Maximizing Your Fleet Profitability & Growth Strategy
As the fuel crisis continues unabated, and as the U.S. economy continues to decline, the profit situation for most fleets in our industry is also changing. You know which of your existing vehicles were profitable in the past and which vehicles operated at a loss. But how will vehicle profitability change as your fleet ages, as fuel prices continue to increase, and as the declining economy causes a reduction in utilization of certain types of vehicles?
If you are interested in assuring that each segment of your fleet is maximizing profits, utilization, and cash flow, or if you would like to analyze the advantages of merging your fleet with another ground operator, a Fleet Performance Analysis Model can help you evaluate your options.
One of our client companies has posted a 8% profit margin (profits divided by revenue) for the first 5 months of 2008. However, on about 25% of their vehicles, the company is losing money. Since roughly 25% of this company's revenue is derived from customers who have resisted paying fuel surcharges, parking older vehicles and "firing" certain customers may actually be a better strategic decision than trading the older vehicles and investing in new equipment (which is the economic equivalent of making a big investment in order to serve customers who are unwilling to pay fair value for service).
If there are multiple ground operators in your market that should be downsizing rather than replacing their oldest equipment, and if you are considering such a strategy, consolidating two or more of those fleets through merger or acquisition might be the strategic answer.
Prospective investors have asked us on several occasions to use our Fleet Profitability Analysis (FPA) Model to analyze the performance of ground transport operators that they are considering for acquisition or merger.
To be clear, the owners and management teams of the target companies must agree and fully participate in such a "strategic analysis". Otherwise, we respectfully decline such an engagement.
Of course, there are more acquisitions and mergers considered in our industry than are actually consummated. However, our FPA Model helps assure that acquisitions/mergers are consummated for the right reasons and that "bad matches" are rejected for the right reasons. And the operations and strategic implications that always flow from the model help companies plot their future course regardless of whether a transaction occurs.
Sample FPA Model Output
The inner workings of the FPA Model and the input data that is gathered from the target companies are complicated (but available if the reader is interested). However, in the interest of the reader's time, we have summarized the model output for a target acquisition company that operates locally in a major metropolitan area with a diversified fleet consisting of 140 vehicles, as follows:
Exhibit 1
---------------Latest 12 months actual data*---------------
----------per vehicle----------
Fleet
Average # units
Revenue
Invested capital**
Revenue
Invested capital**
Motorcoach
8
$1,562,565
$1,680,000
$195,321
$210,000
Midsize bus
44
$5,731,4805
$5,500,000
$130,261
$125,000
Minibus
35
$2,657,598
$2,625,000
$75,931
$75,000
Special buses
22
$2,041,679
$1,713,250
$92,804
$77,875
Sedans
18.5
$1,887,732
$528,571
$102,040
$28,571
Limos
12
$879,466
$725,455
$73,289
$60,455
Total all fleets
139.5
$14,760,519
$12,772,276
$105,810
$91,558
* This analysis includes revenue on company owned vehicles and vehicles "leased to own". It excludes $3.1 million of revenue and corresponding cash flow and profit for vehicles not owned or leased by our client.
**Invested capital (Inv) for each vehicle is fair market value, because the proposed transaction would result in "writing up" the value of each physical asset to fair market value on the date of the transaction.
Exhibit 2
---------------Profit Margins and Cash Flow Margins***---------------
Net profit / Revenue
Fleet Profit/Revenue
Cash Flow/Revenue
Capital Efficiency
Motorcoach
2%
21%
50%
0.93
Midsize
12%
31%
40%
1.04
Minibus
15%
34%
44%
1.01
Special buses
23%
42%
47%
1.19
Sedans
1%
20%
27%
3.57
Limos
-3%
16%
26%
1.21
Total all fleets
12%
31%
41%
1.16
***Definitions: Net profit for each fleet is revenue minus all direct expenses for that fleet and minus an allocation of company overhead expenses. There is no interest expense because this proposed transaction would be financed entirely with equity funds.In this instance, the overhead expense allocation for each fleet is 19% of fleet revenue. However, note carefully that there is no "scientific method" or "Standard accounting principle" which dictates how overhead should be allocated. Arbitrary or overly simplified allocation methods can easily lead to wrong conclusions about fleet profitability.
