November 2003 · Volume 85 · Number 10

Vehicle Replacement Planning 101:
A Key to Meeting Challenges on the Road Ahead

Tim Ammon 
It can be easy to forget, but mostly true, that government services are delivered on wheels. The ability to provide efficient and effective services is dependent on a fleet of vehicles and equipment. Providing such basic services as law enforcement, fire protection, trash collection, and child protective services all require a fleet of suitable and reliable vehicles to meet critical mission demands. Other important services like parks and recreation and elder care also require vehicles and motorized equipment.
Not only are vehicles integral to the provision of services, the age and condition of the fleet can have a significant and material impact on employee morale and productivity. Given its importance to overall service delivery, it should not be surprising to find that the fleet often is the second most valuable asset owned by public sector entities, after building and grounds. Yet, despite its importance and its cost, fleet replacement can be one of the least managed aspects of a locality’s program.
As we might know from personal experience, older vehicles are generally more expensive to operate, less reliable, less suitable to the tasks assigned, and more environmentally harmful than newer ones. Developing and implementing a systematic fleet replacement plan is an important tool available for minimizing the financial, operational, and environmental costs associated with the fleet.
The goal of a replacement plan is to minimize the total life-cycle costs of the fleet by achieving the optimal balance between the capital and operating cost components, subject to constraints imposed by environmental impact, reliability, suitability, and other qualitative factors. This article will describe the strategic components of fleet replacement planning, including determining and analyzing overall expenditure requirements and financing these expenditures.
Developing a Fleet Replacement Plan
At first glance, developing a fleet replacement plan appears to be a simple proposition. It is a relatively straightforward exercise to determine the expected date and cost of replacement for each unit in the fleet. Using time- or mileage-based planning criteria, current acquisition costs, and expected rates of inflation, one can determine when a unit will be due for replacement and how much it will cost.
Accumulating this information for all units in the fleet will yield overall replacement spending projections. These spending projections then are evaluated relative to available revenue services, including reserve fund balances, proceeds from the retirement of debt, and the impact of new ratables. At this point, a locality can determine whether or not it can “afford” to implement its fleet replacement plan. 
Unfortunately, this process oversimplifies certain complexities and subtleties that can dramatically affect the quality and utility of the results, and tends to ignore the cost impact of retaining vehicles beyond a reasonable period. 
Replacement planning does, however, begin with a process similar to the one just described. The first step in this process is establishing a set of planning criteria for determining when to replace a particular type of vehicle. These criteria are typically expressed as the minimum age and/or mileage a unit must reach to be considered for replacement. Generally, these will vary depending on the usable life of the type of vehicle. Police cars, for example, experience much more intense use than a comparable administrative sedan and will therefore be targeted for replacement sooner.
It is important to analyze expenditure projections to determine underlying causes of year-to-year requirements.
Establishing appropriate replacement criteria for each vehicle type is not a perfect science. Economic life-cycle costing can be used but only with significant expense and imperfect results. At best, this type of analysis produces a range of appropriate replacement criteria rather than a specific useful life expressed as months and/or miles of use. Even then, the criteria do not account for such qualitative factors as actual or perceived vehicle reliability or the impression your citizens get of the quality of service delivery based on the appearance of the fleet. Therefore, the experience and opinion of fleet management personnel becomes equally important in the decision.
Fortunately, there are a number of sources available to establish and evaluate replacement criteria. An Internet search for replacement criteria will provide a wealth of information on the criteria used in other jurisdictions. Professional organizations such as the American Public Works Association (www.npwa.net) and the National Association of Fleet Administrators (www.nafa.org) can provide data and contact information. Manufacturers and professional services firms can too.
Once replacement criteria are set, the next step is to develop a vehicle inventory that incorporates the data elements required to make replacement projections. For organizations that lack computerized maintenance management systems or that do not include detailed asset information in the database, gathering this data can be one of the more tedious and time-consuming parts of the planning process. After establishing the criteria and finalizing the inventory, the initial baseline plan can be developed by projecting the replacement date of each unit and accumulating the resulting costs to determine overall annual expenditure requirements.
Analyzing the Results
The projection of annual costs is the first step in developing a viable replacement plan. But developing a funding mechanism to manage and smooth out the annual expenditure amounts will be the key to developing a replacement program that is sustainable over time. There will likely be substantial year-to-year volatility in the expenditure requirements. This is caused by different types of vehicles being replaced on different cycles, the effects of past replacement spending patterns, and the lack of homogeneity inherent in local government fleets.
Due to the relatively static nature of revenue sources, most local government budgets cannot tolerate significant variations in annual spending. Therefore, it is important to analyze expenditure projections to determine the underlying causes of year-to-year requirements. Questions should be asked that include:
•	In what year are the peak projection requirements? 
•	How do the projections for the next several years compare to previous funding history? 
•	What types of units (law enforcement, heavy equipment, construction equipment, etc.) are driving the annual requirements? 
•	What revenues are available to fund the program? 
Answering these and other similar questions is the first step in turning the baseline projections into a viable replacement program. The analysis may indicate it will be necessary to adjust the replacement cycles for specific types of vehicles in order to minimize the peaks and valleys and/or to lower the average annual expenditure requirement. In pursuing this strategy, emphasis must be placed on determining the impact that retaining vehicles past their desired replacement point will have on the operating costs for the affected vehicles. While this strategy should only be considered as a short-term response to a funding shortfall, it can help provide the flexibility to develop and implement a plan that can work over the long term.
