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FLEET DECISIONS – The predictions game that steers lessors out of the

It has been said once or twice before that the real business of the car fleet leasing and contract hire companies is turning new cars into used cars for a profit. As that somewhat convoluted logic might suggest, this is not an easy market to do well in. Essentially leasing is about reading the cycles of boom and bust, or mini-booms and mini-busts, correctly. Cars you lease today return in three years (generally) as awkward lumps of residual value. Predicting what this residual value will be, to within a percentage point or so, can mean the difference between success and failure, because nobody’s profit margins are great enough for a run of mistaken predictions to be borne lightly. Predicting residuals was a difficult enough game when all that the contract hire companies had to do was to second guess the UK economy. But now that the euro has come along to lift the veil on our provincial market and expose us to the multiple, intermeshed car economies of mainland Europe, the prediction game has become even trickier. The first and most obvious manifestation of the way Europe complicates the leasing equation is the issue of European car pricing. The public perception that European cars are priced well below their British equivalents has reached such a pitch that the Office of Fair Trading recently announced that it would be conducting an inquiry into the causes. Howard Thomas, marketing director at Lease Plan, admits that this is an issue of huge importance to the individual consumer, a steady trickle of whom have been tempted to shop for cars on away-day excursions to the Continent instead of down at their local dealer. However, for most significant fleet purchases, he argues, shopping abroad really makes little or no sense at all. “We have examined the market very carefully and there are huge difficulties in the way of acquiring cars from Europe,” Thomas says. Not the least of these difficulties, he points out, is the absence of any real incentive for foreign dealers to sell export models to UK citizens or companies. “Irrespective of what country they are in, dealers like to work on their national allocations and for this purpose, export models do not count. Moreover, once a car is sold to a UK driver or fleet operator, it is gone forever. The dealer doesn’t get any after-sales work from that vehicle,” he says. This means that UK shoppers tend to be sent to the back of the queue when they turn up at foreign dealers. But fleet operators need fixed delivery dates, not vague time-scales geared to when an unmotivated dealer has a sufficient surplus of the car in question to dump some on an overseas buyer. For its part, Lease Plan buys 20,000 vehicles a year and does not need the complications that would come from trying to source those cars from European dealers, Thomas notes. Steve Carman, public relations and brand manager at Lex Vehicle Leasing, agrees. “You might see the director of a two car company in Kent popping across the Channel to buy a car, but we can’t see too much of this happening at the medium-sized fleet level,” he says. Carman argues that someone charged with acquiring and managing a 500-vehicle fleet will have more than enough on their hands already. The last thing they are going to want to do is to go and buy 50 or so vehicles from a dealer in Belgium, 50 from a dealer in Holland and so on. “All the cars will have different specifications. There will be different paperwork and different terms. The amount of additional hassle, for the amount of money saved, will be a huge disincentive,” Carman says. And anyway, he says that he expects price parity to arrive within a few years, irrespective of what the Office of Fair Trading concludes, and that will remove any remaining incentive to shop for cars abroad. Steve Clary, the national sales manager at FCE Bank Plc, the banking arm of Ford Contract Motoring, believes that the current huge differentials in pricing between mainland Europe and Britain are largely illusory anyway. It is not just that shopping abroad can be a hassle; what people find when they try to buy cars in any sort of numbers from the continent is that they are comparing apples with oranges. The British car, he argues, is very highly specified, with far more by way of bells and whistles than its Italian, French or Belgian counterpart. “What the general public needs to understand,” Clary says, “is that while you can compare advertised prices here and in Europe, and see a large differential, things look very different at the end of the deal.” He claims that when it comes to actually negotiating the list price with the respective dealers, and adding back in all the bonuses in the UK, such as the dealer registration bonus, low financing costs, vehicle specification and so forth, the perceived price difference can often dwindle into insignificance. The OFT’s investigation, he predicts, will discover that the apparent price disparity is in reality a list price disparity rather than an actual acquisition disparity. This is not to say that there are no differentials, or that Clary believes that such differentials as there are will soon disappear. On the contrary, he argues that the different taxation regimes and worker productivity factors in the respective countries will keep some kind of differential going for at least a few years yet. “It is possible that pricing differentials may narrow when the UK joins EMU, which I personally believe is likely to happen around 2003, and which looks absolutely inevitable. In the meantime, what we are all asking ourselves is what impact the euro is likely to have on residual values of vehicles here in the UK,” he says. While few in the contract hire industry seem worried about the prospect of fleet managers slipping off to the continent to buy their own cut price fleets, many, it seems, are worried about the additional complexity occasioned by the arrival of the euro. “If there is one thing that I am reasonably certain of, it is that if the euro has any impact on residuals, it will not be a positive one,” Clary says gloomily. Lease