State Department of Transportation Fleet Replacement Management Practices (2014)

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SUMMARY The goal of NCHRP Synthesis Topic 43-14 is to examine the fleet replacement management and financing practices currently employed by state departments of transportation (DOTs) and to summarize their perceived advantages and disadvantages. DOTs rely heavily on fleets of vehicles and equipment (hereinafter “assets”) to fulfill their primary missions of building and maintaining roads. Accordingly, most of them spend large amounts of money on the acquisi- tion, management, operation, and maintenance of fleet assets, and replacement management practices have a direct impact on fleet costs and performance attributes such as reliability, safety, and sustainability. Fleet replacement management practices that consistently result in the replacement of assets at or near their optimal replacement cycles—the period of time over which their combined capital and operating costs are minimized—contribute to the fulfillment of a DOT’s primary mission. Conversely, practices that result in assets consistently being retained longer than their optimal replacement cycles detract from this mission by diverting money to the fleet that could otherwise be spent on things such as highway maintenance. Simply put, the amount of money a DOT spends on the replacement of assets determines the age of its fleet, and the costs and performance of an old fleet are generally inferior to those of a young one. This study gathered information on current fleet replacement management and financing practices and perceptions about them through a survey of state DOT fleet managers. The goal of the survey was to identify the methods currently used to manage asset replacement, includ- ing the financing of replacement expenditures and their relative advantages and disadvantages. Thirty-eight of the state DOTs (76%) responded to the survey. In addition, a literature review was conducted to supplement survey findings in order to identify effective methods for managing and financing fleet replacement costs. The following summarizes the DOT fleet manager survey results. • Replacement Costs – The average number of assets in the respondents’ fleets is 10,000. – The average current replacement cost of an on-road vehicle or off-road equipment asset is $40,000. – The average replacement cost for small engine equipment and attachments is $8,500. – The estimated total replacement cost of all DOT fleets that participated in the study is $13 billion. The average fraction of on-road fleet value that was replaced with new assets in 2011 was 6% (it was 5% and 4%, respectively, for 2009 and 2010). • Replacement Schedules – During the 3-year period from 2009 to 2011, 60% of the DOTs replaced less than 5% of their fleet value with new assets, and only 10% of the DOTs replaced more than 10% of fleet value. – Fifty percent of the DOTs have average replacement cycles longer than 20 years. • Expenditures in Relation to Needed Replacements – The average expenditure per DOT for asset purchases in 2011 was $18.5 million; however, on average, the survey respondents indicated that they believe this amount should be increased by 40% to $25.7 million per year. STATE DEPARTMENT OF TRANSPORTATION FLEET REPLACEMENT MANAGEMENT PRACTICES

2 – Conversely, nearly 20% of survey respondents indicated that replacement expendi- tures should be reduced instead of increased. – Half the respondents indicated that less than 20% of the assets currently in their fleets need to be replaced at this time. No correlation was found between DOT opinions regard- ing needed expenditures and needed replacements; the opinions were contradictory. – Similarly, there was no correlation between the reported ages of fleets and the percent- age of assets that respondents reported needed replacing. Thus, the survey revealed inconsistencies regarding the interrelationships among fleet age, replacement backlogs, needed replacements, and needed expenditures. • Fleet Replacement Decision Support Tools. Following are six decision support methods DOTs use for planning asset replacements that were explored in the survey. 1. Replacement cycle policies based on formal analysis of life-cycle costs; 2. Replacement cycle policies based on judgment, experience, rules of thumb, etc.; 3. Multiyear fleet replacement plans showing future replacement dates and costs by asset; 4. Replacement lists that identify assets meeting pre-defined criteria (e.g., age or mileage); 5. Methods for prioritizing specific assets for replacement when funds are insufficient to replace every asset that should be replaced; and 6. Repair versus replace tools or policies that target specific assets needing expensive repairs. Each of the six methods was considered by at least one DOT that responded to the survey to be either “the most important” or “second most important” method for guiding replace- ment decisions. The following is an overview of DOT responses. Method 4 (age, mileage, cost, and similar criteria) was cited by more DOTs than any other as the most important method; however, fewer than half the respondents reported using it. There is no consensus among the DOTs about which decision support method is the most effective. Half the DOTs (19) noted that if their methods were not used their fleets would be much older. The other DOTs noted that their methods provide only moderate confidence that they will be successful in obtaining needed replacement funds. • Fleet