Fleet Right-Sizing

Nov. 21, 2014

Reprinted with the permission of Equipment Manager magazine, the magazine of the Association of Equipment Management Professionals.

A perfect storm of events has hit asset managers of small, medium and large fleets with such an impact it has changed their mentality of ownership, according to industry consultant Andrew M. Agoos.

One of those events was the 2007 recession that wiped out backlogs, especially in North America, and left “a really nasty taste of what it’s like to have less business,” he says.

In addition, technology has fast-forwarded to the extent that today’s equipment is so complex—and becoming even more advanced—that most end-user technicians don’t have the training or expertise to extend machine life cycles through repair, and even if they did, they don’t have the highly specialized diagnostic tools required to do the job.

As these developments manifested themselves, the industry ran head-long into a do-nothing Congress that wouldn’t make any kind of long-term infrastructure commitment and that “kicked the can down the road several times,” Agoos says.

Infrastructure programs of the “’60s, ’70s, ’80s and on up to the early ’90s were massive. That called for large fleets,” Agoos says. “Those programs are gone now, and we are in a phase where we are adding a lane here, adding a lane there, widening, rather than building—doing maintenance things. Nobody wants to commit to large fleets.”

As in Europe, downsizing has become a natural evolution because jobs are smaller and shorter. “Jobs used to be $25 or $35 million or larger. Now, except for a few mega-jobs, they are $5 million or $10 million,” Agoos says.

With the advent of fleet downsizing and high-tech machines, contractors don’t view machines as a “for-life acquisition,” he says. “Most life acquisitions would be 10,000 to 12,000 hours, for example, or eight years, depending on what type of machine it is. Back in 2002 we bought a machine, ran it for the first full life of such components as final drives, transmissions and engines. We repaired the components and put the equipment back in service for another half life of 5,000 hours or so. We all did that. That was the way we managed equipment for 50 years.”

Survival mode meant fleet managers became more short-sighted in equipment acquisition than might have been the case in 2003-2004. Today, as the business slump starts to subside and backlogs begin to build up again, fleet executives find themselves in something of a quandary: They think the turnaround is not likely to be longterm, according to Agoos.

“The concept of right-sizing has been going on since the backlogs started to creep up. Most of us don’t believe this is a long-term upward growth situation, even though we have a huge need for the infrastructure,” Agoos says. “What has resulted from all this is an attitude change of ‘let’s not own a big fleet. Let’s downsize to a smaller core fleet.’ That’s on everybody’s mind.”

Other major changes in the business climate also have encouraged the shift toward “de-fleeting.” One is the overwhelming demand placed on rental companies. Two is the growing interest in lease or rental or lease-purchase agreements.

“As contractors demand more opportunities for rentals, rental purchase options (RPOs) and things like that, it’s not just a phenomenon happening in Colorado or Florida. It’s happening in most states,” Agoos points out.

“RPOs make so much sense now that dealerships are developing their own large rental fleets. That was uncommon 5 or 10 years ago.”

All this has caused OEMs and dealers to re-evaluate how they do business as well. The first change, Agoos believes, is they now have larger pools of equipment designated as rental fleets and are much more attuned to the concept of rentals.

“If you used to have a rental fleet of 10 machines and now you’ve got 100, you have to finance 90 new machines,” he says.  

“Rental houses have always been out there, but a dealer is a different kind of rental house. You can go to rental houses all day, but you can’t normally purchase their equipment. They don’t have RPOs. That’s just not what they do. Every dollar is pure rent.”

By comparison, he says, if you have a rental-purchase agreement with an OEM or dealer you know exactly what the price is—that is, the asking price minus whatever your discounts are.

The second change at the OEM/dealer level is that they are becoming the primary (i.e. sole) source of product support, due to the increasing complexity of the machines.

Rob Hoffman, CEM, director of the mechanical department at The Lane Construction Corp., is one asset manager who has been right-sizing his fleet for the past several years. It started when the company recognized it was keeping assets too long, he says.

