VIEWPOINT: Mitigating RV risk and boosting profitability
An age of uncertainty
The vehicle financing market has been unpredictable ever since the days of Covid. A long period of unstable residual values (RVs) has ensued, with OEMs and financing companies trying to find reliability in a rapidly shifting environment. Meanwhile, the impact of geopolitics on the global market is turning out to be greater than feared. Furthermore, heavy regulations around sustainability are coming into force, putting greater demands on OEMs to reduce their carbon footprints. This is happening most notably in the EU with its corporate sustainability reporting and Fit for 55, but also globally, with Canada and Singapore among other countries introducing zero-emission targets.
Those who emerge strongest are the ones who are quick to adapt, and have built flexibility into their end-of-term vehicle remarketing approach.
These last five years have shown how quickly the market can change, and uncertain times don't look to be going away any time soon. When faced with uncertainty, diversification is often seen as the best strategy, and for OEMs and financing companies, where residual value risk is key, this means re-evaluating their multichannel and multicycle vehicle financing.
The residual value rollercoaster
The sudden short supply of vehicles during Covid led to used prices increasing dramatically, including a 30-40% jump in 2021 alone. At the same time, some car manufacturers dropped their prices at short notice. The lives of OEMS and finance companies, who base pricing on the ability to predict RVs accurately, were made very complicated as a result.
One thing about EVs is guaranteed: their residual values are unpredictable.
To muddle things further, the return of supplies to pre-Covid levels meant that used vehicle RVs quickly reverted to typical amounts in just a couple of years, and by 2024 had more or less normalised. These shifts have altered the market dynamics from a 'push' model, where dealers focus on upselling to a 'pull' model, and back again. For some lessors, this has meant rapid strategic shifts towards direct sales through online portals, and back to dealerships.
In the EU, ESG regulations such as Fit for 55 require manufacturers to produce 100% zero-emission vehicles by 2035. While some regions have taken well to the EV transition (such as in Norway, where over 90% of new vehicles are zero-emission), much of Europe has lagged behind, with little government incentive to make the switch. However, it's clear that the transition to EVs is a reality, and one thing about EVs is guaranteed: their residual values are unpredictable.
It's time to look beyond the linear view of leasing.
This situation is not expected to settle down. In order to offload enough EVs, OEMs are turning to fleets, and in a few years, the used EV market will be flooded with second-hand EVs from fleets, also in countries where consumer demand for EVs hasn't increased. The inevitable impact is that the volume of EVs hitting the market will reduce the market value of RVs further.
Prudent lessors will consider this and start preparing now, by building flexibility into their remarketing strategy.
Diversifying the remarketing process
So how do you mitigate RV risk, in a time of great geopolitical and economic uncertainty?
Typically, a lease is three years long; the vehicle is manufactured and purchased at the start of the contract, and it is immediately sold and disposed of at the end. This ‘once-and-done’ approach to financing places the risk entirely on the asset’s RV. What if, instead, you had a range of options for each vehicle as it is returned, and were able to transition it into a different area where it could continue to generate revenue, while waiting for the resale value to match the book value? This is where multichannel and multicycle approaches come in.
The strategy must be to diversify your remarketing process.
Multicycle, or extended vehicle life, is the ability to reuse an asset or vehicle in further financing contracts after the end of the initial lease. Some OEMs trialled Vehicle-as-a-Service (sometimes called vehicle subscription) as a response to this, and as a way to meet customer demand for flexible, short-term contracts and fast, easy upgrades. However, most of these trials didn't succeed: the fast depreciation rates for vehicles, alongside customers' expectations around their vehicles and how they use them in their personal lives, proved challenging to combine with profitability. And while profitability is always the goal, risk mitigation must not be overlooked, and short-cycle options for vehicles should be considered part of the bigger picture. Mobility companies have shown that there is demand for flexible mobility products, typically in urban environments where a car isn't an everyday necessity.
Multichannel flexibility is key to finding consistent revenue in uncertain times.
But multicycle is only one aspect of remarketing, and Vehicle-as-a-Service is only one way to give a vehicle multiple lives. Multichannel is the ability to transition a given vehicle into more than one future revenue stream. For example, a vehicle might be moved into a fleet at the end of a lease. Alternatively, perhaps a vehicle starts as a short-term rental, commanding a high margin in its early life when depreciation is steep, and is subsequently moved into a lease contract. The key to a strong multichannel approach is having many channels with strong supporting infrastructure, and therefore plenty of flexibility, for offloading vehicles into their second and third lives.