Replacement Decision-Making Processes A majority of the respondents (60%) reported that the timely replacement of fleet assets is not a high priority for their governor, state budget office, and/or legislature, and 30% that deci- sion making is decentralized and beyond their control. Sixty percent of the survey respondents reported that no formal studies have been made of their departments’ fleet replacement practices in the past ten years. Half of the studies that were made used consulting firms, one-quarter used academic or research institutions, and the remaining one-quarter used a state or DOT auditor. Two-thirds of the DOTs reported that the agency that makes final decisions about asset replacement funding is a central fleet management organization or other unit within the DOT, and the other third that it is an executive branch agency (state budget office, governor’s office, state legislature, etc.). More than 80% of the DOTs noted that decisions about the amount of funding made available for fleet replacement are either entirely or somewhat satisfactory. Most DOTs believe that they fare better in securing fleet replacement funding than do other agencies in their states that also use fleets of assets. Seventy-five percent of DOTs reported that outright purchases using money obtained through the annual budget process is the primary method they use to finance asset replace- ments, with 20% reporting outright purchases using a revolving or similar fund where funds are accumulated over time to defray such purchase costs. Sixty percent of the DOTs use replacement financing programs managed by a central fleet management organization within

3 the DOT, and 20% have programs managed by another organizational unit within the DOT, including individual fleet user organizations. • Financing Methods Most DOTs use one primary method for financing the capital costs of their fleet. Eighty- five percent of the DOTs stated that their method is either somewhat or very effective in promoting the timely replacement of assets; only 10% said it is ineffective. The majority of DOTs that use a revolving fund said this financing approach is very effective. Securing replacement funds through the annual budget process was judged by some survey respon- dents to be ineffective, but no explanations were given for why. Annual budgets were also reported to be the most ineffective in promoting understanding of the trade-offs between asset capital and operating costs and opportunities to optimize them. The explanations respondents gave for this ineffectiveness were: (1) the highly defined separation of capital budget funds in the appropriation process makes it easy to target them for cuts; (2) there is mistaken belief that once assets have been purchased, it no longer costs anything to operate and maintain them; and (3) with centralized replacement budgeting, man- agement, and purchasing fleet users have no incentive to minimize overall fleet size. DOTs using revolving funds for financing fleet replacement costs reported that the source of monies is a system of charge-back rates. Half of these agencies noted that the monies col- lected through the charge-back system for fleet capital and operating costs are maintained in separate accounts, the other half that the monies are pooled. Most DOTs using charge-back rates reported that: (1) revenues cover all costs; (2) all rates have been updated within the past two years; (3) specific methods are used for setting charge-back rates; and (4) replacement reserves in the revolving fund are almost never raided to meet other spending needs. Half of the DOTs that use revolving funds are completely satisfied with them, and the rest are fairly satisfied. No other financing method has such a high level of satisfaction. Only one DOT in five is completely satisfied with using funds secured through annual budgets for financing asset replacements. Some improvements DOTs would like to see in this particular financing method include: (1) more funding; (2) the return of used asset sale proceeds to the fleet budget; (3) restrictions on funds budgeted for vehicles and equipment being used solely for that purpose and not redirected elsewhere; (4) replacement with a revolving fund; and (5) a more level funding stream that allows the replacement of fleet assets on 8- to 10-year cycles. Half the DOTs do not want to change the method they use for financing the capital cost of assets. All the DOTs presently using revolving funds prefer to keep them. Fewer than half the DOTs presently using annual budgeting processes want to keep them. Some want to switch to leasing, or borrowing, or a revolving fund. Two-thirds of the DOTs reported that they use additional financing methods to periodically supplement their primary method. The methods used include short-term rentals (most common), leasing, and guaranteed buy-back programs. Thirty percent of DOTs said they occasionally buy used instead of new assets. A literature review was also undertaken for this study. The state of California’s DOT, Caltrans, recently published the results of a survey it commissioned of state DOT fleet manage- ment practices, including some related to asset replacement and fleet financial management. The study draws no conclusions about the advantages/disadvantages of fleet management practices nor does it make any recommendations for improvement. Nonetheless, it is the only one other than the present study that explores how state DOTs are managing and financing the costs of fleet replacements.

