Fuel Costs — Mobile Detailers Need to “Hedge Their Bets”
Over the years or months you’ve been in business you probably have learned about cash management, proper pricing, and controlling costs. Let’s look at a cost item that you deal with every day, that you may not be controlling adequately: fuel.
The cost of gas is or has been rising daily, and hitting record highs. You cannot afford to ignore this cost since it is a major expense in your mobile business. It is as significant as insurance, maintenance, and vehicle payments. Right now, fuel is affecting mobile detail operators of all sizes, and leading them to question their ability to survive, especially with a nationwide economic slowdown added to the mix.
So what’s the problem? Why not just raise prices? You simply cannot. When times are good, people don’t seem to mind increased costs. But it is hard to raise rates in a down economy. For the consumer, prices are increasing in every aspect of their lives, especially for the essential items, which detailing is not. Many customers don’t understand the connection between high fuel costs and you raising your detail prices.
So, if you can’t raise prices to cover your fuel costs, you have to have a fuel-management program to allay them. Many detail business owners are asking themselves whether they can afford to sustain these rising fuel costs. Some operators are trying to find fleet accounts where they can drive to one place, detail all day and then go home. However, to find such accounts or customers five days a week, 52 weeks a year is nearly impossible. Some are considering vehicles that give better gas mileage and others the benefits of a fixed location. There may be another option: hedging.
WHAT IS HEDGING?
While a bit sophisticated for the detail industry, let’s look at fuel cost hedging. The term “hedging” is derived from the phrase “hedging your bets,” used in gambling games such as roulette. When you buy insurance for your vehicles, you are hedging. Doing so is one of the oldest means of hedging against risk. Insurance is bought to protect against financial loss due to accidental property damage or loss, personal injury, or loss of life. Fuel-cost hedging is the practice often used by airline companies to protect against the shock of anticipated rises in fuel prices.
In the financial world, a hedge is an investment taken out specifically to reduce or cancel out the risk in another investment. By definition, hedging is a strategy designed to minimize exposure to an unwanted business risk such as the skyrocketing cost of gasoline, while still allowing the business to profit from an investment activity.
Some form of risk taking is natural to any business activity. Some risks are considered to be “natural” to
specific businesses; the risk of fluctuating oil prices, for example, is natural to firms that drill and refine oil. Other forms of risk are unwanted but cannot be avoided without hedging. Someone who has a mobile detail business, for example, expects to face risks such as competition, poor service, and so on. The risk of their truck or trailer being destroyed by fire or getting into accidents is certainly not wanted, but can be hedged via insurance policies.
Because fuel costs have substantially risen over the past several years, businesses such as airlines, shipping, and trucking employ hedging in order to maintain positive cash flows. For example, airlines have been hedging their fuel costs since the 1980s. From day to day, we don’t know if gas is headed to $5 per gallon in Los Angeles or down to $3 per gallon in your city, so what are the implications of both? Major weather events such as hurricanes and political instability in the Middle East could cause energy prices to rise dramatically without much warning. How would this affect your business in the upcoming month, quarter, or year? In the words of an ancient Chinese proverb: “Predicting is very difficult, especially as it concerns the future.”
BENEFITS OF HEDGING
For starters, hedging allows you to generate more consistent and stable cash flows. Knowing when you are busiest is easy and more-or-less predictable. Fuel hedging also allows you to take advantage of investment opportunities in times of high gasoline prices. It is more likely that businesses will go bankrupt when fuel and other costs are high, and in such cases they are often forced to sell vehicles, office equipment, and other assets at below-market prices.
Some detailers I talk with think they are too small, or a hedging strategy will not reap any reward or have any effect for them. One of the most frequent questions I get is, “What are the risks of not hedging?” By not hedging, you are taking on the risk of rising fuel prices. That may be okay if you have large cash reserves, but most operators are not in this position with the rising costs of insurance and other daily operating expenses. When fuel prices rise dramatically, it is hard to pass all of the cost on to customers. At some point, raising prices, let’s say greater than 10 percent, can result in a 10 percent reduction in revenue. There is a magic number in there that says at some point raising prices past this point will cause a significant drop in revenue. The success of such efforts over time is unpredictable. Are your clients willing to sustain yo-yo pricing from month-to-month or year-to-year based on changing costs?
Mobile detailers — especially with large gas-guzzling rigs that want to manage risk, prevent huge swings in operating expenses, and enhance bottom line profitability — choose to insure themselves adequately and hedge fuel prices.
Keith Duplessie is technical services manager for Portland, OR-based Detail Plus Car Appearance Systems. You can reach Keith at email@example.com.