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Past Issues

July 2005

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Vehicle Replacement

When and how vehicles are replaced impacts significantly on vehicle operating costs and reliability. It is equally true to say that sensible and sustainable vehicle replacement policies do reduce the risk of unplanned buy or sell decisions. Given these truths, FleetWatch correspondent Max Braun urges operators to put in place a rational and objective vehicle replacement policy. To help formulate such a process, he puts forward what may seem, to some, a simplistic view of replacing vehicles but one which FleetWatch feels will prove useful to a wide cross section of transporters and fleetowners who may think it is mainly about discount, trade-in, top-speed and other bells and whistles. Read on...

There are many approaches to vehicle replacement. These range from applying complicated technical formulae to waiting until vehicles literally fall to pieces. Being too focused on technical formulae may result in failure to establish if there is sufficient money to pay for expensive new vehicles. On the other hand, deferring replacement until there is no other alternative will almost certainly be an expensive choice, not to mention the risk of compromising reputation and customer service.

The high cost of vehicles, the cost and availability of money and the huge cost of keeping trucks on the road long enough to justify investing in them demands keeping in place a rational and objective vehicle replacement policy. Such a policy makes liberal use of previous experience and gaining a thorough understanding of the mix and magnitude of the transport tasks to be undertaken.

Formulating a sustainable replacement policy
There are a number of factors to consider when formulating such a policy to make sure it is compatible with the overall transport objectives (and distribution where applicable) of the business. This is so whether you haul for reward or transport your goods in own vehicles.

Financial factors such as the availability of finance, preferred method of financing vehicles, depreciation, inflation, expected maintenance and repair costs, obsolescence and the ultimate residual value (resale value) are examples.

Deciding what transport tasks will be undertaken now and in the future is fundamental to the success and sustainability of a replacement policy. Replacing vehicles regularly is a costly commitment. Careful thought should also be given as to whether all or some of the transport tasks can be advantageously outsourced to a transporter or third party distributor. If the decision is to continue transport operations with your own vehicles, only then, thought can be given to which vehicles should be acquired and replaced.

When should vehicles be replaced?
There is no simple answer to this question. No two transport operations are entirely the same. Whether cumulative kilometres or age is chosen as criteria to guide replacements, there is always the risk of replacing vehicles too soon allowing the next owner to benefit and losing out on some of the economic benefits that flow from an extended economic life. Replacing too late could mean breakdowns and time off the road resulting in heavy repair bills, loss of income and poor customer service.

When most of the vehicles in a fleet become geriatric or past their 'sell by' date, it could take several years to rehabilitate the fleet. The lack of replacements is frequently the result of allowing a properly structured replacement policy to fall away as a result of using cash resources to fund some other project, or simply a lack of funds to maintain the policy.

The ability to justify and successfully motivate a sustainable vehicle replacement policy requires management skill, expertise and experience if financial managers and chief executives are to be convinced there is a real need to acquire new vehicles. Rational replacements policies are overturned when managements take subjective decisions to meet short term, expedient considerations. Under such circumstances a reduction in total owning and operating costs cannot be achieved.

For some companies, the problem of trying to predict the optimum economic life of vehicles has shifted to a financial problem of how best to acquire vehicles, reduce taxation and beat inflation. However, steps must be taken to reduce the risk of making expensive mistakes.

Replacement decisions should be taken on the basis of individual vehicles. Deciding to keep a specific vehicle for another year or two is a short or medium-term commitment. Acquiring a new one is a long term commitment to meet the costs for at least the estimated first economic life. The following examples based on current market-related operating costs illustrate the point (see Table 1)

A rational basis for judging whether a vehicle should be replaced is when the expected operating cost of an existing vehicle for the next year exceeds the average annual cost of a new vehicle over its estimated first economic life. This approach first predicated in South Africa by Dr Helmuth Eggers, a former Durban-based transport consultant, highlights the important need to forecast the economic life of the replacement vehicle before acquiring it.

Before judging the merit of any suggested method for replacing vehicles, most financial managers and chief executives would like to see the numbers before agreeing to further investment in trucks. Typically, this may include:

• Actual depreciation 

• Original purchase price and how much cash you can get for the vehicle at the end of the estimated economic life (expressed in kilometre and/or age or in hours and/or age where applicable).

• Opportunity cost. The cost of money to pay for the new vehicle or the opportunity lost by not investing in some other income-earning asset or project. If there is no agreed rate for this then the current bank rate could, as a minimum, serve the purpose.

• All maintenance and repair costs including tyres

• A realistic estimate of fuel costs based on the forecast of annual distance, topography, road conditions, traffic density, loads and driving skills.

The graph is a hypothetical example depicting the theoretical optimum time when the cumulative cost of depreciation and maintenance costs are the lowest. The example is based on reducing balance depreciation and maintenance on an average cost of 80 cpk over one million kilometres.

Planned replacements
Keep the plan to replace vehicles simple and easy to manage. Consider these suggestions. Base replacements on kilometres (or hours in typical tipper or related operations) to smooth the rate at which new vehicles should be acquired.

The benfits of good planning includes:

• Reduce the risk of expensive mistakes and disrupting daily operations. 

• Avoids unplanned or hasty buy or sell decisions

• Allows more time to consider alternatives and negotiate better deals

• Reduces the risk of premature replacement, when due, or already "too late"

• Simplifies budgets, introduces a degree of certainty, facilitates financial planning, administration and control.

