Kuldeep: Tours and Travels are in the business of running taxis on hire. The business was set up three years back by Kuldeep's father, a retired mechanical engineer. The business has a fleet of ten Tata Indica cars. Currently, all the taxis of the firm are running on diesel. The firm prefers taxis that run on diesel due to the low costs of running them. These days. Kuldeep, who has a sound grounding in finance, is looking after the day-to-day operations of the business. His fathers concerns are limited to strategic issues only. Kuldeep wants to adopt an aggressive business policy with an all out focus on profit maximization. In view of increased demand for taxis, the firm has decided to add 20 more vehicles over the next one year to its existing fleet of taxis. Kuldeep and his father sit across the table to discuss the issue.
Kuldeep: I propose to buy only CNG-run cars, because driving on gas reduces running costs considerably. The cost of driving on natural gas is 20-40% lower than diesel. On an average, the cost of running on CNG works out to Rs 1.30 per kilometer, while that on diesel, the cost is around Rs 2.20 per kilometer. If we buy CNG fitted cars, the ratio of CNG-run and diesel run cars would be 2:1. A high proportion of CNG-run cars in the fleet will bring down the running costs. It is just like increasing the proportion of low cost debt in the financing mix so as to bring down the overall cost of capital.
Father: Son, the analogy of debt is fine, but why do you forget that like debt, the CNG option has its own risks. Have you thought about the availability of CNG? It is not an option for long distance travel due to the shortage of CNG filing stations in interior areas. Also, the one time storage capacity of CNG is limited. Do not forget that there is a limit to which we can utilize the boot space for fitting additional CNG cylinders. The boot space belongs to the customers who hire the taxis. Not to mention the maintenance cost issue, CNG causes dryness in the engine as a result of which, the fixed and regular servicing cost of the CNG-run vehicles comes to be higher than that for the diesel vehicles. CNG tends to have lower octane levels and continues to contain impurities that hinder continuous combustion in the engine chamber. Running the car on gas for an extended period may also lead to engine damage. The risk of a breakdown in the absence of maintenance is higher for such vehicles. So, as an entrepreneur, you must not only be looking at the cost savings but also the associated risks. There is a limit to which you can use the lower cost option without adding to your risk.
Kuldeep: Does it imply that we have to forego the low cost option of CNG-run taxis and opt for 100% diesel vehicles? Doing so would mean foregoing the probable savings on account of low running costs. Would it not compromise with our profits?
Father: No, 1 never said that. The idea here is to take the benefit of both CNG- and diesel-run vehicles. Since your total running cost is the weighted average of the cost of running both CNG-run vehicles and diesel-run vehicles, you should try to bring down the running costs by maximizing the usage of the CNG-run vehicles but also manage the risks associated with them. For running within the city limits, you should try to maximize the usage of CNG-run taxis, but for long distance service, diesel-run taxis would be a better idea. By having a mix of both CNG and diesel taxis in your new fleet, you will be able to capture the savings from CNG-run taxis, yet contain the related risks.
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