Introducing … a tool to help you rethink your approach to pricing

[Article originally published in Fleet Leasing]

Next time you pop into a corner shop, have a chat with the owner behind the till.  In many ways they are the perfect business person because they know everything about their business: the cost of every item they sell, the local competition, how much they have to pay every year in rent, rates, insurance and so on and how much they have to put in the till every week to cover these fixed costs and feed the family. Armed with all of this knowledge the owner finds it relatively easy to decide how much to charge for each item they sell.

I asked a local shopkeeper about his business recently. He told me that he has a great relationship with his customers, many of whom he has known for years. “However”, he said, “I’m here to make money, not friends”.

As businesses grow, roles and responsibilities begin to get divided up between different people and very soon there is no one person who knows everything. People are slotted into silos. They become great experts on their part of the business but they are not particularly familiar with the details of the work being carried out elsewhere in the organisation. Management has to be careful to ensure that decisions made in one part of the business that look perfectly reasonable when viewed through the prism of that department’s responsibilities are still optimal when it comes to meeting the needs of the overall business.

Let’s talk now about leasing company pricing. In most contract hire companies someone is responsible for obtaining new vehicle data, someone else negotiates discounts with dealers and someone else obtains VRB details and negotiates tactical deals with manufacturers.  A team of people probably works on setting residual values, another team works on maintenance budgets and someone else works out the cost of funds for each period and deal profile. Taken together, these items form the cost elements for each vehicle for every term and mileage. Someone from each ‘silo’ pops their contribution into the pricing system. Given that each of these numbers has been arrived at by a process or negotiation or judgement, each leasing company has a different base cost for each vehicle. The sales director is then given a target volume and margin to hit and they do their best to ensure that they quote for each deal as well as they can.

There’s an analogy to be made here with cake-baking. If someone bought the flour they thought would be best for the job, someone else bought the dried fruit, someone else bought the sugar, someone else the butter, someone else decided the quantities to use and how to mix them up and someone else decided how long at what temperature to cook them, you might end up with the perfect cake. Or you might discover that it tasted absolutely awful, because no one person had an overview of what was going on and was thinking about the impact that each decision was going to have on the ultimate texture and flavour of the finished cake.

So, the trick for a contract hire company sales director is to gather together all of the information they can from inside and outside the organisation, assemble this in some way and use it to help them decide how much to quote in every situation. That’s quite a tall order!

All contract hire companies impose some level of control on their sales people to ensure they do not quote at suicidal prices. And all contract hire companies have some market knowledge available to help them to decide what rental to quote.

Here is an interesting tool that you can use to assess how well your company does its pricing. It’s called the Pricing Journey. For the purpose of this article, “price” means margin (which you might call “margin over cost of funds” or “overhead contribution”) plus cost (interest cost, maintenance cost and the other elements shown above).

For the purpose of this article, “price” means margin (which you might call “margin over cost of funds” or “overhead contribution”) plus cost (interest cost, maintenance cost and the other elements shown above).

 

This chart looks at two factors that will be present in every leasing company.

  1. Customer insight is the insight that you have into the way the client is likely to respond to your quote. Customer insight grows if you have a lot of market knowledge, a lot of experience in doing business with that particular customer and a real understanding of where your price sits in the market.
  2. Management control is the control that management introduces to minimise exposure to risk or sub-optimal decisions. So, in a pricing context, management exercises control by imposing minimum margins: the salesperson needs to refer to their line manager for approval to issue a quote below this limit.

If a company has low customer insight and low levels of management control, the result will be chaos. Salespeople will be issuing quotes ‘blind’, with no real idea whether they are pitching very high or very low. As there is no management control, this is a recipe for disaster.

Typically, management introduces controls to impose discipline. They try to gain greater insight into the prices that should be quoted so that opportunities are not being lost by quoting too high, whilst money is not being ‘left on the table’ by quoting too low. This is Pricing Order.

As management increases the amount of data it reviews and the analysis it carries out, it begins to recognise that it has information that it can provide to the salesperson that will increase the probability that the salesperson will be quoting optimum prices. ‘Optimum’ here means the price that maximises the probability of winning the deal whilst being as high as possible.

Management then develops ways to systemise this information, and can then start delegating some decision-making to the salesperson in the knowledge that quotes are being issued with the benefit of a good level of customer insight.