The benefits of multichannel and multicycle strategies
A well realised multicycle and multichannel approach to vehicle financing has several positive outcomes.
The main risk for a typical lease contract is that the vehicle’s resale value won't meet the RV that was used to price the contract. If you can find a second or third life for the asset rather than sell it, then you're less exposed to this risk.
For OEMs, a multichannel approach - alongside strong partnerships, and a strategy for offloading returned vehicles - also means keeping control over the volume and quality of what’s hitting the market. By extension, this allows them to exert pressure on the RVs of their own vehicles - both upwards and downwards - leading to more effective and predictable contract pricing.
Some OEMs have struggled to maintain brand value while selling pre-owned vehicles. Many, such as BMW, Tesla and Rolls-Royce, have introduced special programmes to bolster resale values by creating a more structured remarketing process. These programmes often include refurbishment and the use of telematics to identify higher-quality used vehicles; and knowing the vehicle's quality and condition can help determine its optimal second or third life.
For EVs however, the RV is strongly influenced by battery health. Startups like Generational are providing a key service in this area. Without a guaranteed state of health, RVs are even less predictable, and could result in no sale at all. To maximise your return as more used EVs become available, it's crucial to remarket high-quality vehicles. Having contractuals and data in place to incentivise end users to protect their EV battery health will help RVs meet expectations.
By finding more lives for vehicles and reducing production, companies are reducing their carbon footprints. While producing fewer vehicles may not be the goal for OEMs, it's important to note that selling services is as important as selling the vehicle for profit, with some OEMs finding that services make up as much as 40% of their profit.
OEMs embracing this have seen that vehicles are increasingly software-powered, and that powerful, user-friendly services are a way to boost profit margins without requiring more production. Focusing on extending the profit captured through the asset lifecycle will help OEMs and lessors to improve their profitability while reducing their carbon footprints. For an OEM or finance company to make the most of multicycle and reduced production, it is important that the assets aren't sitting around in lots waiting for their next lifecycle to start.
In traditional single-lease models, after the end of a lease and the return of a vehicle, the remarketing process begins. For some vehicles, this can be a time-consuming process where the asset sits idle in a backlog. By focusing on asset utilisation and multicycle approaches for assets, the lessor can earn revenue from a greater period of the useful life for each asset. Establishing clear channels for offloading assets and understanding their needs allows for proactive management of end-of-term vehicles, quickly transferring them between channels and minimising downtime.
For EVs, electric vans and luxury vehicles with high up-front costs and rapid depreciation rates, maximising the usage of the vehicle is essential for improving ROI. This is a crucial consideration for capital expenditures, particularly when RVs are unpredictable. When an asset consistently generates income, its depreciation curve becomes less significant.
By keeping control of a greater period of the vehicle's useful life, the finance company also keeps hold of the profit for longer. Second and third lives for assets can be very profitable, but this is lost when the strategy is always to remarket the asset as soon as it is returned. Improving uptime for each asset and offering a wider range of products leads to improved risk management and diversified revenue streams.
Using a multicycle approach, each asset can produce multiple income events, leading to improved returns. Each subsequent asset cycle carries reduced RV risk, as the depreciation curve for the asset has already flattened. To use this strategy effectively, lessors need various channels for asset distribution. Partnering with fleets, rental companies and mobility providers allows for different revenue streams: fleets provide high volume, rentals offer high margins and scalability for demand surges, and mobility operators are less strict about vehicle condition. Flexibility on the segments to which a vehicle can move means it can be monetised in different ways, and tailored to each customer market.
By maintaining the asset on your books for an extended period, you can extract greater value through the add-ons and services, which are contributing increasingly to the profit generated from vehicle financing. More cycles also means more data collection, which can feed back into resale value optimisation, or by selling the information as insights to third parties. Each cycle contributes not only financial value but also informational value. Making the best use of this additional data can provide a competitive advantage.
Using a multichannel approach means being able to offset downturns in one market by shifting more of your vehicle portfolio into other adjacent markets; for example, if there is decreased consumer demand for EVs, you can move more EVs to fleet customers.
Multicycle and multichannel isn't just the answer to mitigating RV risk; it's also a powerful way to increase revenue.
