SEPT. LCT: Choosing the right leasing and purchasing options is critical to running vehicles that provide stable short- and long-term cash flows.
If it seems that your business expenses have taken a life of their own lately, leaving you dumbstruck and wondering what happened, you are probably not alone. One reason might be that you haven’t quite mastered the skills of calculating your costs. Don’t worry. You don’t need the forensic talent of TV’s CSI team to tackle this mystery. A pencil, paper and calculator or, even better, a computer will do. LCT enlisted the insight of industry experts to provide this guide to calculating fleet costs. It’s designed to help you set the right price for your services during the current economic downturn and beyond.
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When Dinesh Ganganna, a 24-car operator in Maryland, first entered the limousine industry, he didn’t pay much attention to detail, he said. But as the years went by, he realized that one of the most important things in this business is to figure out what he calls “the bottom line on each vehicle.” “I started to figure out what it really cost me to run each vehicle, and then I started to see if a particular vehicle was not making me enough money,” Ganganna says. Ganganna’s situation is not unique. When new operators enter the limousine market, they more often than not have a very simple way of setting their price: they look at their competitors and charge what they do, or perhaps a little less. “If you think you can just arbitrarily set price and everything will work out in the end, you’re wrong,” says Tom Mazza, NLA executive director and a former operator. “The No. 1 thing to determining price is figuring out where your cost is and what mark-up you need.”
While it is always a good idea to keep informed of your competitors’ practices and rates, simply copying their rates for lack of a better cost-setting practice is hardly the best option. Knowing your costs will also make you a better negotiator, since you know how far you can afford to stretch a rate. If you are looking to sell limousine service to corporate clients, they especially tend to appreciate an intelligent negotiator who can argue price based on fact. “There is a cost of doing business and you have to know what it costs you to put vehicles on the road,” Mazza adds. “The people in this business that make money have a handle on those costs.” At a minimum, you have to make a profit on a trip, he explains. If you are charging $65 for an airport run, you have to know all the expenses that go into making that $65 trip.
That means looking at the direct trip costs per mile, the wear and tear on the vehicle and its depreciation, etc. You could also look at the total lifespan cost of the vehicle using a “lifecycle costing formula,” suggests Mike Antich, editor and associate publisher of Automotive Fleet. Keep in mind that this formula is just one example of how expenses can be calculated. Since every limousine company is different from others’ in some way, you should consult an accountant or cost expert to best figure out how to calculate your costs. For example, “home-based operators who do most of the work themselves differ from operators who have an office staff,” says Arjang Tagavi of Los Angeles-based Hollywood Limousine. “A home-based operator that also drives is different from a home-based operator who does not drive. Everyone has a different cost structure.” Thus, one operator’s expenses and profit margins would differ from another operator’s. It is important to note, Mazza says, that home-based operators who double as drivers often think they are saving the money they would have paid for chauffeurs, typically 25% to 30% of their total expenses. “Well, that’s inaccurate thinking,” Mazza says. “They’re basically undercutting prices because they think they save $30 off the top of a $100 trip, leaving them with no profit.” Even home-based operators who also drive should, in the long term, factor in a profit margin of 25% to 30% in lieu of chauffeur’s pay, Mazza says.
Lifecycle costing is a formula for figuring out how much a vehicle will cost during its entire lifespan, according to Mike Antich of Automotive Fleet magazine. It can also help you determine what vehicle is the better pick when thinking of expanding your fleet, as well as determining when to replace a vehicle, he explains. “To control expenses, you need the capability to track them,” Antich says.
Typically, net depreciation represents more than half of your expenses, Antich points out. Therefore, it’s imperative to know how to calculate that before you do anything further (see Step 2 of lifecycle costing analysis below).
Depreciation is the difference between the net acquisition cost (the factory invoice price minus factory incentives and other price adjustments) and the net resale price of a vehicle at the end of its service life. Other factors include the finance/lease rate, insurance costs, gasoline prices and car licensing fees. Some of these, such as car licensing fees, can vary significantly based on where you live. The following are hypothetical percentages and merely offer an example of how your expenses could be represented. Operators should look closely to their financial records to determine the specific percentages for their companies.
There are three categories of vehicle-related expenses:
Once the expenses have been identified and the data collected and categorized, you are ready to calculate your lifecycle cost, Antich says.
We’ve chosen to illustrate these steps by using a hypothetical 2001 sedan:
This is the factory invoice price minus factory incentives and other price adjustments. Example:
Factory invoice price: $33,800
Luxury package cost: + 1,200
Frequent buyer rebate: - 1,000
Net acquisition cost: = $34,000
This is the net acquisition cost minus the estimated resale value of the car. Example:
(include all your standing and incidental vehicle-related costs):
Estimated total lifecycle cost: = $33,000
The $33,000 is the amount the hypothetical 2001 sedan would have cost your company to own or lease and operate until the car is retired from service. “Lifecycle costing can be as extensive as you want,” Antich says. But some expenses, such as overhead expenses (rent, salaries, etc.), are perhaps better left out and accounted for later, since they are not directly vehicle-related.
Using the total estimated lifecycle cost of your car, you can now figure out what that specific car costs you per month, year and mile, Antich notes. Again, we’ll be using the hypothetical 2001 sedan as an example.
Take the estimated lifecycle cost of the vehicle ($33,000 for our hypothetical sedan) and divide it by the number of months that the vehicle will be in service at your company, which is presumed to be 24 months. If you, for example, keep your cars an average of 3 years, enter 36 months, etc. But remember that the lifecycle cost for our hypothetical sedan would also differ with a longer lifespan, since the $33,000 is based on a 24-month cycle.