As the quality and quantity of data available to the salesperson at the point of sale improves, customer insight grows to the point that the salesperson can be empowered to issue quotes without very much management control or oversight at all. Management knows that the salesperson is so well informed about the company’s competitive position generally – and for each client specifically – that the salesperson can be empowered to make optimal pricing decisions.

This article is designed to provoke some thoughts. Where is your company on this chart? Are you in position 3, Pricing Order? What would you need to do to move to positions 4 or 5, Pricing Control or Pricing Delegation? Would it ever be possible for you to get to Pricing Empowerment? What would you have to do to get there and what would things look like when you arrived?

Many leasing companies have been looking at this issue. They have realised that all too often they issue quotes with no real idea of whether they are likely to be quoting £10 per month above the competitor’s quote, £10 below, or precisely where they need to be – a few pence below. They know for example that it makes no sense to apply one blanket margin to a particular client (“3% over cost of funds”) regardless of whether the client is ordering cars where the lessor’s RVs are high or low versus the market average. They also know that if they have recently issued 400 quotes on a particular make, model, period and mileage and won 80 of these, and issued 400 quotes on a different make, model, period and mileage and won 20 of these, this is probably telling them something about their relative competitiveness on those two deals and that they should use this insight to nudge up their pricing on one deal and nudge down their pricing on the other.

And they are coming to realise that it is necessary to have one person – one brain – sitting on top of all of the data and information at the company’s disposal in order to try to make sense of it and to use it to improve the way the business does its pricing.

Professor Colin Tourick

 

How good is your relationship with your contract hire company?

temp coverThe relationship between contract hire companies and their customers varies enormously. In fact someone should write a book about this topic one day. At the one extreme you have fleet managers who say “we’ve been doing business with them for years, they give us the service we need and we never give the relationship a minute’s thought”. At the other extreme you have the fleet managers who say ” they charge us a fortune, hefty unexpected  invoices arrive for all sorts of things we hadn’t budgeted for and we are wary of them”.

Most client/supplier relationships lay somewhere between these two extremes of course, but if you are a fleet manager and you recognise some elements of your own situation in the second situation described above – “we are wary of them” – this article is for you.

The core proposition of every contract hire company is that they will deliver a vehicle, let you run it for some years, renew the road tax annually, pay for tyres and service, maintenance and repair (“SMR”) costs and collect the vehicle at the end of the contract.

Delivering this ever-so-simple product (one supplier used to advertise “We look after everything – all you have to do is put in fuel and drive it”) is anything but simple for the contract hire company. You may see very little activity from them – it may seem that they just they deliver you cars, send in a monthly invoice and pay the bills. However, rather like a swan, whilst it all looks serene up top they are padding away furiously just below the surface.

They have to manage a cat’s cradle of relationships with manufacturers, dealers, roadside assistance companies, banks, data providers, technology companies, remarketing companies, daily hire companies, accident management companies, fuel card companies, the DVLA and others, to ensure that you get the service you need.

Where tension exists between leasing companies and their clients, as often as not it’s because the leasing company hasn’t explained adequately why it does some of the things it does.

It can be annoying when they ask you for financial information about your company. “Why do they need that? They can always repossess the cars if we don’t pay.” Well yes, they can, but they don’t want to and their pricing certainly doesn’t allow for that sort of cost.

It can be frustrating when one of your employees leaves, you ask how much it would cost to terminate their car lease and you’re told it will be thousands of pounds.

And – perhaps top of all fleet managers’ lists of gripes – it can be perplexing when a bill arrives for vehicle damage you didn’t know about and the driver insists the damage wasn’t really that bad at all.

Let’s look at the detail behind those last two items – early termination charges and end-of-life damage charges – because they probably generate more heat between leasing companies and their clients than anything else.

First, early termination.

There is one key difference between leasing companies and daily hire companies. When you order a hire car for a few days or weeks you probably aren’t that bothered what make or model of car turns up. So long as the car is in the right hire group – small, mid-size, estate, 4×4 etc – you’ll probably be happy.

