How to understand TCO
Discover the 10 key elements of the total cost of ownership of a fleet vehicle.
What is Total Cost of Ownership?
The total cost of ownership (TCO) of a vehicle is the sum of all the costs associated with acquiring and running it over its fleet life. This can be expressed either as an overall figure, but is more commonly seen as a cost per kilometre.
TCO covers the complete range of expenditure on a company car or van, including depreciation, the interest payments on loans or leases, taxes, service and maintenance, insurance and fuel.
When all of these costs are combined into a single TCO, it makes it easier for fleet decision makers to choose the most cost-efficient vehicles.
The TCO of an individual make and model is based on both historical experience of running that vehicle, such as its real-life service, maintenance and fuel costs, as well as forecasts, particularly of residual values.
The TCO of a vehicle is not fixed, however, and can fluctuate as residual values change, new taxes are introduced, and fuel prices rise or fall.
For simplicity, some fleets use lease rentals as an alternative to TCO for ranking vehicles, but lease rentals do not always include insurance, never include fuel, and can fail to show some of the tax and accounting advantages of some vehicles, particularly zero emission electric cars and vans, that can significantly reduce their TCO.
Use applications of TCO
A detailed TCO approach provides businesses with essential information for budgeting future fleet expenditure.
It can also be used to establish the most cost effective company car and van choices, providing greater depth than fleet policies based on lease rentals or the list price of vehicles.
And TCO is especially important in supporting the business case for electric vehicles, which typically have higher acquisition costs than petrol and diesel alternatives, but enjoy significantly lower taxes, running and fuel costs.
KEY ELEMENTS OF TCO
1. Borrowing costs
Using a loan or a lease to finance a vehicle involves interest payments on the money borrowed, which has to be included in the TCO.
Cash-rich businesses that use their own funds to buy vehicles outright need to factor in the lost opportunity cost of this money through discounted cash flow modelling.
The biggest element of TCO is typically depreciation. This is the difference between the actual purchase price (not the official list price) of a vehicle, taking into account the cost of any extra specification as well as any fleet discount and government subsidy, and the value it achieves at the end of its fleet life when it is sold to a new owner.
Depreciation varies between makes and models – premium brands often retain more of their value than mainstream brands, which can mean their TCO is extremely competitive.
Residual values fluctuate during the lifecycle of a vehicle, so there is no guarantee that the forecast made when a vehicle joins a fleet will be the value achieved when it is eventually sold.
3. Service, maintenance and repair
The cost of servicing and maintaining fleet vehicles depends heavily on their mileages. OEMs publish service intervals and many franchised dealerships will have fixed cost service plans, so an outline service cost is readily achievable.
Real-life experience, however, provides a more accurate basis for forecasting service, maintenance and repair (SMR) costs, especially for fleets that keep vehicles for longer than the warranty period.
Tyres represent a significant additional cost within a vehicle’s maintenance budget, but projecting their cost is complicated. Two identical vehicles with similar mileages but different driving patterns, such as stop-start city driving or motorway miles, will have very different tyre wear. Fleet managers also have to decide whether to replace tyres on a like-for-like basis with the brand fitted by the OEM; and whether to fit a cheaper tyre to a vehicle close to the end of its fleet life.
There is still a shortage of data on the SMR costs of electric vehicles, but early indications suggest they are proving to be much cheaper to keep on the road than vehicles with combustion engines, because they have many fewer moving parts to replace.
The costliest day-to-day element of a vehicle’s TCO is its fuel costs. Multiplying a vehicle’s projected business mileage by its official WLTP fuel consumption figure provides a guide to its lifetime fuel costs.
Fleets that use a fixed rate per kilometre to reimburse their drivers for business journeys can multiply this rate by the anticipated total business kilometres to estimate the fuel costs over the life of the vehicle.
A more accurate approach, however, is to reimburse drivers according to their actual expenditure on fuel for business journeys, using fuel card data. In this scenario, fleets will normally have to use aggregated real-life fuel economy figures as a basis for calculating TCO, because different drivers can return very different fuel economy figures from the same vehicle.
Remember, too, that job and operational changes can significantly increase or decrease the annual mileages of employees, which would impact TCO.
And, of course, pump prices can rise and fall sharply over the course of a three or four-year fleet holding period.
The rapid transition to electric vehicles creates a new challenge for fleet managers attempting to forecast TCOs. Put simply, there is a massive gulf between the cost of recharging a car or van overnight from a driver’s home charge point, taking advantage of the lowest cost electricity tariffs available; and the cost of recharging at an ultra-rapid charge point on a commercial network.
An accurate TCO will have to forecast where drivers will recharge their EVs.
Once the recharging tariff is established for the TCO, the same calculations for ICE vehicles apply to EVs in terms of energy costs.
6. Charge zone fees
As cities take bolder steps to combat local air pollution, congestion charges and ultra-low emission fees may be applied to some vehicles but not others. In many instances electric vehicles are exempt from these daily charges, which can give them a huge TCO advantage over diesel cars and vans that have to pay the fees.
Every country has its own tax structure for company vehicles encompassing a wide range of taxes, including VAT (and what percentage can be recovered), registration tax, annual road tax, supplementary taxes on vehicles with high CO2 emissions, and employer contributions based on the benefit in kind tax paid by employees.
The tax advantages enjoyed by zero emission vehicles, compared with petrol or diesel models, can be an important factor in helping EVs compete with ICE vehicles on TCO.
8. Accounting allowances
Some national tax regimes offer businesses a writing down allowance on the capital expenditure on assets that they buy. How these allowances and other tax reliefs are calculated can often deliver TCO advantages to low emission cars and vans. They can also sometimes make a key difference between the cost efficiency of buying or leasing a vehicle.
For smaller fleets, insurance premiums can differ from vehicle to vehicle, as in the private motoring market. Larger fleets are more likely to negotiate a blanket insurance policy, with a fixed premium per vehicle, which needs to be factored into TCO calculations, but does not differentiate between vehicles.
Fleets that self-insure or operate a large excess (deductible), however, will find that repair costs vary sharply from one make and model to the next. Hopefully, these are a variable that will never come into play if a fleet has a comprehensive safety policy.
10. Breakdown and recovery
The cost of cover for roadside assistance, which is effectively an insurance, is unlikely to vary from vehicle to vehicle and is therefore less useful for TCO comparisons. But for a fleet trying to establish the true cost of running vehicles, breakdown and recover services ought to be included in TCO.
TCO is a key tool to analyse and evaluate the lowest cost vehicle options for their entire fleet life. At the strategic level it supports the selection of best value vehicles, as part of an appraisal that must also consider a vehicle’s fitness for business purpose.