“Not too many years ago the mentality was we own the equipment, we don’t owe anything on it and, although it’s not getting much utilization, we’ll keep it as a spare in case we need it,” Hoffman says. “Of course, we recognized that older units have higher repair costs over time, but they are still assets and are worth money.”

These idle machines were like bags of money sitting out there, he says, but that money wasn’t doing anything. “It was earning negative interest. Rather than having the equipment just sitting there losing money, we decided to turn it into cash and reallocate the cash to either buy more equipment or reallocate it elsewhere in the organization,” Hoffman says.

Once that change in mentality occurred, Hoffman scouted the entire fleet of several thousand production machines and support equipment looking for underutilized units. “We started eliminating those units. That was the beginning,” he says, adding, “It takes time to accomplish, but you have to stay at it. It’s ongoing.”

He has a word of caution, however: “We can talk about utilization, but you have to be a little careful when somebody tells you they have X-percent utilization rate. Each company is different, so you have to know how they measure that.”

The Lane Construction fleet is made up of rentals, leased units and owned machines. “We rent a fair amount of equipment to supplement our needs,” he says. “We own more and lease a lot.”

Leases provide a lot of flexibility in utilization, he says. “We have very good relationships with the finance arms of OEMs,” he remarks. “Our leased equipment is modern equipment with all the telematics and all the compliances for the [EPA] Tier engines. That means the machines are modern and reliable.”

Consider this situation: If Lane Construction has a 36-month job in the Midwest that calls for large dozers or excavators that are not usually available in the existing fleet, those machines are leased. “Sometimes we also include maintenance in the lease,” Hoffman says. “We know what the monthly payments will be on the lease, we keep close tabs through telematics on how the machine is used, and when the job is finished we turn in the equipment and move on.”

Hoffman credited OEMs for “really stepping up” when the mentality shift occurred. “Leasing through the financial arm of Deere, Cat, Komatsu or Volvo, for instance, is an important added benefit for us,” he says. “It’s one-stop shopping.”

Lease-purchase agreements have been around a while, he adds. In Lane Construction’s case, “We brush them up about once a year. It’s all about having good partners whom you trust and stay in close communication with.”

Greg Kittle, who earned his CEM in 2003, has worked in the equipment industry for more than 30 years, including equipment manager positions of major fleets.

“Fleet work is sporadic in that contractors may not get the job they thought they would, so the way I approach right-sizing is by having a core fleet with a sizeable amount of forecast work or hours,” Kittle says. “Then I had leased components for the purpose of funneling, or feeding, the owned fleet.”

Kittle says he always used RPOs as a release valve so he could quickly grow or reduce the fleet size.

“While doing that,” he says, “you stagger leases so that the lease expirations come up at pre-determined times. That approach simplifies fleet right-sizing. In my situation I didn’t need to rent. I always preferred RPOs, even if I didn’t plan to convert or sell the machine to harvest the equity.”

The decision to rent, lease or buy depends on the company, but in his case, Kittle says, 50 percent of the fleet would be owned, 25 percent rented, and 25 percent RPOs.

“The first thing you have to do is understand productive utilization,” he says. “It’s not merely collecting individual machine meter hours. You have to know the percent of the total collective hours of all those machines. That’s the first step in right-sizing.”

Another thing in the decision-making process is understanding the tools (machines) and the variety of work those tools do. That way the right tool can be placed on the right job.

“For example, you have to be very aggressive in managing a fleet of hauling units,” he says. “That is a very important component of the fleet, making sure the right tool is available for the right job at the right time.”

Preferred vendor agreements are also important in right-sizing. “You sit down with your local or national vendors and you work with them on your forecast,” Kittle says. “That way they can have the right equipment in their rental fleets, and that fleet is set up for your requirements.”

Another benefit is the local or national vendor can play an important role, not only in the acquisition of a product but also the disposal of a product during the conversion process.