However when you order the company car you’ll  be driving for the next three or four years you will be very fussy indeed about which car arrives, and so is every other company car driver. So the leasing company will have gone out and ordered that car specifically for you and by and large they will be unable to redeploy it once you hand it back. They’ll have to sell it, which causes a problem because the price they receive will depend on the age and mileage of the car when you hand it back, and the state of the used car market at that date.

You might decide that you want to know at the outset how much it would cost you to early terminate the car. Alternatively, you might prefer that they just sell the car and charge you the amount necessary to clear their books. Almost all leasing companies will allow you this choice, and will build it into your agreement. Incidentally, that’s something you really must do if you want to avoid shocks later: build the early termination method into your lease agreement.

If you want complete certainty as to the amount you will have to pay to terminate your lease early, your leasing company will probably offer you one of four methods: percentage of future rentals, a fixed number of rentals, the rule of 78 or the annuity method.

Percentage of future rentals [or the fixed number of future] are self-explanatory. “If you terminate in the first 12 months we will charge you X% of all future rentals [or 12 rentals], if you terminate in the second 12 months we will charge you Y% of all future rentals [or 6 rentals], etc.

We have covered the rule of 78 and annuity methods in these articles in the past so won’t go into detail here now. Suffice to say that these are ways to determine the balance outstanding on a financing agreement at any point in the life of the contract. If you know how a repayment mortgage works you’ll be familiar with this approach: each month’s payment is allocated mainly to pay off interest in the early part of the contract and mainly pay off capital later on. (If you would like us to explain this in more detail in next month’s article, please let us know).

The alternative approach is the actual cost method, whereby the lessor will charge you the balance outstanding in their books less the net price they receive on selling the car.

Any of these approaches might be more or less expensive than the other, for a particular car on a particular day. You just need to choose which method you prefer and this should help avoid any shocks. If you don’t like uncertainty, go for the actual cost method.

The other tricky area in relationships between customers and suppliers is end-of-life damage charges. Most UK contract hire companies belong to the British Vehicle Rental and Leasing Association and they have to comply with the BVRLA’s excellent Fair Wear and Tear Guide which defines the line between fair wear and unfair damage. If you haven’t seen the Fair Wear and Tear Guide, ask your leasing company for copies and make sure your drivers are familiar with the contents.

The best way to ensure your leasing company doesn’t charge for damage is to make sure the car is in an acceptable condition at the end of the lease. This means ensuring that your drivers keep their cars in reasonable condition, report damage as soon as it occurs and get it repaired. Make sure the work is done professionally, otherwise the leasing company may still charge for the damage.

Most leasing companies don’t send damaged end-of-contract cars for repair. They sell them at auction to dealers who can get cars repaired for roughly the same price as the leasing company would pay. The leasing company will charge you for the reduction in the value of the car but in truth this figure is very hard to calculate. The actual price a car fetches at auction on a particular day can be affected by all sorts of things, not just its condition, so they will do their best to calculate the diminution in value of the car. This calculation is part art and part science.

If you think a charge is particularly high, challenge it. Every leasing company will be prefer to explain something rather than leaving you dissatisfied.

Most leasing agreements say that the supplier won’t charge you for unfair wear or tear if the value is less than a fixed amount, often £100 or £150.

And if you really don’t want to eliminate the issue of damage charges, have every vehicle professionally inspected shortly before the end of the lease so that any necessary remedial work can be done before the lease ends.

Professor Colin Tourick

Grant Thornton Professor, University of Buckingham Business School

Colin Tourick’s article on mobility management

Fleet management – what’s next?

As a fleet manager you have some clear priorities. You need to: keep your staff mobile so they can do their jobs effectively; ensure that the cars and vans they choose are appropriate for the jobs they need to do; keep costs to a minimum; handle a lot of admin (parking fines, driver licence checking, etc); manage relationships with suppliers (which might include a leasing company, broker, dealers, manufacturers, insurance broker, etc); keep abreast of a wide range of regulatory issues (health and safety, tax, lease accounting, etc); keep drivers happy and strike the right balance between the needs of all your stakeholders including your company’s employees, shareholders, management, HR director and FD.

You probably outsource some of this work to expert third parties but being a fleet manager is still hard work.

The purpose of this article is to highlight a change that is beginning to happen and which could make your stakeholders happy. Though I’m not sure it’s going to make your life any easier.

