The trick to making fleet cars pay their way.
When the government announced it was to tackle the spiralling car
When the government announced it was to tackle the spiralling car
When the government set out to tackle ‘rip-off Britain’ as far as car dealer forecourts were concerned, it probably never crossed ministers’ minds to consider what the knock on effects for the vehicle fleet leasing sector would be. In fact, simply by stating it was going to look into overcharging by vehicle manufacturers, the government managed, at a stroke, to knock the entire contract hire industry back on its heels. Why? The answer lies in the simple arithmetic of supply and demand in the used car market. When new car prices drop, residual values drop, usually by a corresponding amount. In the past, manufacturing surpluses and a certain amount of ‘dumping’ have caused slumps in residuals, but these are cyclic events and tend to be somewhat predictable. For the industry a sudden blue-sky intervention by government wasn’t at all predictable and the pain it has generated has shaken up the entire industry. One way of looking at the company fleet market is to see contract hire as a mechanism for turning new cars into used cars. The trick to making a profit in this industry lies in being able to forecast, hopefully within a percentage point or two, what the residual values on today’s new cars are going to be in three years time. If you can safely forecast a high residual value, you can write some very attractive business by lowering the price of today’s contract. If you are looking at bleak residuals three years hence, then you have to raise your charges accordingly in order to bear the increased write off. Getting the balance right is a tough trick at the best of times. One of the dominant features of this market is that no one fleet leasing company has more than five percent of the market. With plenty of suppliers competing for business, the industry always faces huge price pressure. Company A might want to write ‘sensible’ contracts, based on a modest view of residual values, but if the bulk of the competition are writing crazy business based on hopelessly optimistic estimates of residual values, then Company A’s contracts are going to wind up looking too expensive. The only thing it can do then is to take its losses and play the long game, hoping the down turn will hurt the opposition more than it hurts it. As Jianni Geras, head of marketing at Lease Plan, observes: ‘For the last three years everyone in this industry has been writing business based on residuals that are now impossible. One consequence has been a marked consolidation in the industry, particularly at the top end of the scale.’ All the lead contract hire firms, with the exception of GE Capital, which is itself a finance house, are backed by major banks, who have traditionally seen the fleet leasing market as a way of adding value to their money. However, at best the leasing industry is simply a good side bet for a bank so it is hardly surprising to find one or two of them reconsidering the wisdom of placing this kind of a bet in a market so vulnerable to perturbations. Barclays Bank, which owned Dial – one of the major players – recently reconsidered its position, for example, and sold Dial lock stock and barrel to Lease Plan. The Halifax, which bought another major player, Lex, some 18 months ago after showing interest in taking a hand in the game for months before the purchase, must by now be wondering where the attraction lay – particularly since Lex recently issued a profits warning. However, Richard Bennell, sales director for GE Capital Fleet Services, points out the slide in residual values has not just hurt the contract hire companies. Businesses who buy their own fleets have also suffered. ‘It is easy for businesses to miss the impact that falling residual prices have for them,’ he argues. Accountants write down cars to zero, usually on a straight line reducing balance, over four years. So when the company sells the car at the end of that period, whatever it gets for the car looks like profit. Bennell suggests the following reality check. ‘Directors should compare what they get for their sold off fleet cars this year, against what they were getting two years ago. They will be shocked to see the depth of the residuals slide that has gone on,’ he says. However, there is a bright spot or two ahead for the sector. Most importantly, as Nick Gafney, marketing manager contract hire company Velo, points out, through all the turmoil, demand for fleet services has remained high. It might be expected that one implication of falling residual values would mean that company fleet managers and financial directors would end up paying more to lease new fleet cars. In fact, a combination of price pressure, keen competitive practices and falling new vehicle prices have more or less stabilised the costs faced by fleet managers. This means of course, that falling new car prices are not working their way through to fleet managers, but it also means they are not being asked to underwrite the full cost of the slump in residuals either. Another glimmer of light for the industry has come from the government’s attempt to shift the taxation of company cars to a greener, more environmentally friendly footing. Of course, this will not please all motorists, and there is plenty of sympathy across the vehicle leasing industry for company road warriors. This group embraces those car-based engineers and sales folk who regularly drive over 18,000 miles a year on company business and who will be disadvantaged by the government’s decision to shift to an emissions-based scale for taxation. They lose their current high mileage tax discount since the new scheme, being based purely on emissions, has no way of distinguishing between high mileage and low mileage drivers. However, what the industry is pleased about, as Lease Plan’s Geras notes, is that the new scheme actually offers incentives to casual low mileage company car drivers, to stay with the company car rather than to accept cash alternatives. Previously, under the old scheme, such drivers had paid penal tax levels for the privilege of having a company car. Now, under the new scheme, which comes into force in April 2002, those penalties vanish, provided drivers choose a low emissions vehicle. ‘The way we read the Budget, it has brought something into play which we think will keep the company car alive as a proposition for a long time to come,’ Geras argues. GE Capital’s Bennell agrees. ‘Several of our customers are raising this point with their HR remuneration planners right now. We definitely expect a bigger uptake of the company car by low mileage drivers,’ he says. Cash alternatives will still form an important part of a company’s HR remunerations package, but now more casual drivers will want to switch back into the company car scheme. Britain’s love affair with the company car, it seems, is far from over. This may be a paradoxical side effect of the government’s new green policy – one of many, some would argue – but that only goes to show there is no easy way for government to intervene in a market without producing unintended ripples. While the implications of the Budget for the casual fleet driver are perhaps of minor significance for companies, the dissatisfaction among corporate, dedicated road warriors could create more intractable problems. Leasing companies are unlikely to be able to help corporates to solve this issue, Geras points out, because the obvious ‘solution’, namely a personal contract plan (PCP) doesn’t hold much appeal for drivers where the mileage is high. No one wants to flog their private car to death in the service of the company. Basically PCPs are leasing devices which take cars out of benefits in kind taxation, while still being in some vague sense corporate inspired schemes. Under a PCP, the employee leases the car as his or her own asset. However, the employee’s company facilitates the scheme by arranging collection of the monthly sum and, possibly, by some kind of cash for car compensation scheme. The employer also reimburses the employee for business mileage at rates set by the Inland Revenue. However, the appeal of this kind of scheme fades as the number of business miles the employee has to travel moves beyond a certain point. According to Bennell, companies are going to have decide whether to cash compensate their mobile warriors, or tough it out. At an estimated #230 per month per serious mobile user, compensation could add plenty to the corporate payroll budget. However, telling people who are travelling long miles working for you the reason they are now poorer is all the government’s fault may not turn out to be the smartest staff retention policy, either, he says. THE ENTRY OF E-SERVICES Will e-commerce reshape the vehicle leasing market? Once the current traumas in the industry have settled down, far and away the biggest factor for change going forward, in this sector as in all others, is likely to be the entry of e-services. This is the view of Jianni Geras, head of marketing at Lease Plan. He says fleet management services and consultancy services underpinned by state of the art IT have been a big differentiator among vehicle leasing companies. E-services offer companies the chance to drive costs out of their business, enabling them to provide better deals for fleet managers. ‘E-commerce really has the ability to reshape our industry thanks to the cost savings and efficiencies from trading on-line. We launched Lease Plan Business Direct earlier this year, which provides an exclusively Internet based fleet hire service for companies with a fleet of below 100 vehicles. This has enabled us to take a lot of costs out of the equation. We expect to see a strong take up among businesses that do not need personalised account management,’ he notes. Where one major leads in this industry, the others have to follow, so the dash for the Net is now on.