• Eliminates subjective and emotional decisions

Management information
An up-to-date, reasonably comprehensive management information system that provides a record of costs for individual vehicles is the backbone of a sustainable replacement policy. Whether the fleet is large or small, a simple but adequate record system can be set up on a PC using MS Excel software. If it is not possible to set up and employ a full-time competent person to administer the system, there are several fleet management companies that offer a wide range of products to meet such needs. The growth in vehicle manufacturer maintenance contracts, full maintenance leasing, management maintenance service providers and tyre management contracts go a long way to taking the pain out of maintaining credible vehicle histories.

More than a numbers game
Satisfying financial managements that assets are properly managed and maintained to ensure book value is kept in line with realisable value are important considerations. These managers carry the can for their forecasts of estimated future costs. Technical managements, however, have concern for productivity, reliability and safety. They are interested in:

• Optimum legal payloads and higher average speeds - the path toward achieving more transport with fewer trucks.

• Improved fuel consumption.

• Improved ergonomics - cab comfort, visibility, storage facilities etc,

• Compliance with current and emerging legislation, this especially so in respect of new regulations around emissions, cleaner fuel, braking, mass and dimensions (axle and gross mass regulations).

The chief executive wants to know if more transport will be achieved with fewer vehicles - what opportunities will there be to gain more of the economic potential modern state-of-the- art trucks offer? Improved availability, increased productivity and lower maintenance costs are powerful elements to motivate the replacement of vehicles.

Rebuilding trucks, is this a viable option?
Some fleetowners still ponder the complex question of whether rebuilding trucks to extend "economic" life is a viable option. The concept of rebuilding trucks is much more than refurbishing the cab and overhauling the engine. There are numerous opinions of this contentious option. However, so far, a single best solution has yet to appear.

Based on experience over recent years, here are some of the views expressed by transporters and fleetowners that undertook rebuilds and those who rejected the concept in favour of replacing vehicles:

• Investment in properly selected components with adequate capacity when replacing vehicles allows first economic life to be significantly extended.

• Correct selection, timely maintenance in accordance with the manufacturer's recommendations and good driving skills can extend the expected first economic life by more than 100 per cent. 

• Modern vehicles offer significantly improved fuel consumption. At current fuel prices this is a huge benefit.

• Improved payload ability and performance holds the potential to reduce the number of vehicles to do the work and a significant reduction in operating costs.

• New generation vehicles have extended service intervals, extended warranties and access to vehicle manufacturer maintenance contracts to suit specific transport tasks.

• Significantly improved ergonomics offers better driver comfort through improved cab layout, seats, visibility and storage facilities. All contribute to better driver attitude and safety.

• Replacing vehicles enhances the average age of the fleet.

• To retain a competitive edge, there should be a balance between old and current technology.

• Before replacing vehicles give careful consideration to refurbishing them and redeploying them in less demanding transport operations. There is often scope to do this with rigid tippers and freight carriers.

• Not all makes and models are technical suitable to be successfully rebuilt.

• Any decision to rebuild trucks must be planned well in advance.

• How much will a rebuild cost and how will it be financed?

• In many instances, rebuilds prove to be expensive, equal to paying for the vehicle a second time over the parts counter.

• How long will it take to complete a rebuild?

• Parts availability and how long will it take to get them?

• How many additional vehicles will be needed while rebuilding takes place?

• Is the model still in production?

• Is the make still represented in South Africa?

• Who will undertake the work?

• If own facilities, will it disrupt the normal maintenance and service schedules?

• If undertaken by an outside contractor, evaluate their reputation, standard of workmanship, ability to meet promised delivery times and get a detailed quotation.

• Will there be tax implications. Agree with SARS if the cost of rebuilds can be capitalised or written off as an expense?

• Are there legal implications? Rebuilds cannot be re-licensed as new vehicles.

As mentioned, there is no one best answer to the question of "when should vehicles be replaced". Every transporter and fleetowner is in a different situation according to the type of operation, the average age of the vehicles and available financial resources. It is a question of weighing the advantages and disadvantages between replacing now or later.

To conclude this simplistic view of the many factors to be considered in pursuit of a rational and sustainable replacement policy, I quote the words of David Lowe, an eminent British transport consultant who undertook a variety of projects for many major British companies involving cost-effective transport operations. Lowe says replacement policies can be based on four different sets of criteria:

• Arbitrary - when vehicles break down for the final frustrating time or when customers complain about poor delivery service, the replacement decision becomes inevitable.

• Predetermined - when a vehicle reaches the end of its originally projected economic life.

• Rational, economic - when replacement is made at an optimum time calculated on the basis of progressive cost analysis throughout the life of the vehicle to the point where it is obvious the maximum predetermined cost has been reached and increased cost will commence.

• Productivity Oriented - When replacement is determined by cost criteria measured by either excessive downtime or the vehicle's inability to achieve predetermined productivity standards (availability and volume of deliveries - the workload).

"The most important aspect in assessing the cost of acquiring and operating a vehicle is its total life cost rather than the purchase price alone. Total life cost includes and relates to the quality and durability of the product, plus operating costs such as repairs, maintenance and downtime and a below average resale value. David Lowe sums it up succinctly in his well-known equation:
 

Purchase Price plus Operating Cost less Residual Value equals Total Life Cost

Purchase price reflects what you are buying in terms of specification, quality, durability and service. Operating cost reflects what you pay for in fuel consumption, maintenance and repairs and downtime. Residual value reflects what you get - how attractive it is to used truck buyers. Total life cost reflects the best result.