Historically, a fleet manager would either buy or lease company vehicles and would probably outsource the maintenance and administration to a leasing or a fleet management company. A whole industry – the fleet industry – has grown up to help fleet managers in their role. Manufacturers, dealers, quick fit companies, roadside assistance companies and other suppliers are attuned to your needs and will do all they can to make your life easier.

If you lease your cars it is quite likely that your leasing company gives you access to online tools to help you do your job more effectively: obtaining quotes, downloading P11D information, keeping tabs on who is driving which vehicle, seeing which cars will need defleeting soon, and so on. These tools and services have been refined over decades and in general are very good.

However they were designed to answer one basic question that every fleet manager asked; “What’s the best way to fund and manage our company vehicles?”

Now there’s a new question that fleet managers are asking; “What’s the best way to meet our company’s mobility needs?”

Mobility – it’s a word that keeps on popping up in fleet circles nowadays and if you haven’t considered it now may be a good time to start.

Your employees need to use their company or private (grey fleet) cars for business journeys but you need them to think before they jump behind the wheel every time they go from A to B. Is this journey actually necessary? Is videoconferencing a viable option? Would it be realistic to go by public transport? Could they share a car or use a pool car? Or if they don’t have a company car and are thinking of renting a car, could they use another employee’s company car instead?  Would a car club car be a viable option?

It would be great if they could think through these options and then make the conscious decision to use their company car or personal car if – and only if – that was indeed the best option.

What do we mean by the ‘best’ option?

The best option is probably the one that offers the best trade-off between cost, emissions, journey time and hassle value. And the calculation of this trade-off will probably differ wildly between different businesses.

There’s no point an employee saving £5 off the cost of a journey if the decision-making process is so complex that they end up spending more than this in time-cost whilst making the decision.

And there’d no point saving a few g/km of CO2 by using a lower-emission car if the overall journey is going to take an extra hour (and risk leaving the driver stranded at a train station for another hour if they miss their connection). Though of course it may well be that a rail journey will be a more effective option than a car journey even if it does take much longer, because the employee can work on the train but cannot do so when driving a car.

For some companies (especially those in heavy industries where emissions are the subject of great scrutiny), CO2- or NOx-reduction might be very highly weighted in this trade-off calculation, whereas in other industries cost-reduction might be more important.

So there are all of these trade-offs that need to be considered in designing a system – a mobility system – to optimise cost, emissions, time etc.

Unfortunately there is at present no system out there that can help fleet managers automate this decision process and then organise the journeys. It would be great if a driver could go onto their company’s intranet, key in the details of the journey they want to take and be told the optimum way to travel. It would be even better if the system then gave the driver the option to click a button that would automatically book the railway ticket, reserve the pool car, book the car share or do whatever else was then necessary to make the journey happen, whilst simultaneously registering the cost-savings and CO2-reduction that had just been achieved. And whilst taking into account the company’s travel rules, which would include decisions on how to deal with the trade-offs referred to above.

Whilst there is no such comprehensive system available today, partial systems do exist and a lot of companies are working on comprehensive solutions.

A truly comprehensive solution would need to hold a list of employees (including their home and office addresses), details of the business and personal cars that are currently available to be driven on business journeys (including cost per mile and CO2), the current location of those cars (derived from telematics units), live links to external suppliers (eg daily hire company, car club, rail company etc) and links to live traffic and transport timetables (such as on Google Maps).

If you like the idea of such a system, have a chat with your leasing, car rental or fleet software company and ask how they can help you move forward in this new era of mobility management.

Professor Colin Tourick

Grant Thornton Professor of Automotive Management

 

 

 

 

 

 

 

 

New Asset Finance International webinar series

Asset Finance International, the website for leasing experts around the world, has launched an ‘online conference’ for its 28,000 registered members, which Colin Tourick is chairing.

Experts on equipment finance, motor finance and fleet leasing from all major leasing regions across the world, are being asked to prepare and deliver presentations covering:

  1. An overview of their market in 2011
  2. Some positive developments in 2011
  3. Some negative developments in 2011
  4. Some reasons for lessors in their region/sector to be optimistic in 2012.
  5. The main challenges they will face in 2012

The first presentation has been recorded with Rafael Castillo-Triana of The Alta Group and you can download it here.

The series is sponsored by White Clarke Group.