Fleet profit is net profit for each specific fleet before deducting overhead allocations. While a substantial % of total company costs are excluded from this calculation, fleet profit margin provides a comparison of the several fleets that is not prejudiced by arbitrary overhead allocations. However, Fleet Profit Margins (and Cash Flow margins), must be high enough to cover all overhead expenses. For example, the 16% fleet profit margin for the Limo fleet reflects a poor performance regardless of which method is used to allocate overhead expenses.
Cash Flow is Fleet Profit plus depreciation expense and capitalizable maintenance expense for that fleet. Examples of capitalizable maintenance expense are major engine overhauls and major refurbishing of bus interiors.
Capital Efficiency ratio is Revenue divided by invested capital. Simply stated, it is the amount of revenue generated per $ of invested capital.
Return on invested capital**** See Exhibit 3 for three different calculations of return on invested capital:Fleet Profit/Invested Capital, Net Profit/Invested Capital, and Cash Flow/Invested Capital.
**** It is helpful (and accurate) to think of return on invested capital as profit margin multiplied by the capital efficiency ratio. For example:
(Fleet Profit/Revenue) X (Revenue/Invested Capital) = Fleet profit/Invested Capital
For the Sedan fleet, 20% X 3.57 = 71%
Motor Coach fleet, 20% X .93 = 19%
Limo fleet, 16% X 1.21 = 19%
Midsize Bus fleet, 31% X 1.04 = 33%
Minibus fleet, 34% X 1.01 = 34%
Special bus fleet, 41% X 1.19 = 50%
Exhibit 3
---------------Return on Invested Capital (Inv)****---------------
Fleet
Net profit / Inv
Fleet Profit / Inv
Cash Flow / Invested Capital
Motorcoach
2%
19%
46%
Midsize
13%
33%
42%
Minibus
16%
35%
45%
Special buses
28%
50%
56%
Sedans
3%
71%
98%
Limos
-4%
19%
31%
Total all fleets
14%
36%
48%
As you can see from the Motorcoach fleet in Exhibit 3, Cash Flow return on invested capital of 46% (Cash Flow / Invested Capital) and Fleet Profit return on invested capital of 19% do not necessarily reflect excellent performance. The Net Profit return on invested capital for the motorcoach fleet was only 3%.
Since allocated costs (of company overhead) are 19% of total revenue, Return on Invested Capital calculations should be seen only as an indication of which segments warrant deeper investigation. However, please note that the company's 14% average return on invested capital (Net Profit / Invested Capital) consists of fleets with returns ranging from excellent (special buses, for example) to questionable (Motorcoach, sedans, and limos). The following section provides a closer look at limos.
Exhibit 4
Limo fleet: latest 12 months
Age of vehicles
Rev per vehicle
# Units
Revenue
Cash Flow
Fleet Profit
Net Profit
Direct Maintenance as % of revenue
9 years +
$44,667
2
$89,335
$(1,519)
$(10,382)
$(27,355)
35%
8
$48,893
3
$146,678
$(975)
$(15,527)
$(43,395)
35%
4
$98,590
3
$295,771
$102,193
$72,851
$16,655
5%
3
$86,920
2
$173,841
$61,844
$44,598
$11,569
4%
1
$86,920
2
$173,841
$64,959
$47,713
$14,684
2%
Total limo fleet
$73,289
12
$879,466
$226,502
$139,255
$(27,843)
5%
It should be no surprise that the 5 oldest limos (those 8 years old and older) are less profitable than the newest limos (4 years old and newer). More importantly, regardless of which "profit" measure is used (cash flow, fleet profit, or net profit), the oldest limos lost money in the latest 12 months. The 2 major reasons are obvious from Exhibit 4:
1.) revenue per vehicle on the newer limos exceeds utilization of the oldest vehicles by approximately $45,000 per vehicle per year; and, 2.) maintenance costs for the oldest vehicles is excessive. Note carefully that the 5 oldest vehicles had negative cash flow, even without including capitalized maintenance expense or maintenance department overhead (which includes indirect labor.)