The Great Recession, which dissipated backlogs, “although painful, was actually a benefit rather than a burden,” Kittle says. “Once people felt the pain of massive equity loss and horrible utilization, then right-sizing became very important.”

It made clear that you can’t hold on to assets hoping you will have work. Today, you want to make sure your fleet is flexible enough to scale up quickly and scale down quickly—based on business conditions. You want to make sure your core fleet retains a solid equity position, he says.

Another suggestion from Kittle is to understand what the secondary markets are, where you can go with very specific kinds of machines, what those values are, and at what point in the life cycle the decline in value occurs. 

After all, fleet equipment is really where a typical contractor’s net worth is. “Everything else is kind of blue sky,” he says.

All contractors, however, are not made alike, says Agoos. Some are more sophisticated than others when it comes to industry trends and equipment technology and how to determine if rent, lease or buy is the right way for them to go.

Mike Vorster, professor emeritus of construction equipment at Virginia Tech, says there are no right answers when it comes to determining which is best—renting, leasing or owning fleet construction equipment.

“There are only intelligent choices,” he says. “Rent, lease and buy are not similar. They are different forms of finance. Apply them each to specific acquisition decisions to manage the risk of fixed cost recovery. Lowering cost is less important than lowering risk.”           

Smaller contractors are not falling by the wayside, Agoos says. They are going through their own kind of change, re-evaluating the way they do business. Many are becoming, in his words, niche contractors, not general contractors. And he says the number of niche contractors is growing. 

“[Niche contractors] could be experts in curbing, for instance, or land-clearing contractors or pile-driving. In looking at their own operations they figure out what they do really well and focus on that,” he says. “I don’t know this for sure, but I think that’s what is happening.”

To illustrate his point, Agoos says big contractors build the golf courses; subcontractors do the specialty areas, such as retention ponds and supporting utility work. “Being a general contractor today is more complicated,” he says.

Layered on top of all the factors that influence how business is done in the United States is another element, Agoos says. Many large contractors in the United States are foreign-owned. “I don’t know the numbers, but it is sizeable. There are so many Euro dollars out there that many large contractors are owned by Portuguese, Brazilian, English and French companies, for instance,” he says.

French companies, such as Colas and Vinci, are two of the top-five largest construction companies in the world, Agoos says. Those two companies alone probably own 20 general contracting companies in North America.

“They owned the company I used to work for,” Agoos says, “and they are strong, well-managed companies. We had better participate because this trend is going to continue.”

The United States is a great investment, he says. The Japanese and the Chinese are buying U.S. companies. Many European companies are investing here, and that changes the way U.S. companies are managed.

“I’m not saying that in a negative way,” Agoos remarks. “The big companies are getting bigger and the smaller companies are becoming specialized.”

Because foreign corporations bring a new dynamic and frequently new acquisition rules, it complicates an already evolving fleet situation, Agoos says.

The evolution of niche contractors benefits both sides. “If I am a small contractor and very good at, say, small site work, I can do it over and over again and make money doing it,” he adds.

Another step contractors can take is plan to have a smaller fleet. “If you don’t do curb and gutters well or profitably, then look for an alliance partner, a subcontractor who does,” he says. “Keep and manage the things you do well even though you’re not building the entire project. Subcontract the work out to somebody else and don’t view equipment as a for-life acquisition.

 “If I were a contractor—and I’m not—I would figure out what I do well, develop a strategy that says, ‘okay, I’m not going to own all this iron and create an RPO program with a local dealer.’ I’d try to use the dealer’s total maintenance and repair approach. Outsourcing just makes sense. That’s the trend today.”

Recession, technology and politics all have left their mark on the industry. “There are a lot of things a fleet manager has to deal with now—emissions, lower backlogs, technician shortages, much higher fuel costs. That wasn’t the case 10 years ago,” Agoos says. “Today’s fleet managers have a much tougher challenge. I am in awe of what they have to do,” he says. “It’s a tougher world out there, a different game with new players.”