April 13, 2004

Automotive Warranties:

Ford and GM are not only the largest providers of automotive warranty. They're also paying a higher percentage of their revenue in claims than everyone but the makers of RVs and rider mowers.

The weight of warranty claims and accruals reported by General Motors Corp. and Ford Motor Co. is so great upon the automotive industry that they more or less set the averages by themselves. Together, Ford and GM reported just under $8 billion in claims and accruals during 2003, and the other 130 U.S.-based automotive manufacturers reported roughly $3.6 billion. In percentage terms, it's only 2.6% to 2.8% of sales, but that's significantly higher than the rate seen by most of their competitors and virtually all of their suppliers.

Ford and GM are the 800-pound gorillas of warranty. These two companies spent almost $1 million an hour on their warranty programs during 2003. With the addition of funds spent by DaimlerChrysler, Toyota, Honda, and the other import nameplates, warranty work is by far the largest and most consistent source of revenue for most automotive dealerships. Warranty programs for passenger car manufacturers are so large and so oversized compared to other types of manufacturing that one could view them as more of a reward for brand loyalty and less of a mere reimbursement for repairs.

Other major manufacturers such as General Electric and Boeing simply don't pay anywhere near as much in warranty claims, nor do they accrue as much per quarter or hold as much in their warranty reserves. That's no reflection on product quality. It's simply an acknowledgement that warranty means more in the passenger car industry, especially in the way it binds dealer to manufacturer, than it does in other industries. Relatively speaking, GM and Ford even pay out hundreds of times more than some of their biggest parts suppliers.

Any analysis of warranty expenditures in the automotive industry should therefore divide the whole group into two parts: 1) passenger car OEMs, and 2) everyone else. Since the only passenger car OEMs reporting their warranty fund balances to the U.S. Securities and Exchange Commission on a quarterly basis are GM and Ford, the first list will be pretty short. But let's just get by them quickly so we can see how the other half lives.

As Warranty Week has detailed several times in the past three weeks, GM and Ford are number one and two among all manufacturers in terms of warranty claims, accruals, and reserves. They're so far out front that they're a third of the whole warranty industry and almost 70% of the domestic automotive industry, at least in terms of warranty. Together they saw claims of $7.959 billion and accruals of $7.952 billion in 2003, and they ended the year with $14.117 billion in their warranty reserves.

Warranty Claims and Accruals
for General Motors and Ford, 2003


Source: Warranty Week

As the chart above details, the claims and accrual rates for both companies fluctuated all year in a narrow band between 2.6% and 2.8% of automotive product revenue. From the limited amount of historical data available, it's difficult to tell whether this range is historically high, low, or about where it's always been. Indeed, for DaimlerChrysler the "natural" rate lately has been more like 3.6% to 3.8%, while Toyota and Honda more typically see rates closer to 1.2%. But let's assume for the time being that 2.6% to 2.8% is a typical rate for a typical passenger car manufacturer.

Now we can ask the question whether warranty claims and accrual rates for manufacturers of other types of vehicles are higher or lower. One can ask whether parts manufacturers have a similar warranty experience, and indeed, whether the aftermarket parts makers and the auto parts stores are also expending a similar proportion of their revenue on the adjustment of warranty claims.

It turns out that nobody is similar to GM and Ford. Anywhere you look -- trucks, buses, emergency vehicles, golf carts, motorcycles, or riding mowers -- you're likely to find lower "natural" rates of warranty spending. Take away GM and Ford, and for the rest of the list claims and accrual rates fall closer to 2% for other vehicle manufacturers, 1.5% for engine and transmission makers, and under 1% for parts manufacturers.

You could almost say that the further one gets from the passenger car distribution model, where customers demand good warranty coverage and dealers virtually live off the work it brings in, the lower the cost of warranty. That correlation works in almost every direction. In terms of larger vehicles, warranty rates drop for highway trucks, garbage trucks, fire trucks, and construction equipment. In terms of smaller vehicles, warranty rates are lower for everything from motorized wheelchairs to snowmobiles. And in terms of parts, components, and assemblies, the manufacturers of virtually everything that goes into a vehicle typically experience lower warranty claims and accrual rates than GM or Ford.

The only exception found during an examination of a year's worth of data was recreational vehicles. As a group, the makers of RVs generally experience warranty claims and accrual rates in the vicinity of 2.5% to 2.7% -- about the same as GM and Ford. But even in this rather narrow sub-category there is a noticeable difference between the warranty experiences of the final vehicle manufacturers and the makers of components such as the RV's aluminum walls, the carpeting, and the air conditioning systems.

Small Claims for Big Trucks

It's something of a surprise to find that the warranty programs for trucks, despite their size and high mileage, are not consuming as high a percentage of sales revenue as do passenger cars. This may have something to do with the structure of warranty in the trucking industry -- how the engine is warranted separately from the chassis and how the typical trucking fleet tends to handle many of its own repairs. It also may have something to do with the fact that some highway-class trucks cost 10 times as much as passenger cars. But it also may have something to do with the relationship between dealer and manufacturer.

Let's forget for a moment that Ford and GM are major truck manufacturers, especially if one classifies SUVs and pickup trucks under this heading. Let's look at just major truck OEMs such as Navistar and Paccar, as well as truck engine makers such as Cummins and Caterpillar. Let's also include some of the specialized large vehicles of Federal Signal Corp., Oshkosh Truck Corp., Deere & Co., and even Ingersoll-Rand Co. Ltd. (a leading manufacturer of refrigerated truck trailers). In percentage terms, truck warranties are noticeably less expensive than passenger car warranties.

