As organizations pilot today's choppy economic waters, the bumpy ride has a jarring impact on the equipment-replacement plans of fleet professionals. As construction markets degenerate, public funding dries up, and credit markets retain a stranglehold on investment, construction equipment fleet managers are left with few, if any, projects in the pipeline. As a result, they are challenged with taking corrective measures to adjust to the downturn.
When the needs of equipment users change, it sets off a ripple effect that flows to each point of the Equipment Triangle, including equipment manufacturers and distributors as well. This was clearly documented in the results of a recent study conducted by Industrial Performance Group for the Associated Equipment Distributors (AED).
The study was based on an electronic survey of 86 fleet managers and equipment purchasers, 19 manufacturers, and 64 equipment distributors. Fleet managers confirmed that the ailing economy had caused their needs to change. Today, according to the survey, fleet managers have a greater focus on controlling costs, they are placing emphasis on equipment utilization, and they are not purchasing new equipment.
A total of 62 percent of end-users says the down economy had changed the way they shop for and purchase construction equipment and services. Fleet managers are more focused on ROI and total cost of ownership; are looking at how purchase decisions impact cash flow; are price shopping for the best deal; and are not purchasing new equipment.
OEMs reported that the present economic downturn has caused users to purchase less new equipment, operate old equipment longer, and do more price shopping when they are in the market. Distributors agreed that users are buying less new equipment, are price shopping, and running old equipment longer. Plus, distributors reported that users are opting for more rentals.
Adjusting to these changing needs of equipment users, 40 percent of OEMs are ramping up product support; offering extended hands-on training; providing faster, more flexible production; and helping customers diversify. Some 30 percent of distributors are adding customer support personnel, offering more services, expanding customer training, and developing maintenance programs.
Fleet managers' responses to the economic situation fall into two schools of thought. Like religion, both strategies seek the same destination. They just use different roads to get there.
One strategy is to stick with the current equipment-replacement plan. The other approach is to make do with the equipment you have, put the replacement plan on hold, and use the capital elsewhere in the corporation to earn a better return on investment.
A proponent of the "stay the course" strategy is Dave Gorski, CEM, shop administrator for K-Five Construction. Gorski says a fleet manager doesn't have a crystal ball to know what is going to happen in the future. But the one thing he does have is a road map and that map is his scheduled equipment replacement plan.
"Like any other journey," Gorski says, "there may be detours, but as long as you know your destination it makes it easier to get around the detours.
"No one knows where the detours are," he says, "and that's where we are now. That equipment replacement plan may be a road map, but it is one that you have to massage and constantly monitor throughout the year. Since you can't pinpoint everything, you have to look at the aggregate of the fleet, for example, 600 pieces of equipment. In our case, we are going to do what we always do with our equipment replacement plan. We are going to execute it like we do each year by sitting down and evaluating everything we have."
For example, Gorski might have "X" pieces of equipment coming up for replacement this year.
"When we buy equipment, I set it up based on its category, then a projected number of years and hours of service in the fleet," he says. "If a piece of equipment purchased in 1999 was set up on a 10-year useful life and a projected number of hours, that piece would be part of discussions this year as to where it stands in the fleet. Did it attain sufficient hours in the projected number of years and where do the O&O cost come in?"
K-Five "runs a very, very lean fleet," Gorski says. "We have enough equipment to get us through July and August. After that, we know we have to rent equipment. That's the way we are set up."
Other companies prefer keeping equipment in the yard for spare parts or keeping spare equipment to avoid rentals. But Gorski says the problem with that is "when you do go to start it, you have to spend $3,000 just to get it going. Renting, on the other hand, might cost you $4,000 — plus your operators get to run the 'latest and greatest' equipment that is out there."
K-Five relies heavily on concrete and asphalt paving equipment, machines that cannot be readily rented. Everything else, Gorski says, can be rented.
Perhaps Gorski's strongest argument for sticking with the plan has to do with emissions regulations."If you look at projects around the Chicago area — a tollway project or new runways at O'Hare International Airport — all these jobs require equipment with Tier 3 engines. If somebody doesn't stick to their equipment-replacement plan and hangs on to older machines, where are they going to be when jobs come along next year? How are they going to be able to bid on jobs?"
Gorski says K-Five's production will fall short by about a month, giving the company a "decent year." Beyond that, "there is nothing ringing any bells," he says.
