In the war for consumer popularity Nestle and Rowntree have been neck and neck for years.
For TV ratings, EastEnders and Coronation Street have been vying for public affection for 20 years and in politics, Labour and Conservatives have pipped each other to the post at election time on several occasions. There is a similar theme in fleet funding.Contract hire and outright purchase are two funding methods which have had, more or less, an equal share of the fleet market in recent years.
The decision to choose one method over another relies on individual fleet circumstances but for a new fleet starting out on the funding path, the decision can be daunting. Both have merits and pitfalls. Using a five-tick system, zero being the lowest score and five ticks the highest, we weigh up the pros and cons of each method in a simple, easy-to-understand format, in a bid to help fleets decide which route to take.
Contract hire
- Replacement cycle
CONTRACT hire agreements usually operate on a three-year/60,000 mile basis so fleets must be sure that they require the vehicle for a set period. If the vehicle is returned before the agreed time, a penalty is usually charged.
Flexibility is key to some fleets and the idea of being in a set contract for three years may be restrictive. Andrew Cope, chief executive at Zenith Vehicle Contracts, said: ‘Many companies feel that contract hire is inflexible. On outright purchase, the only costs you suffer will be the difference between your write-down position and what the car is worth, whereas with contract hire you pay a termination penalty which may be a higher cost, depending on your contract.’
However, things have begun to improve in recent years and contract hire is more flexible than it used to be. Some companies will offer some form of open book profit sharing.
- Mileage
CONTRACT hire companies will charge excess mileage if drivers exceed a pre-agreed limit. The amount charged will vary between suppliers but on average it is usually between 5p and 7p per mile. It sounds nominal but costs could rocket by completing a few extra miles a week. By clocking up 70 miles extra in one week, fleets could see charges of more than £20 a month added to the bill.
- Maintenance
FLEET decision-makers can pay extra to have maintenance included on the contract. This would cover all routine servicing and take some of the workload from the fleet, putting more onus on the contract hire company.
Some fleets with in-house bodyshop and repair facilities would not benefit from paying the extra costs but for those without such provisions then maintenance could benefit.
Paul Taylor, operations director at Car Benefit Solutions, said: ‘Using an off-balance sheet solution, companies can outsource residual value and maintenance risk, although this would be reflected in monthly repayments.’
- Cost savings
ONE of the major plus points of contract hire is that fleets are able to budget as costs are fixed on a monthly basis. As the contract hire company is responsible for the vehicle, it takes on some of the risks. Residual values do not affect the fleet. Also as the fleet does not require initial funding, it is also the contract hire company which will be affected by any changes to interest.
As costs are spread over the contract, companies may be left with additional capital which would traditionally gone towards the purchase of vehicles. This can be put back into the company says Steve Underwood, business development director at Hitachi Capital Vehicle Solutions. He said: ‘Contract hire allows companies to preserve capital which they can use to invest in activities and other parts of the business.’
- Added costs
WEAR and tear is one of the pitfalls of contact hire. Charges for damage can vary considerably and the issue of what constitutes fair wear and tear is still a grey area. This can bump up the true cost of contract hire and can affect budgets. Sean Welham, strategic marketing director at TLS Vehicle Rental, said: ‘It should be clear what will be deemed fair and what will require extra payment from you.’
Outright purchase
- Replacement cycles
AS outright purchase is more flexible, fleets can decide at the last minute not to replace vehicles, without worrying about excess mileage charges or fees for additional wear and tear.
As the replacement cycle can be changed easily fleets can often feel as though they have more hands-on control. However, if a vehicle is sold early, the re-sale value may be less than expected, thanks to the vagaries of the used market.
Welham said: ‘If you sell a vehicle early, its sale value could be considerably less than its book value, which will raise your true monthly cost.’
- Mileage
MILEAGE is one of the largest factors to bump up costs on outright purchase fleets. High mileage vehicles are likely to incur greater maintenance costs as the vehicle deteriorates over time.
Alongside condition, the age of the vehicle and how many miles it has clocked up will also be a determining factor at disposal time.
However, it is a balancing act as keeping a vehicle for a longer than average cycle could be beneficial according to Underwood.
He said: ‘The only context in which outright purchase is a valid option is when a company records very high mileages among its drivers and has a policy of running vehicles into the ground.’
- Maintenance
MAINTENANCE is another culprit for denting budgets on outright purchase fleets. Fleets will be responsible for ensuring all vehicles are properly maintained and costs can vary depending on how vehicles are treated.
The types of vehicle used on the fleet will also determine maintenance costs so it is importance to source various quotes from suppliers.
Welham said: ‘Make sure you understand the projected average maintenance costs.
Remember, the maintenance costs will get higher towards the end of the holding period as time and miles take their toll. Make allowance for future expense and identify the best time to sell a vehicle.’
- Cost savings
ALTHOUGH fleets will be responsible for vehicle remarketing, as the fleet manager has full control of the fleet, if any windfall profits are made at sale time, these will go straight back into the company.
To ensure this happens, fleets must keep a stringent check on the age, mileage and condition of the vehicles which will warrant high residual values at the end of the replacement cycle.
- Added costs
IF vehicles are purchased with a variable loan and interest rates fluctuate, then monthly budgets could increase.
But whichever method is chosen for funding, whether it is a loan or a lump sum, capital will be tied up in the vehicles.
Taylor said: ‘The amount of capital required to fund the initial purchase and furthermore the capital investment is tied up in a non-core activity asset.
‘For those companies which do have the available resources to purchase their own fleets, there are a number of opportunities to maximise financial efficiencies.’
Summary
OUR feature puts the funding option question in its simplest form and is not meant to be a complete guide. Both funding methods have advantages and disadvantages.
For fleets wanting diminished responsibility or to operate without a fleet manager then contract hire may be the way forward.
However, if there is a dedicated fleet decision-maker or a company has spare equity, then outright purchase may be a better option.
Companies need to weigh up the pros and cons before deciding which method best suits their circumstances
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