August 2008, Automotive Fleet - Feature
Pros & Cons of Extending Replacement Policy
Replacement policy is one of the most critical aspects of fleet management. Nearly every other cost, both fixed and variable, hinges upon when vehicles are replaced. Maintenance and repair expense, fuel efficiency, and of course, depreciation are all sensitive to replacement policy.
The most commonly accepted cycle, for many years, has revolved around time/mileage combinations of 36 months and 65,000 miles for autos; approximately 48 months and 75,000-100,000 miles for light trucks. While this cycle reflects a certain logic, the many changes in vehicles, warranties, and financial considerations have led some fleets to consider lengthening replacement policy.
Traditional Policy Focuses on Three Years/65,000 Miles
For years, the logic in replacement policy has been that vehicles kept beyond three years or 65,000 miles risk major component failure, as well as a drop in residual value, the combination of which causes total lifecycle costs to rise. Replace too soon, and depreciation will be too high; replace too late, and both mechanical failure risk as well as overall variable expense will spike.
That logic held much truth. Years ago when this “common wisdom” was
established, new-vehicle warranties were 12 months and 12,000 miles, and vehicle quality was mediocre. Keeping vehicles in service too long, beyond the 36-month cycle, did indeed risk engine and drivetrain failures, and rising depreciation as well.
Variable expense tends to ratchet upward. For the first 35,000-45,000 miles, variable expense is generally limited to preventive maintenance: oil changes, wheel alignments, tire rotation, etc. The two largest (nonfuel) predictable variable expense events are tire and brake replacement, which generally occur sometime after 30,000 miles.
Click here to open Figure 1
At this point, variable expense, measured in cents per mile (CPM) spikes upward as tires and/or brakes are replaced. As mileage further accumulates, CPM begins to decline, but not back to the previous level. This “ratchet” effect generally continues throughout the life of the vehicle.
On the fixed-cost side, comprising primarily depreciation, the curve in CPM is dramatically different. Depreciation cost begins high, as the vehicle is titled and driven off the lot. As mileage accumulates, the depreciation expense curve declines steeply; the vehicle continues to depreciate at a relatively slow rate for the balance of its in-service life.
In fleet usage, mileage is accumulated at a rate approximately twice that of the typical personal vehicle. For that reason, previous logic determined even a well-maintained vehicle suffers increased risk of major mechanical failure as time in service and mileage accumulate.
Relating depreciation cost trends to the variable expense narrative, then, with mileage accumulating quickly, the best time to replace fleet vehicles is after the first incidence of tire/brake replacement, but before the next one, i.e., somewhere in the 65,000-75,000 mile range.
Figure 1 details CPM costs at 5,000-mile intervals. The trend can clearly be seen. The variable CPM is relatively nominal until the 30,000-mile increment, then spikes high at 40,000 miles with the replacement of tires and brakes, declines slowly again until the second round of tires and brakes hits at 80,000 miles.
Using these assumptions, the most cost-efficient time to replace, based upon variable cost, is between 70,000 and 75,000 miles. Naturally, actual maintenance and repair expense is not quite so cooperative as to fall in neat, predictable increments; tires go flat, hoses and belts breach, windshields need replacement. A replacement policy cannot predict such events when initially established. As the fleet ages, actual expense history can be blended into, and ultimately replace, the assumptions. The trend, however, is not likely to differ greatly.