4 The AASHTO Standing Committee on Highways recently commissioned a report on future equipment fleet management research needs. The report includes recommendations regarding research that should be conducted on the development of asset replacement cycle guidelines, asset repair-rebuild versus replacement decision making, fleet replacement plan- ning, and fleet replacement financing. The report sheds light on what a group of state DOT, FHWA, and consulting company officials that met to identify research needs deemed to be key elements of an effective fleet replacement program. A few reports by academicians describe decision support tools for determining when to replace specific assets in fleets so as to minimize total costs. All but one of these studies were made for state DOTs. The authors of some of these reports acknowledge that the content is highly technical and may require the help of experts in order to apply it. The reports have valuable discussions of underlying principles for effectively replacing fleet assets. Consulting reports often use a standard methodology for evaluating the soundness of fleet replacement practices. The first step is a multi-year plan that estimates the future costs of replacing assets. The resulting forecasts show that replacement spending requirements often fluctuate from year to year, which causes too few assets to be replaced when DOTs are strapped for cash. An alternative approach for estimating future fleet replacement costs is to simply divide the current replacement cost of the entire fleet by a target average replacement cycle (e.g., seven years). Under both approaches, estimates of future costs provide a benchmark against which past replacement spending levels can be compared. Much of the consulting literature analyzes the pros and cons of different types of capital financing that are used by government jurisdictions, including (1) outright purchase using funds secured through annual budgeting processes; (2) purchase using a revolving fund and charge-back system; (3) purchase using borrowed funds; and (4) leasing. The first is the most common and the last is the least common method used. Two key points made by a number of these studies are that old fleets cost more than younger fleets and that the choice of a replace- ment financing method can have a significant impact on the age and hence the costs of a fleet. The biggest challenge in making a fleet younger and more economically efficient is securing the funds for replacing obsolete assets that have been backlogged. The literature shows that outright purchase of assets with cash is the least beneficial method for financing assets (despite its widespread use by governments). It has the biggest impact on an organization’s budget in the near term, and it frequently incentivizes the repair and retention rather than the replacement of obsolete assets. Financing approaches that lever- age cash (e.g., debt financing and leasing) are usually more viable, partly because they do not require fluctuating amounts from year-to-year. In 2002, the TRB Standing Committee on Maintenance Equipment published a circular on capital financing methods used by state DOTs. The report is a primer, intended to provide information to fleet managers regarding the various financial acquisition choices and how each impacts budget, total costs, and fleet upgrade factors. It summarizes different acquisi- tion methods, cost factors, and how life-cycle bids are used by state DOTs. The section on acquisition states that “cash purchase is the lowest cost method for owning, operating, and disposing of a piece of equipment.” This statement does not align with other reports reviewed in the literature review. Articles published in fleet industry periodicals occasionally cite the savings from downsizing fleets and reducing fleet age. Although its primary readership is corporate fleet managers, Bobit’s Fleet Financials has many articles on the characteristics, pros, and cons of various types of fleet lease agreements, offering a good source of introductory information.