detrimental curbing vehicle acquisitions would be is essential for showing the true cost of only going after the low-hanging fruit. A fleet’s lifecycle management policy should not be tossed aside in the interests of immediate capital cost reductions. Postponing asset replacements and running the existing ones into the ground is not the right response.
What Directives Could a Fleet Manager Expect to See?
• Right-size the fleet
• Curtail take-home use of vehicles
• Reduce fleet replacement reserves (“just in case” vehicles)
• Reduce operating costs
• Reduce capital costs
Each of these directives is worthy of its own article. Here, we will only focus on reducing capital costs, specifically by discussing alternative financing methods. These methods are applicable regardless of how a fleet is funded: ad hoc appropriations or replacement reserve funds.
Now is the time to innovate and advocate. A significant number of government fleets purchase their vehicles outright. Why? “Because it’s always been done that way.” Mercury Associates refers to this as “pay-before¬-you-go” financing. It’s paying for the entire pie upfront when you’re only having a slice or two. Money is tied up long-term when the same amount of money could be funding vehicle replacements for the next two to three years by using another financing method. Interest rates are at historic lows and will likely remain low for the foreseeable future, making the idea of interest charges more palatable to decision-makers who aren’t fully educated on why purchasing is not necessarily the best option.
Fleet managers can’t rely on precedent anymore, not if they want to maintain a minimum level of operational capability. At some point the budget cuts will affect the safe operation of assets, downtime will increase, and both internal fleet customers and taxpayers will be less than happy. So, what’s a fleet manager to do?
Examine the Acquisition Strategy from Start to Finish
• Is the fleet right-sized?
• Do you need to increase the fleet size because of the need to have appropriate numbers of sanitized vehicles on hand?
• Do you have the right vehicles for the right jobs?
• Are you engaging internal customers in the vehicle selection process?
• Have you looked at Total Cost of Ownership (TCO) recently?
• Have you determined the optimal replacement cycle timing for each vehicle segment in your fleet?
• Are there other vehicles that meet requirements but have better incentives or better residual values?
• Are you timing your vehicle orders correctly based on order-to-delivery and upfitting timeframes?
• Are there opportunities to short-cycle assets to take advantage of strong residual values?
• Are there cases when extending a vehicle makes sense?
Pull together financing options once the fleet acquisition strategy has been updated. The options may seem overwhelming, but the benefit is that a highly customized program can be created to address every fleet’s individual needs.
Fleet Financing Options
The most common alternate financing methods are outlined below. Fleets can use any combination to meet their vehicle replacement goals. All of these will free up cash and permit the continued replacement of assets. This is “pay-as-you-go” financing. Going back to the pie analogy, you’re only paying for the slices you eat, rather than the whole pie.
• Open-end (TRAC) Lease – The lessee holds the residual risk and is responsible for the shortfall if the vehicle does not sell for book value at lease end. Conversely, the lessee pockets the gain on sale if it sells for more than book value.
o Flexible term, if a 12-month minimum is met
o No mileage or excess wear and tear penalties
o No restrictions on vehicle upfitting and modification
o Potential to be upside down if the lease is structured incorrectly
• Closed-end (Walkaway) Lease – This is similar to a retail lease but can be customized for specific mileage and usage requirements.
o No residual risk but no equity or gain on sale
o Walk away at the end of the lease term with no further obligation
o Early termination penalties
o Excess mileage and wear and tear penalties
• Finance (Capital) Lease – The lessee has use of the asset over most of the economic life and beyond. Title is automatically conveyed upon payment of a nominal consideration (typically $1) at lease end.
o Useful for assets that have a long lifecycle and stable technology
o Full cost is amortized over the lease term
o Higher monthly payments
o Exercising purchase option before lease end can be costly
• Municipal Lease (Tax-Exempt Lease Purchase) – This type of lease is only available to political subdivisions and non-profit organizations with a sponsoring governmental unit.
o Lowest interest rate possible out of all leasing options
o Not considered debt
o Loss of accumulated equity if non-appropriations clause is exercised
o No option to walk away from the asset
• Certificates of Participation – This is another form of tax-exempt lease financing, used by municipalities to acquire real assets. COPs are secured by selling shares of lease revenues rather than issuing a bond.
o Does not require a referendum or other form of voter approval
o Allows for master leases so different types of assets can be bundled together
o More complex than traditional leases and requires an underwriter or placement agent
o Subject to SEC oversight
• General Obligation Bond – The municipality backs the bond using the full faith and credit (and taxing authority) of the issuing jurisdiction. They are useful for assets or projects that do not generate revenue.
o Usually the least expensive financing tool
o Long-term debt is incurred
o Flexibility in the design of debt service
o Usually requires voter approval
Less common—but still useful—financing methods include fair market value (FMV) leases and long-term rentals. FMV leases are operating leases where the FMV is determined at the end of the lease rather than at the beginning. Long-term rentals are ideal for project- or time-based needs that last more than a few months but less than 12. Regardless of the methods chosen, the goal is to leverage the capital on hand and give some predictability to acquisition costs year over year, without spending any more than is absolutely necessary.
Fleet managers are a resilient and pragmatic group of professionals. They will find a way or make a way, no matter the obstacles placed in their path. There will be budget cuts, if they haven’t been implemented already. If those cuts affect vehicle replacement spending, they can create both immediate and long-term increases in fleet operating costs if the fleet is already old. Replacement backlogs are difficult to reverse without a substantial shift in funding strategy, as evidenced by the Great Recession. Money removed from the budget is rarely returned when times are better. Switching to alternative financing methods can free up cash while still permitting asset replacements, even in economic downturns.
Understanding the difference between economic reality and what makes financial sense is vital to proposing changes that stand a chance of being approved. All stakeholders need to be engaged from the beginning. Making the case to revisit and revise the asset funding method will require thorough research and data to back up the savings. Fleet managers should be proactive and strike while the iron is hot by advocating now for the cost-reduction strategies that do the least harm—and may actually address long-standing deficits—before arbitrary cuts are forced upon them.