Kicking the habit?

vAugust new car sales have been reported as 18 per cent down
on the equivalent period in 2007, but the used car market appears
to have held up, although prices have slipped. The challenge with
changed market conditions is perhaps not so much for the private
car owner, who may expect to change their car every three to four
years and can hold off if necessary, as for the fleet operator or
leasing company, with a steady stream of returning units with
residual values determined in happier economic circumstances.

The problem of collapsing residual values is focused most
strongly on fleet operators and most significantly on leasing
companies where contracts are tightly governed by time and mileage,
and lessees anticipate regular unit changeover.

The challenge for the fleet operator and particularly the
leasing company is how do they stem their short/medium term losses
on residual values until they have implemented new pricing
formulae? The trite answer is, not easily – but are there steps
which can be taken by fleet operators and leasing companies to cut
losses. How might that affect finance programmes?

The first group of challenges are those of the fleet operator.
Are there immediate steps to be taken to help minimise the impact
of collapsing residual values? Previous economic downturns have led
to a variety of risk minimisation exercises. Consider some of
them:

  • Extend the replacement cycle of current vehicles; merely
    because a unit is four years old does not mean it has come to the
    end of its economic life. A caveat – don’t implement a decision on
    vehicles to be replaced immediately as they may have entered an
    ‘end game’ and it would be expensive to bring them back to
    standard. Work with those units that have up to date maintenance
    and could be continued.
  • Look for selective replacement if units are inside their real
    operating lives are being returned ahead of schedule – why not
    switch them with lower quality units to enhance fleet
    quality? In the case of the leasing companies, the picture is
    more complicated as they have a steady stream of returning cars.
    What steps might they take to reduce the impact of falling
    residuals?
  • Offer extended contracts on current units at attractive prices;
    the impact may be to spread the depreciation over a longer period –
    but it may have implications for future contracts and prices on
    new, replacement units.
  • Offer used vehicle leasing with some carefully selected clients
    and offer them extended rentals at a discount on current cars.
    Watch for any mantraps though! This strategy was fraught last time
    it was practiced.
  • Look to reducing transaction costs on changing the units – what
    costs can be cut or eliminated? There can be at least twenty
    transaction costs involved in changeover – just how many can be
    reduced or eliminated?
  • Used vehicle disposal – is it as smart as it could be? Are
    there ways it can be speeded up to get units off the books faster
    and save that elusive £8-10 a day on depreciation?
  • Sell direct to the next stage buyer rather than use an auction.
    Maybe that’s a step too far for most lessors – but what about
    selling direct the most attractive units?

Coping mechanism

Strategically, one may hope this is a short-term drop in
residuals, but it is unpleasant while it lasts. Clients will be
reshaping their business to respond to the recession. It’s best
practice if you do the same – so are there clients who cost more
than they are worth? Are there some clients you may well seek to
drop from your book?

It may well be that the leasing industry is entering a period of
consolidation and seriously changing the way it does business.
Indeed, that may well be the mantra for the industry. Leasing rates
may, very probably will, have to rise as a result of dropping
residuals – the challenge will be to trade even smarter,
short-term, to stem losses and longer-term to look perhaps to
change the financial product you are actually offering.

A product or business model that has been successful in the past
may not necessarily be successful in the future. Kicking the habit
of returning to the old product may be difficult and it could well
be the businesses that can handle the changes necessary that will
survive.
Good luck. 


Professor Peter N C Cooke, KPMG Professor of Automotive
Management, University of Buckingham