June 20, 2006

Auto Warranty vs. Quality:

Does the total cost of warranty have any correlation to product quality? Based on the worldwide claims rates seen for the top five carmakers and quality data collected in the U.S. by J.D. Power and Associates, one does seem to be related to the other.

In something of a surprise, General Motors Corp. and Ford Motor Co. switched places during the first quarter of 2006. GM used to report a slightly higher warranty claims rate than Ford. But now, Ford's rate is slightly higher than GM's. And DaimlerChrysler's claims rate continues to be higher than both.

As is detailed in Figure 1, the warranty claims rates of the top auto manufacturers have rarely intersected. Traditionally, for whatever reasons, DaimlerChrysler has always paid out the highest percentage of its automotive revenue for warranty claims, while Toyota Motor Corp. has always paid out the least. Honda Motor Co. Ltd. has always been close to Toyota's claims rate, while GM and Ford have always been close to each other.

Whether this is an indication of the relative quality of their vehicles or a product of the cost and frequency of repairs is something we can only begin to analyze here. Because there are three currencies and three national accounting standards involved, not to mention differences in product mix and warranty durations, it's probably an oversimplification to say that low claims rates equal high quality. It may have more to do with who's better at pushing claims back onto suppliers, or who's better at hedging against currency fluctuations.

Warranty Cost per Vehicle

What we can say with some confidence is that based on some crude and oversimplified modeling, Toyota is paying out roughly half as much per vehicle as Ford, and that for some reason -- perhaps partially because of the strength of the euro -- DaimlerChrysler is paying out twice as much per vehicle as Ford. We'll leave it up to the marketing departments to decide whether that means that Japanese cars are better than American cars, or that American cars are better than European cars.

First, let's look at the claims rates, which are not affected by currencies or by marketing budgets. In each case, dollars spent on claims are divided by dollars reported as revenue, or yen divided by yen, or euros divided by euros. But also in each case, the figures for claims are net, which means they reflect payments made minus reimbursements received.

The big news here is that during the first three months of 2006, GM paid out 2.6% to Ford's 2.7%. During the past three years, GM's claims rate has never been lower, while Ford's has never been higher. And DaimlerChrysler, while down considerably from a year ago, is now on its way back up.

Figure 1
Warranty Claims Rates of the Big Five
2003 to 2006


According to industry figures, these five manufacturers have roughly 80% of the U.S. market, 75% of the North American market, and just over 47% of the worldwide market. In unit terms, the total U.S. market in 2005 was around 17.5 million vehicles, while the North American total was 20.5 million vehicles and the worldwide total was around 64.7 million vehicles.

On that basis, then, we can assume we don't know the warranty costs of around 20% of the U.S. market, 25% of the North American market, and 53% of the worldwide market. Or do we? What follows is a somewhat crude exercise in market sizing which suggests that these five companies account for 56% of a worldwide total OEM warranty spend of $27.5 billion.

The Raw Numbers

GM reported that just under half the 9.17 million vehicles it sold worldwide in 2005 were sold in the U.S. Around 57% were sold in North America. Ford reported that just over half the 6.82 million vehicles it sold worldwide in 2005 were sold in North America. It also estimated its own U.S. market share at 18.2%, which we're extrapolating to yield a figure of 46.6% for the percentage of Ford's total worldwide units that were sold in the U.S.

The Mercedes Car Group reported that 19% of its 1.22 million units were sold in the U.S., while the Chrysler Group sold 82% of its 2.81 million units in the U.S. And there were around 183,000 commercial vehicles sold by DaimlerChrysler's various units in the U.S., out of a worldwide total of 825,000 units. Together, that implies that a little over 52% of DaimlerChrysler's total worldwide units were sold in the U.S.

According to industry estimates, the Toyota brand names (including Lexus, Scion, and Daihatsu) had around 11.4% of the worldwide unit count, around 11.1% of the North American units, and 13% of the U.S. units. Honda and Acura had a 5% worldwide share, a 7.7% North American share, and an 8.4% U.S. share. However, neither company has yet released its annual report for the years ended March 31, so we don't yet have any firm unit counts.

Multiple Brand Names

Of course, Ford, GM, and DaimlerChrysler each sell automobiles under multiple brand names. In the U.S., the primary brand names used by GM are Buick, Cadillac, Chevrolet, GMC, Hummer, Pontiac, Saab, and Saturn. GM also has an equity interest in Suzuki and Isuzu.

Ford also uses multiple brand names, including Aston Martin, Jaguar, Land Rover, Lincoln, Mercury, and Volvo. It also has an equity interest in Mazda.

For passenger cars, DaimlerChrysler uses the Chrysler, Dodge, Jeep, and Mercedes-Benz nameplates, but it also has multiple brand names involved in truck and engine production. It also has an equity interest in Mitsubishi.

The reason we mention this is because each company reports only one set of warranty figures. Warranty claims are not broken out either by nameplate or by the size or type of vehicle. We just can't tell which of the brands account for the most or the least warranty cost.

In calendar 2005 on a company-wide basis, GM reported just under $4.7 billion in warranty claims, equal to 3% of its worldwide automotive revenue. Ford reported just under $4.0 billion in claims worldwide, equal to 2.6% of its automotive revenue.