In the equipment finance sector, the circular economy, multicycle, and multichannel approaches are the norm rather than the exception. There are clear reasons for this: primarily, the rapid depreciation of vehicles, and consumer expectations regarding the quality and condition of personal assets. Equipment finance companies have long used rental > lease > resale strategies, and it's time for vehicle financing companies to follow suit. While these ideas aren't new, it's the right moment to revisit them and exploit modern technology for better outcomes.
Implementing advanced remarketing
To implement multicycle and multichannel strategies successfully, it is essential to consider the overall approach to remarketing strategies and how value is generated throughout the asset lifecycle.
Traditional vehicle management models need to be reimagined. Establishing a suitable cross-organisational structure is essential to breaking down silos between departments. A holistic view considers financing as more than just a single-use perspective of a lease, with remarketing at the end.
A coordinated and cohesive approach is essential, and to achieve this, you need a robust technology stack capable of managing flexible contract structures and multicycle financing. Additionally, it should enable you to pilot new products that can adapt to evolving remarketing requirements.
More second life opportunities can be opened up by fostering partnerships, and breaking down silos between departments. Capturing the profitability of each second-life option is essential for informed decision-making.
Having well structured and readily available information enables AI and machine learning to assist in making informed decisions for each vehicle. For instance, should it be leased, or repurposed for ridesharing? Should it be sold at a local auction, or exported to another country?
One effective way to expand your channels is by forming partnerships with other mobility companies. For instance, establishing a strong alliance with a rental company or ridesharing fleet can create new opportunities to offload larger volumes of assets as they return from leasing. The main concern lies in ensuring that the resale values meet expectations; so implementing a software system - one which manages asset usage and maintenance, incentivises responsible usage, and customises end-of-term options based on the user type - is critical to addressing this challenge.
Three ways to turn a prediction problem into an optimisation solution
- Determining the right time to sell or repurpose a vehicle depends on understanding its market value. Access to accurate valuations throughout the life of each vehicle enables proactive decisions about when to sell. If the resale value of a specific vehicle is high, then it's not the right time to allow a customer to extend their contract. However, making these decisions is impossible without having the right information at the right moment.
- This may require integration with a notable data provider.
- Multicycle approaches involve keeping assets on your books longer, necessitating advanced software to manage the extended depreciation of the asset and capture depreciation accurately as the asset transitions through each cycle.
- You need a system that can manage multiple lifecycles for each asset. It should also support a flexible remarketing process, allowing you to sell or retain the vehicle. Additionally, the system must be capable of facilitating the vehicle's movement to the next revenue stream.
- It's important to gather detailed information about each contract, including contract types and values.
- Understanding each vehicle's second and third lives is invaluable. This data can improve pricing calculations and inform remarketing decisions, ultimately leading to better ROI.
Conclusion
In a volatile market with erratic demand and supply, regulatory pressures, and global geopolitical events, consumer habits can shift in just weeks. As a result, traditional RV forecasting has become increasingly unreliable. OEMs and financial institutions should consider diversifying their lease products, exploring ways to continue generating revenue from each asset. This approach can help reduce capital expenditure and diversify revenue streams.
A multichannel remarketing approach helps businesses regain control of RVs and improve profitability. While the financial benefits are clear, it also coincides with a growing regulatory emphasis on sustainability reporting and the transition towards electrification, creating a synergetic environment with the shift in consumer demand towards greener and more flexible solutions.
The market is currently facing significant pressure, pushing all stakeholders in the same direction; and making the multicycle, multichannel approach to financing essential. ESG is a top priority in many countries, particularly in the EU, where strict EV regulations are compelling OEMs to meet their CO2 targets. Additionally, uncertainty in the market, combined with sudden and rapid shifts due to unforeseen geopolitical events, has intensified profit pressures.
Moving to a multichannel, multicycle approach isn't just mitigating risk; it's enhancing your returns by making better use of the assets in your portfolio and capturing value that would otherwise be left for your competitors.
Those who will best survive uncertain periods are the ones who are flexible and quick to adapt. Failing to optimise asset usage, or effectively timing their sale, can lead to unnecessary losses. Having sufficient information at the ready, and the right options optimise market timing, can mitigate this.
Now is the time for financial institutions and OEMs to ask themselves, will they continue thinking of assets as single-use commodities, or will they unlock the flexibility and value of the asset lifecycle with a multicycle-multichannel strategy?
The opportunity to be ahead of the curve is right now, and the pressure to act only increases.
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