Residual value (RV) risk is the risk in the price that a vehicle will achieve on resale.

If you buy your own vehicles then sell them on your own account, you are taking the residual value risk.

Contract hire companies estimate residual values for a living. They have to – the contract hire company gives complete residual value protection to the client.

In assessing this risk and setting an estimated residual value, you should take into account all of the macro-economic and micro-economic factors that can affect the sale price of a car.

We can divide these into supply side and demand side issues.

Supply side issues

• New vehicle supply numbers

The number of new vehicles entering the market today will determine the supply of used
cars in the market in three years’ time.

• The willingness of owners to sell their cars

This used to be easy to measure because about half of all new vehicles were operated by companies and sold after 36 months.

This is now slightly less certain as many companies run vehicles for four years to reduce average costs. Private owners will extend ownership cycles if the economy cools.

• The short-cycle market

Manufacturers supply heavily-discounted new vehicles to daily rental companies. These will have a direct impact on the number of nearly-new cars hitting the used car market in a year’s time. If this is a large number it will have a knock-on effect on the price of used cars in two or three years’ time.

• The life-cycle of the vehicle

You need to consider whether a vehicle will still be a current model at the time of sale.

• Manufacturers’ consumer offers

Manufacturers use special offers to promote particular models, normally targeting retail rather than fleet buyers.

These deals depress the new price of a vehicle and therefore have a direct effect on the used price.

Demand side issues

• The economy

You will have to consider the general economic climate – gross domestic product, inflation, interest rates and employment.

• The amount of disposable income in the hands of private individuals

Disposable income is a function of economic growth, employment, interest rates and the willingness of people to part with their savings.

• Technological and environmental changes

Three years is long enough for technology, legislation or fashion to change and affect the attractiveness of a used vehicle to a buyer. Some changes can be foreseen and you can attempt to measure their likely effect on residual values.

Others are harder to measure. For example, the sharp increase in the number of company car drivers choosing diesel cars perplexed many RV-setters who had to decide how the used car market would accept a sharp increase in the number of used diesels on offer.

• Demographic trends

Trends in the UK population are likely to make some cars more popular than others. With an ageing population, smaller cars are likely to gain in popularity over large, expensive ones.

• Changes in vehicle models by manufacturers

Old models look old and are not as attractive to the used car buyer. Product life-cycles vary. By reading motoring publications you can usually ascertain whether a model change is likely to occur within the next year or two and whether it is going to be a facelift or a total replacement.

However, it is not normally possible to get information on model changes planned for later than this.

• The availability of substitutes

The buyer of a three-year-old Ford Mondeo 1.8 LX is likely to have a fixed budget. If, for reasons listed under ‘supply’, the prices of used Mondeo 1.8 LXs are high, they will buy a different make or model and prices for those models will rise. The substitution effect is very real but is hard to predict.

• Disposal methods

The price achieved in a private sale is usually significantly higher than that achieved at auction.

The portfolio effect

If you have a large mixed fleet you will be cushioned against some market downturns by
the portfolio effect (an over-estimation on one vehicle may be compensated for by an under-
estimation on another).

Contract hire companies routinely get their sums wrong when estimating residual values on individual cars but the portfolio effect helps them.

Generally, they gain if the used car market rises unexpectedly and they lose if it falls unexpectedly.

• This article is an abridged version from Managing Your Company Cars in Nine Easy Steps, published by Eyelevel Books in association with Daimler Fleet Management.
• Fleet News readers can purchase the book for a special price of £12 (retail price £15) by logging on to www.tourick.com and entering the promotional code 1598.