Plan’s Thomas points out that any view of what residuals might do under the influence of the euro has to be placed in the context of the way in which the real price of new cars has fallen over the past few years. The list price of new cars may have increased, he says, but this masks the fact that more and more high-specification items are now appearing as standard, without impacting on the cost. This policy of absorbing add-ons as part of the standard specification started with sun roofs, then spread to air conditioning and is now moving to embrace ABS braking and other high-price items. “What we have seen is that apart from a marked drop in the last six months of 1998, which caught everyone out, used car prices have held steady or risen, while new car prices have dropped in real terms. We have seen new cars come down 24% in value for key models over the course of 1998,” he says. Against this background, Thomas expects the euro to erode residual values, if only through the uncertainties that it introduces into the market. “If used car prices drop it follows that depreciation increases, so the whole life costs associated with ownership also increase. This means that for all types of motorist, it is going to cost more to own cars in future, irrespective of any budget changes,” he says. Lex’s Carman expects the impact of the euro to be felt more or less immediately. Lex, he points out, is already moving fast to enable its customer-facing systems to deal in euros for its larger customers. “Companies such as Pilkingtons, Computer Science Corporation and Yorkshire Electricity will be able to pay us and bill us in euros before the end of the year,” he says. Carman predicts that ultimately, as big UK companies move to euro-based accounting, this will lead to price transparency across all markets, including the car market. This will not end list price disparities, but it will help the UK industry to get across to the public the fact that the basis of the disparity lies in the level of specification, not in some arbitrary profiteering. Also, he says, the euro will not help reduce the uncertainties in the residuals pricing issue; in fact those uncertainties will continue to be amplified by the new visibility of the European markets. “This is essentially a cyclical business. When new car sales are depressed, fewer used cars are created and three years later the price of used cars goes up. When new car sales hit record levels, used car values plummet further down the cycle,” he says. Right now, according to Carman, we are in a position where the supply of used cars exceeds demand and so the contract industry is suffering. “On the Continent, used car values vary widely from country to country, partly as a function of the way second hand cars are sold in the various countries,” he explains. (Some countries route everything through the dealer channel, some use auctions. The UK uses both channels in roughly equal measure.) Robin MacKonochie, the external affairs manager at the British Vehicle Rental and Leasing Association, (BVRLA), on the other hand, argues that the euro will probably have little or no discernible effect on residual values in the UK for some time to come. “What is far more important, from our perspective,” he says, “is trying to figure out what the effect on residuals will be when the changes the Chancellor has promised for 2002, to benefit-in-kind taxation, come into force.” Currently, benefit-in-kind is based on 35% of the list price of a vehicle where the driver does up to 2,500 business miles, plus a 10% discount (to 25%) for company car drivers who do more than 2,500 miles and less than 18,000 miles, and a further 10% discount for those who drive more than 18,000 miles a year. After 2002, the Chancellor plans to do away with the discounts for mileage, and to introduce instead a discount scheme based on car emissions. This, of course, begs the question of which emissions, exactly, will be deemed to be worth taxing by 2002. At this moment in time, the Government is saying that carbon dioxide emissions will definitely be caught, but that other gaseous emissions, such as nitric oxides, may be included by the time the legislation is passed. “It seems reasonable to predict that whatever measure they use, larger cars will be hit harder than smaller cars. But it is much harder to tell what the knock on effect on the residuals market will be,” MacKonochie says. As a result, large cars may become less desirable, because of the associated tax penalties. But there may also be a glut of small cars on the market, which would be likely to drive down their residual values. Large cars being scarce, could, perversely from the standpoint of the Government’s proposed litigation, see their residuals appreciate in accordance with the laws of supply and demand, making ownership cheaper. Ford’s Steve Clary argues that with all the uncertainties surrounding the issue of residual values, the only way a leasing company can hope to steer a steady course is by putting together a residual values committee composed largely of risk analysis managers, with just one or two members who wear a business development and sales hat. If you let sales orientated folk drive the process of estimating residuals, he points out, they will inevitably end up buying two years worth of wonderful sales figures by wildly overestimating residuals. The key point here, of course, is that the higher the leasing company’s estimate of the expected end of contract residual value of the vehicle, the less it has to charge the leasee, allowing it to price its bids and contracts more competitively. As a result, the leasing industry has had more than its fair share of managers with a spate of glittering two year track records at different contract hire companies behind them. “If you want to succeed in this business, get yourself a decent residual values committee with the proper balance, and make frequent use of experts from outside your organisation,” Clary argues. Leasing companies who do this, and who have pockets deep enough to ride the cyclical ups and downs endemic in the industry, need not fear the euro.

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