A more sustainable strategy is to consider making adjustments to the size and composition of the fleet. Ultimately, if it is determined that a fleet unit is required for the delivery of services, that unit must be replaced at some point. Deferring its replacement in order to meet short-term funding objectives can be a viable strategy, but sustainable reductions to capital spending on the fleet will require the elimination of fleet vehicles or the substitution of less costly units.
Developing and implementing a systematic fleet replacement plan is an important tool available for minimizing the financial, operational, and environmental costs associated with the fleet.
Matching the supply of vehicles more closely to the demand requires in-depth discussion and analysis with the users of the fleet and your fleet manager.
Financing Projected Replacement Costs
Local governments are finding that financing must be the first step, not the third, in the planning process. A manager often discovers that in reality, he or she must find the funds and then fit capital needs to funding availability. Regardless of when a locality decides to conduct its process, the funding analysis evaluates the options available to finance projected expenditures.
Simply, it becomes clear from the analysis of replacement projections that, over time, the key challenge is to develop a financing strategy that supports the desired average expenditure requirements. It is expected that even with a detailed analysis and adjustment of replacement dates, there still will be substantial volatility in year-to-year expenditure requirements.
Even if the average expenditure falls within past budget limits, this volatility demands that a financing strategy be developed to smooth out the highs and lows. Actual replacement of fleet units will have to be deferred or brought forward in order to smooth out year-to-year spending. This is a subtle shift, since it is a financing and not a funding issue that determines if you will be able to replace fleet units in accordance with the desired schedule. This assumes, of course, that the average annual requirement falls within the locality’s means.
There are three primary financing mechanisms used by governmental organizations for funding fleet replacement: cash, reserve funds, and debt financing. Each of these options has distinct benefits and drawbacks that need to be considered. Communities continue to use the traditional method of taking cash from current revenues to finance fleet replacement. This choice remains popular because it is simple to implement and often is the cheapest from an economic perspective.
Unfortunately, using cash from current revenue has several disadvantages that directly affect the ability to acquire fleet assets on a pre-determined replacement schedule. First and foremost, it is difficult for cash appropriations to accommodate year-to-year fluctuations in expenditures because of the overriding need for smooth year-to-year budgets. In addition, the annual appropriation process creates competition for the limited cash available for all of the capital projects desired by the community. This competition can result in the deferral of many vehicle purchases and cause a backlog of fleet replacement needs.
The resulting backlog will become progressively more difficult to overcome since a dollar of fleet replacement deferred does not translate into a dollar avoided. Finally, the “once and done” approach of acquiring vehicles with cash does not promote a continuing recognition by users or administrators that there is an ongoing capital cost component associated with the ownership and use of a fleet vehicle.
The use of a reserve funds is an increasingly popular method of financing replacement costs. It is intended to overcome some of the drawbacks of using direct appropriations. These funds operate like savings accounts that are drawn down when expenditures are greater than incoming revenues, and they are replenished when the situation is reversed. The primary advantage of this approach is its ability to limit the large swings in appropriation requirements that can result from using cash.
By using the fund balance as the shock absorber, replacements can occur on schedule while stable annual appropriations are provided for fleet replacement. This approach also can promote the cost recognition that is absent from cash financing by requiring the use of annual charge-back rates to replenish the fund. A major drawback of this approach is the difficulty of maintaining an adequate fund balance. Either annual appropriations or charge-back revenue in years of low replacement requirements will increase fund balances and the corresponding pressure to use the balance for other purposes.
Financing commonly used for fleet replacement that eliminates this major drawback is debt financing, and methods of debt financing can vary. Common instruments include bond programs, revolving lines of credit, and closed-end leases from vehicle manufacturers. A major advantage to debt financing is its ability to accommodate year-to-year fluctuations in requirements, without the need to maintain a large reserve fund balance.
Since cash appropriations only need to cover the debt service in any given year, not the entire acquisition price, a shock absorber effect is created similar to that provided by a reserve fund. Another major advantage to this type of financing is its ability to help eliminate large existing replacement backlogs without a major influx of cash.
Lease programs are generally simple to manage because they do not require the use of internal charge-back fees (outside of the principal and interest payment determined by the amount borrowed) and have no fund balances to manage. The elimination of the reserve fund balance requirement is particularly beneficial because it prevents funds accumulated for vehicle replacement being used for other purposes when finances tighten. Finally, the annual principal and interest payments associated with lease financing promote the cost recognition that is critical in successful vehicle management.
Despite its apparent appeal, lease financing also has both real and perceived drawbacks. The real drawbacks surround the economic costs associated with the financing instrument and, depending on the mechanism used, the effect the additional debt will have on the locality’s bond rating. And depending on the type of financing used, it often can be costly to get out of a leasing program once it is started.
These real financial costs need to be thoroughly considered prior to implementing a leasing program. A further constraint in implementing a lease program can be the public official’s viewpoint that incurring debt is irresponsible and undesirable. This thinking often is the most difficult aspect of a proposed leasing program to manage in the decision-making process.
The key factor to consider in choosing a replacement financing mechanism is to ensure that it will address both the short and long-term replacement needs as dictated by the expenditure projections. For example, if the projections indicate that a substantial backlog of replacement exists, it would be reasonable to consider a lease program in order to renew the fleet and then look at a transition to cash or a reserve fund to provide financing on an on-going basis.
Ultimately, what must be remembered is that as financial and operating requirements change, a periodic review of the overall replacement projections and replacement financing methods will be necessary to support the programmatic needs of service delivery. This will ensure that a locality’s fleet operation is able to provide safe, reliable, and cost-effective transportation.  

Tim Ammon is vice president, Management Partnership Services, North Wales, Pennsylvania (tammon@mpsconsultant.com).