Using lifecycle costing to figure out what your expenses are could ease the trouble of setting price. So far, we have only taken into consideration vehicle-related costs, since they are directly applicable to the operation of your vehicles. All other costs – such as salaries, benefits, office supplies, rent/mortgage, your own salary, etc. – are still unaccounted for. Adding these overhead costs into the lifecycle costing analysis would be inaccurate.
Why? If, for example, you have 10 hypothetical sedans and you, therefore, add 10% of your overhead costs into the analysis for each car, what would happen if you buy a new car or one is out of service due to repairs? You would account for 110% of fixed costs if you added a car or only 90% if you lost a car, or one was out for service.
Thus, it is better to introduce into the analysis a common denominator, such as the number of miles or hours the cars are out on the road. Since our previous example was based on miles, let’s stick to that. If you know how much you pay for overhead expenses, you could add them all up and divide them by the number of miles your total fleet travels per month – or year, week or day if you prefer – and figure out how much a particular run costs. Let’s say your overhead expenses are $10,000 per month and you operate 10 of our hypothetical sedans.
Now you can figure out what a run costs by dividing the total monthly overhead costs, in this example $10,000, with the total number of miles your cars travel in one month. Your actual monthly mileage will vary, so you should go back and look at a specific month, find the actual mileage for that month and compare that to the total revenue for that month. Then it really does not matter whether or not a car is out of service for a month, or if you add to your fleet, as long as you keep track of the total mileage per month traveled by the cars that do operate.
To illustrate this, we’ll calculate a hypothetical monthly mileage based on a 2001 sedan that will have 110,000 miles on it after two years. That works out to 55,000 miles traveled a year and 4,600 miles a month. Multiply that by 10, since our hypothetical fleet has 10 such cars, and we arrive at a combined total monthly mileage of 46,000. Then, take that $10,000 in monthly overhead costs and divide it by the total monthly mileage of 46,000 and you arrive at a per-mile, per-car overhead cost of 22 cents.
At the beginning of this article we cited a $65, 100-mile airport run. Remember, that run would have cost you 30 cents per mile in direct vehicle-related costs. Now, add the per-mile overhead cost of 22 cents to the per-mile direct-vehicle cost of 30 cents, and the total per-mile cost of that airport run is 55 cents. Multiply that 55 cents by the run’s total miles of 100 and your total cost for that $65 airport run is $55, leaving you with a profit margin of $10.
After having figured out a way to crunch the numbers, Dinesh Ganganna could pinpoint his expenses, using a process similar to the lifecycle cost analysis. “For example, my 15-passenger van was not generating [as much] revenue as my mini coach; I was always farming out my mini coach jobs,” he says. “Therefore, I replaced my van with [another] mini coach because the numbers justified my doing so. Although the cost [for the mini coach] is a lot higher than for the van, the income justifies it.” This is a brief cost break-down for one of Ganganna’s sedans, based on what he calls an average day:
Ganganna then looks at his overhead expenses and subtracts them from his daily gross profit. At Deluxe Transportation, those expenses are:
Having listed his overhead expenses, Ganganna can then find his net profit by comparing his overhead expenses to his daily gross profit. For example, on average Ganganna says his overhead expenses equal $95,000 per month. We know that his average per-sedan, per-day gross profit is about $205 and that he operates a fleet of 24. If 10 of those 24 were sedans, Ganganna’s gross total per-day profit for his combined sedan fleet would be $2,050 (205 x 10 = 2,050). By multiplying $2,050* by 30 days, we come up with a hypothetical average monthly gross profit of $61,500* for the sedans. (*These are hypothetical figures.) Now, let’s say Ganganna’s other 14 vehicles together generate a gross monthly profit similar to that of the sedans, approximately $60,000*. Ganganna can then combine the two profits and subtract his overhead costs to come up with a total monthly profit:
(* hypothetical figures) That hypothetical profit of $26,500 represents approximately 22% of the total revenue (26,500 —: 121,500 = 0.218).
Assuming business travel rebounds, “Operators should be doing about 15% to 20% [profit] if they’re doing everything right,” Mazza says.
What should you do if you, after calculating your total run costs, find out you cannot afford to charge $65 for that 100-mile airport run, yet all your competitors do? Or, what should you do if you initially were content with a $10 profit but then your overhead charges increase and you instead just break even? You have to expand your horizon, Mazza says, “because you’re not going to be able to compete on price alone.” If you need to charge $80 for that same airport run, you need to find ways to justify a rate that’s higher than your competitors’, and sell based on that. For example, maybe you have newer cars than your competitors, or perhaps your chauffeurs are better trained. Do your cars have features or amenities that you competitors’ don’t? “The Holiday Inn sells rooms at [Los Angeles Airport] for $129 and the Park Hyatt charges $299, so obviously it’s possible,” Mazza says.
Another thing you could do if you cannot justify charging above your competitors is to focus on finding a niche. If you’re in close proximity to the airport and would like to continue to service that area, “look to maybe do shuttle work, employee transportation or maybe get into flight crew transportation,” Mazza suggests. “Maybe you could hook up with a hotel and be the transportation company for that hotel – your numbers might fit then.”
SEPT. LCT: Choosing the right leasing and purchasing options is critical to running vehicles that provide stable short- and long-term cash flows.
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