DaimlerChrysler, were it to be included here, would probably raise the average a bit. But that wouldn't have much to do with their truck subsidiaries. It would have more to do with the importance of warranty to their passenger car brand image and advertising campaigns, and the importance of warranty work to the continued well being of their dealerships. Daimler subsidiaries Freightliner and Detroit Diesel belong on this list, as do Mack and Volvo. But each of these are classified as foreign-based companies, and none are reporting their warranty activity on 10-Q or 10-K statements.

What we're left with is a list of 13 manufacturers for whom warranty is a fairly stable expenditure. In 2003, the claims rates of this grouping trended slightly downwards all year, falling from 2.2% to 2.1%. Accrual rates, meanwhile, fell from 2.4% to 2.0%. As the graph below illustrates, this means that while accruals outpaced claims early in the year, the reverse was the case later in the year.

Warranty Claims and Accruals
for Truck Manufacturers, 2003


Source: Warranty Week

Again, there is little historical data to help us decide whether this stability is typical or not for truck manufacturers as a group. But in numerous sub-groups of the trucking industry, claims and accrual rates are even lower. For instance, Warranty Week tracks five makers of ambulances, public safety vehicles, and fire trucks: Federal Signal Corp., Oshkosh Truck Corp., Spartan Motors Inc., Collins Industries Inc., and Rexhall Industries Inc. None saw claims or accruals rise above 1.9% last year, and as a group they stayed within a range of 1.0% to 1.5%.

Construction vehicle makers saw claims and accrual rates close to 2.0% all year. Caterpillar and Deere were slightly above that average, but Ingersoll-Rand, Terex, and Astec Industries Inc. were a bit below it. Manufacturers of farm vehicle and lawn equipment also fell close to that trend line, again with Cat and Deere above the line but this time with Textron and Toro below the line.

Recreational vehicles were the only OEM group trending higher than passenger cars. In fact, a list of bus manufacturers also trended higher than passenger cars, but of the five bus manufacturers on the list, three also make RVs. Of the other two, one is Navistar, which has seen claims and accruals vary from 2.0% to 2.8% at different points during the year. But even Navistar is only partially a bus manufacturer. Also, some of the largest bus manufacturers are British owned, and are therefore not disclosing their warranty accounting to the SEC. Bottom line: we don't believe this list of bus manufacturers is representative of warranty spending patterns in the bus manufacturing industry.

It's a Small World

There also are plenty of vehicle OEMs whose products are smaller than a passenger car. There are golf carts, forklifts, snowmobiles, motorcycles, jet skis, all-terrain vehicles, and even some riding lawn mowers. Not all use combustion engines, but who could say they're not automotive products just because they're battery-powered? NACCO Industries Inc., a forklift manufacturer, and Stewart & Stevenson Services Inc., one of its dealers, are both well below 2% for both claims and accruals, but the latter has yet to file its fourth quarter report with the SEC.

Only one motorcycle manufacturer made the list, but they also kept claims below the automotive industry average. Harley-Davidson Inc. has kept claims and accrual rates below 1.0% all year long, even after all their biker apparel revenue is subtracted from the figures used to calculate the percentages. In fact, of all the different types of manufacturers of small motorized vehicles, the only group that consistently approached the rates seen at GM and Ford were the makers of lawn mowers -- Briggs & Stratton, Toro, and Deere.

Therefore, in terms of fully completed vehicles sold to end users, RVs are the only large-type vehicles with claims rates comparable to GM's and Fords, and riding lawn mowers are the only small-type vehicles with rates in that 2.5%-and-above range. The ones we're not sure about are buses, for which there's no "pure play" example among U.S. manufacturers.

It's also obvious that most auto parts and components manufacturers are not experiencing warranty claims or accrual rates in that 2.5%-and-above range. Visteon is the most glaring example. A Ford spin-off, this parts maker declared $17.66 billion in 2003 revenue, and only $17 million in claims (albeit $25 million in accruals). Ford, with roughly eight times as much revenue as its spin-off, experienced 200 times more claims and 140 times more accruals than Visteon.

Warranty Claims and Accruals
for Auto Parts Makers, 2003


Source: Warranty Week

As a group, 70 assorted automotive parts and tool suppliers spent well below 1% of their sales revenue honoring warranty claims. There was no meaningful difference when the customer was an OEM such as Ford, Toro, or Winnebago, or when the customer was a shopper at retail warranty providers such as Midas, AutoZone, or the Pep Boys. The only exception were the engine and transmission manufacturers, who generally saw higher claims rates than the brakes, exhaust, HVAC, interior, and electrical component manufacturers. The only anomaly was Standard Motor Products Inc., whose claims and accrual rates were in a range of 6% to 8%. This was multiple times higher than other aftermarket parts manufacturers. For instance, Modine Manufacturing Co. remained in a range of 0.8% to 1.0% all year.

Even within the drivetrain category there were noticeable differences in rates, however. It appears that engine makers see higher claims and accrual rates than those whose products fit further down the drivetrain. Cummins saw claims rates of 2.7% and accruals rates of 2.9%, but both Dana and ArvinMeritor saw rates of 0.5% to 0.9% all year. Perhaps OEMs are more likely to recover from their engine suppliers than from their transmission and axle suppliers? Or perhaps the differences are in the nature of the product?

There aren't many car audio manufacturers that are both public companies and U.S.-based. Of the six that are, however, claims and accrual rates tended to remain in the 0.7% to 1.3% range. Tire manufacturers -- all three of them -- saw claims and accrual rates down in the 0.3% to 0.5% range. There were 12 U.S.-based companies supplying vehicle heating and air conditioning systems to OEMs, but as a group their claims and accruals came in at the 0.5% to 0.8% level.

Back to Part Three  

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