The reader will be tempted to conclude that the obvious solution is to replace the oldest limos with new. However, there are other possible solutions, which we will examine through use of the FPA Model. One possible alternative is to improve utilization of the oldest vehicles. Another approach could possibly involve closer management attention to the maintenance department.
Using the FPA Model for "What If" Analysis
If the company had traded the 5 oldest limos for 5 new limos, would there have been more limo revenue during the previous 12 months? Possibly not. And even though the pure math suggests that 3 new vehicles could have easily handled the revenue of the 5 oldest vehicles, there are multiple days each year when 10 total vehicles (even a new fleet) cannot cover all of the work that was covered by the 12 existing limos. Therefore, we ran 2 "What If" cases (based on past 12 months data). Case 1 replaced the 5 oldest limos with 3 new and allowed limo revenue to decline to reflect the revenue lost on days that 11 or 12 limos are needed. Case 2 also replaced the 5 oldest limos with 3 new, but allowed total revenue to increase modestly (based on the expectation customer preferences for new vehicles would cause revenue to grow). The vital model output changed as follows:
# of vehicles
Difference vs Base case:
Age of limos
Base case
Case 1
Case 2
Case 1
Case 2
9+
2
0
0
(2)
(2)
8
3
0
0
(3)
(3)
4
3
3
3
-
-
3
2
2
2
-
-
1
2
5
5
3
3
Total limos
12
10
10
(2)
(2)
-
Revenue per vehicle
$73,289
$83,386
$90,397
10,097
17,108
Total Revenue
$879,466
$833,857
$903,973
(45,609)
24,507
Cash Flow
$226,502
$275,575
$303,187
49,072
76,684
In "What If": Case 1, limo fleet revenue drops $45,609 (because with just 10 vehicles some customers will not be served on certain peak days), but cash flow increases $49,072 (because average vehicle utilization is higher and direct maintenance expense is lower for the newer fleet.) In Case 2, limo fleet revenue increases $24,507 (because newer limos attract more business on many days, offsetting the disadvantage of "inadequate" fleet size on surge days) and cash flow increases $76,684.
It is impossible to know whether revenue will rise or fall as the result of replacing 5 very old limos with 3 new. However, in both Case 1 and Case 2, the improved cash flow is more than enough to cover the increased ownership costs associated with 3 new limos. But even after trading the 5 oldest limos, in both Case 1 and Case 2, the Limo fleet would still be the poorest performing fleet at this company and would still be producing inadequate returns on investment.
Recommendations
We recommended that the company should sell the 5 oldest limos and not replace them. The company should emphasize using limos to serve customers who use vehicles from 2 or more fleets (for example, certain types of projects require limos in combination with sedans and / or minibuses). Of course, the downsized limo fleet can be used for "limo only" clients when such use does not interfere with multiple vehicle projects. But the company should analyze the profitability of regular "limo only" customers to assure that the remaining limos will be used to serve profitable accounts.
For reasons that cannot be seen in the data presented here, we recommended several changes in the procedures, practices, and standards of the maintenance department. Maintenance cost as a % of revenue is expected to decline for each of the six fleets, which will cause the profit margins and returns on capital to improve for all six fleets. We will then repeat the analysis of the six fleets and consider the possibility that older vehicles should be replaced with new or that perhaps certain fleets (such as the motorcoach fleet) should shrink to make capital available for expanding the size of the most productive fleets (which currently appear to be special bus, minibus, and midsize bus).
Because the executive sedan industry is expected to consolidate throughout the U.S., we are helping the company examine opportunities to increase utilization of the sedan fleet and to explore options for participating in the inevitable consolidation of that sector.
If you are interested in assuring that each segment of your fleet is maximizing profits, utilization, and cash flow, or if you would like to analyze the advantages of merging with another ground operator, please submit the contact form below to discuss how our Fleet Performance Analysis Model can help you evaluate your options.
