Replacement Funding Requests Vulnerable
Even during good economic times, securing sufficient funds for timely vehicle replacement is a challenge for many organizations. This challenge stems in part from a lack of understanding of the trade-off between a vehicle's capital and operating costs, as illustrated in Charts 1 and 2 (see pdf).
Many decision makers also do not fully appreciate the role fleet plays in supporting an organization's primary mission. Intellectually, they may understand vehicles are a necessary tool for directly or indirectly supporting the delivery of goods and services. When push comes to shove, however, decision makers may be quick to cut fleet funding in the belief vehicle purchases are, at least to some degree, a discretionary expense deferrable during times of fiscal constraint.
However, the vulnerability of fleet replacement funding in most organizations stems less from a lack of appreciation of the importance of vehicles or the need to replace them on a regular basis, than from an inability to deal with year-to-year fleet replacement spending needs, inherently lumpy in most organizations.
Chart 3 (see pdf) illustrates the long-term replacement costs of a small government fleet of about 160 vehicles. The fleet comprises 56 different types of vehicles and pieces of equipment. The replacement cost (i.e., purchase price) in today's dollars of each of these assets ranges from $5,200 to $353,000. Their replacement intervals range from four to 20 years. The weighted average replacement cycle for all the fleet assets is 10 years, and the weighted average replacement cost is $62,000.
As demonstrated, projected annual replacement costs for this fleet are quite uneven, ranging from a low of about $250,000 in 2011 to a high of almost $3 million in 2016. This lumpiness is common in virtually all government fleets.
The biggest impediment many organizations face to replacing vehicles in a timely manner (and thus minimizing vehicle total cost of ownership) is the lack of a replacement program to deal with such volatile spending needs. Specifically, organizations do not know how to accommodate year-to-year changes in spending requirements when the source of funds for such expenditures is relatively static.
The solution to this problem lies in pursuing one of two courses of action:
- Eliminating the volatility in fleet replacement spending requirements.
- Eliminating the volatility in replacement funding requirements.
What's the difference?
Fleet Replacement Financing Alternatives: Ad Hoc Appropriations
Fleet replacement funding requirements are a function of the way in which an organization pays for or finances vehicle acquisitions. If vehicle acquisitions are financed through ad hoc appropriations of cash and outright purchase, year-over-year replacement funding needs are every bit as volatile as spending needs. This is because cash financing involves paying for a vehicle in full at the time it is acquired and placed in service, and because the confluence of replacement dates for the many vehicles and different types of vehicles in a typical government fleet results in peaks and valleys in the annual number of replacements.
Many organizations believe cash payments are the cheapest way to replace fleet assets. Interest charges are not involved in this financing method, as is the case with leasing, loans, or other types of "pay-as-you-go" financing. Thus, it would appear an economically as well as fiscally prudent way to acquire vehicles.
Such thinking overlooks the fact, however, that using cash to finance fleet replacement costs creates the volatile funding requirements illustrated in Chart 3 (see pdf). While near-term peaks and valleys in annual replacement spending needs sometimes can be eliminated by manipulating the timing of the replacement of individual vehicles, no amount of such manipulation completely eliminates year-to-year fluctuations in spending and, hence, funding needs over the long term.