"By looking at our equipment-replacement plan, we see an opportunity in evaluating next year. For instance, we may be doing a lot of asphalt work, but hardly any excavating work. There are no 500,000-square-foot buildings being built right now, so we know business is going to be flat on the commercial side."
If that is the situation and, for instance, he has four motor graders that have zero to Tier 1 engines, he disposes of them. If he needs them unexpectedly, he either buys new ones or rents them. "A case like that gives us an opportunity to step back, look at where we are going and take that money to upgrade our core equipment, which is asphalt pavers and concrete equipment.
"We are not changing our equipment-replacement plan as far as capital budgeting is concerned. We are just changing where the money is being used," Gorski says.
Pat Crail, CEM, emphasizes that one of the key elements of any replacement plan is flexibility.
"You have to be willing to review it periodically to make sure it is still appropriate for your organization, not just follow a replacement plan religiously," he says. "Circumstances change and there are no cookie-cutter strategies. I think the term 'best practice' sometimes is abused. Unfortunately, there are some fleet managers who think you should follow best practices no matter what."
Extremely low business cycles, such as the one we are in now, could well warrant another approach, he says. "The capital that you would usually invest in equipment you no longer need, might be invested in bonds, or used for acquisitions if competitors are on the ropes. What it all boils down to is that equipment is an asset that is expected to provide a return on investment for the corporation."
He gave this example:
Suppose a medium-sized asphalt and aggregate producer has a fleet of 100 wheel loaders. The replacement plan, based on your typical business cycle, assumes an average 2,000 hours per year on each machine. The ideal economic life is calculated at 20,000 hours, the point at which total hourly owning and operating are at a minimum. The plan calls to replace 10 machines per year, maintaining an average age of approximately 5.5 years for the fleet of loaders.
Now suppose business is off 30 percent for 2009. During the slack season, the organization has built up inventories and gotten ahead of plant maintenance while keeping the workforce employed. But now internal forecasts point to a slow 2010, and it's time to place equipment-replacement orders. Does the firm forge ahead with its replacement plan or delay replacement until the machines can work productively and at capacity?
"Do you invest $3.4 million of your firm's capital in 10 wheel loaders for the sake of maintaining fleet average age, or do you conserve capital and put it to work where it can earn a return?" Crail says. "The opportunity cost of that $3.4 million will vary depending on your organization and its alternative uses for that capital, but any positive return has to look attractive when compared with the alternative. Capital invested in idle machines earns a negative return, as opportunity cost and depreciation expense take their toll. Capital invested in underutilized machines fails to earn the organization's required rate of return and results in increased hourly ownership cost."
Granted, there is some risk involved in delaying replacement. Machines that should have been retired may break down while you try to squeeze that extra year out of them. You may have to replace some failed engines and transmissions that you would otherwise have avoided, increasing repair and maintenance cost. Reliability will likely suffer.
"However, if your forecasts are correct," Crail says, "you'll have plenty of excess machine capacity to pick up any slack caused by breakdowns, and the use of the additional capital may well justify any extra repair expense. There is also a risk that your forecasts are wrong, and that you'll end up with plenty of work. If that happens, you'll be asking these machines that should have been replaced to work a full year at capacity, and the downtime could be costly."
If there is a sudden rebound, the fleet manager can use the deferred capital to lease or rent.
"That's one of the keys," Crail says. "Everyone needs to understand that when you opt to defer equipment replacement, it is exactly that — a deferrment. It is the fleet manager's duty during strategy discussions to make sure the owners or CFOs understand you are not avoiding that replacement cost. You are merely postponing it."
Another risk of postponing equipment replacement is exchanging fixed costs — buying younger machines — for variable cost in terms of repair, maintenance and breakdowns. As the fleet ages, repair and maintenance costs go up; reliability will suffer; downtime will increase; and support resources, such as shop operations, technicians and field support, will be pushed to capacity.
Despite the risks, deferrment gives the organization the option to use that capital for other strategic initiatives, including paying down debt or making acquisitions. "The use of that cash should not be taken lightly," Crail says.
No matter what equipment-replacement strategy is employed, Crail says, it is critical that the decision be part of a well thought out strategy that fits your organization's goals. "Any decision should take into account the risks and rewards. If you can't articulate your plan, whatever it is, you've probably made a knee-jerk decision, and would be better to walk away from it.