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15 Apr 15

Why Residual Values matter to your company fleet

Residual Values may seem far removed from the everyday concerns of fleet managers. But they are a huge component of TCO – and most fleets have yet to learn how to use that to their advantage, explains Global Fleet Expert Tony Elliott in this Q&A with Fleet Europe.

What is Residual Value (RV)?
RV is the net price for which you sell a vehicle at the end of its primary use period.

How is RV determined?
If a vehicle at the end of a three-year lease period has a mileage of 120,000 km, those two factors – age and distance - will be crucial to its RV. But not in equal measure: distance is responsible for 90% of the depreciation, age only for 10%. In theory, a slightly older car with lower mileage should have a higher RV than a slightly younger car with higher mileage.

In theory? Are there other factors as well, then?
Yes. Apart from the variables proper to the car, there are also the many variables proper to the market: How many used cars are there in the market at any given time, and how many of each particular model? What about the confidence of the market? Do potential buyers have enough money in pocket? All this applies to LCVs as well as to cars.

Given that multitude of factors, how can one predict RVs?
It's almost impossible, because emotions and taste play an important role. And those elements are difficult to judge, and even more difficult to predict, because they can change very rapidly. For example, a few years ago, baby blue became the most popular colour for new cars in the UK. Not long after, that colour became the most disliked. With obvious implications for RVs.

How precisely does RV interact with TCO?
Total Cost of Ownership (TCO) is made up of a number of variables, some of which vary more than others. As those increase, RV will decrease, and vice versa.
To take an average example: if Fuel Cost represents 31% of TCO; Service, Maintenance and Repair 14%; Insurance 11%; Financing (i.e. Interest) 7%; Admin and Management Fees (including profit for the lease companies) 2%; then RV makes up the remaining 36%. If fuel cost goes down 2%, RV will go up 2% - the total has to be 100%.

Fuel cost may stay down for a long time. What will be the impact on RVs?
RVs will stay the same in value terms, but become more important as a share of TCO. It can be expected that they become much more prominent in the considerations of fleet managers.

Still, many fleets don't feel directly affected by RVs. Why are they wrong?
Because end-of-lease cars need to be sold for the best possible value. If they aren't, the rental amount eventually will have to go up. Increasingly, lease companies take the condition of returning vehicles into consideration when setting their prices for particular customers.

What is then a sensible fleet approach to RVs?
What is done all too rarely: spread the risk. Both procurement departments and leasing companies are too eager to strike large, single-model deals. But if that model is too popular at some point, its RV will be relatively low a few years down the line. So, make sure to get a few different models, even if it is for the same job.
This also opens the door for smart procurement. Fleet companies know that a diversified fleet has better RV perspectives. Procurers should insist on diversification, and ask for reduced rental prices in return.
However, leasing companies don't generally practice that level of operational risk management, and procurement departments often have a short-term vision, contenting themselves to achieve a one-off, up-front reduction in cost.

How can you ensure contracts are transparent for RVs? 
Most big companies simply demand that lease companies offer them a complete breakdown of the RVs. The lease companies have that information. It is time the small and medium companies start asking that same question in their negotiations.

What should be on the checklist of a fleet concerned about maximising RVs?
How many cars of the various brands and models in the running are being sold? What are the terms they are being taken out on (i.e. with discounts or not)? What colours can I get – and can I get away with? Will the model change soon? If it does, depreciation will increase. How will technology evolve? For example, diesel is increasingly under fire as bad for the environment; this is likely to increase fiscal penalisation, and thus push down Rvs.

Isn't procuring top brand vehicles a sure way to guarantee good RVs?
Not really, because the initial value is higher as well. Suppose you get a 50% RV on a €30,000 top-brand car: it will have depreciated by €15,000. Now suppose you get a 35% RV on a €20,000 medium-brand car. This car will only have depreciated by €13,000.

It is even possible to give general advice in order for fleets to maximise their RVs?
In general: stay away from the herd. The best way to avoid the risk inherent in the unpredictability of depreciation is to spread the risk – don't have too many of the same model, brand or even the same colour. So, beware of OEMs offering large reductions on new vehicles. When the time comes to resell those vehicles, buyers won't offer 35% of the original price if that price has already been discounted at the front end.

How can companies best ensure that their vehicles are returned in the best possible condition, thus maximising RVs?
The single most important factor in that respect is driver behaviour: this impacts fuel use, service requirements, even insurance amount. In the Asia-Pacific region, most vehicles are fitted with telematics, and drivers are penalised for costly behaviour. That is still rare in Europe, but with savings of up to 15%, telematics as behaviour-modifying technology is bound to make inroads in Europe as well.

Authored by: Frank Jacobs
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