For GM, that works out to around $512 per vehicle. For Ford, that's around $585 per vehicle. However, keep in mind that some warranty claims paid in 2005 arose from vehicles sold in 2004 and 2003, and perhaps even a few from 2002 in the case of luxury vehicles with four-year warranties.

Furthermore, U.S. auto warranties last a bit longer than elsewhere. The U.S. benchmark is 36 months or 36,000 miles. In some markets, all the buyer gets is a year. In addition, some warranties expire on mileage rather than time. Bottom line, these figures are very rough, and could probably do with some polishing. But since sales have been relatively flat for the past few years, the truly precise figures are probably not that far off from these crude numbers.

DaimlerChrysler on the High Side?

DaimlerChrysler reported just under 5.6 billion euro in warranty claims worldwide. That works out to 4.2% of the company's industrial revenue, which includes cars, trucks, engines, and even some interests in aerospace. At an exchange rate of $1.19 to the euro, we'll translate that figure into $6.66 billion.

That's an incredible amount of money. What we're saying is that although DaimlerChrysler is fourth worldwide in terms of units sold, it's far out ahead in first place in terms of claims paid. And this is not a contest you want to win. During the first quarter of 2006, the company paid out 1.473 billion euros in claims on 33 billion in sales, for a 4.5% claims rate.

On a per unit basis, it's even scarier. With 4.85 million vehicles sold last year, $6.66 billion in warranty claims work out to around $1,370 per vehicle! However, keep in mind that DaimlerChrysler makes more than a quarter of its total revenue from the sale of large commercial vehicles, which sell for upwards of $55,000 each, on average. Also, it's reporting its financial figures in euros, and it's fixing many of those vehicles at European labor rates.

For just these three companies, then, worldwide warranty claims topped $15.34 billion, on sales of some 20.8 million units. That's just under a third of the worldwide total in terms of units sold. If these three are also paying out only a third of the worldwide warranty claims, then we're talking about a worldwide total upwards of $47 billion in claims paid.

Clearly, that's too high. It suggests impossible totals for the manufacturers we haven't mentioned, as expressed on either a per vehicle basis or as a percentage of revenue. In fact, we estimate the worldwide total for automotive OEM warranty claims in 2005 to be closer to $27.5 billion, giving the Big Three a 55.8% share of the total worldwide warranty spend.

In the U.S., however, it now makes more sense to talk about a Big Five, because of the market growth of Toyota and Honda in particular. Add their nameplates to those either owned or controlled by GM, Ford, or DaimlerChrysler, and you have roughly 30 nameplates that represent 80% of the U.S. marketplace.

Toyota and Honda on the Low Side?

In the fiscal year ended March 31, 2005, Toyota's worldwide claims rate was around 1.27% of automotive revenue while Honda's rate was around 1.65% of a combination of car, motorcycle, and generator revenue. In the fiscal year ended March 31, 2006, Toyota's claims rate increased slightly to 1.31%, while Honda came in just above that level at 1.32%. But remember, Honda also makes motorcycles and portable generators.

To come up with a per vehicle estimate for these two companies, we've made some assumptions. First, we're going to assume that warranty occurs at the same rate in every market for Toyota and Honda, which is probably not the case. Not only are there national and regional differences in warranty durations, but also differences in parts costs and labor rates. There may also be differences in the way that suppliers are charged back for their share of warranty claims. A lot also depends on which currency is used to figure the final cost, and which national set of generally accepted accounting principles are used in the final calculations. In other words, a Japanese 1.2% may not be the same as either an American or a German 1.2%, if there were such a thing.

Second, we're going to assume that until we hear otherwise, the most recent claims rates of 1.65% for Honda remained the same throughout the balance of 2005 and into early 2006. Based on an upturn in recalls, that may not be true either. However, Honda has stayed within a tight range of 1.2% to 1.65% for three years running, so let's give them the benefit of the doubt and assume they did it for a fourth straight year.

Third, let's assume that warranty occurs at the same rate on both Honda's motorcycles and passenger cars. We suspect that's not true either, based on a quick comparison of Harley-Davidson's 0.7% claims rate and Ford's 2.6% rate. Generators are only 4% of Honda's revenue, as opposed to 80% cars and 13% motorcycles, so we can safely leave those out of our model. But let's assume that all of Honda's products have the same warranty claims rate.

Warranty Cost vs. Quality

So let's assume for a moment that all these conditions are true. That would imply that Toyota is paying around $265 per vehicle in warranty claims and Honda is paying out around $330 per automobile. That's considerably less than Ford's $585 or GM's $512, not to mention DaimlerChrysler's $1,370 per vehicle. However, recent quality data suggests this may indeed be the case.

As mentioned, Toyota has reported claims rates close to 1.3% for four consecutive years. Honda has reported three consecutive increases, from 1.2% in 2003 to 1.4% in 2004 and 1.6% in 2005.

Ford, meanwhile, has reported claims rates in a range of 2.2% to the current 2.7%. GM has reported figures between 2.6% and 3.2%. DaimlerChrysler has ranged all the way from 2.7% to 5.2%. In Figure 2, what we're doing is plotting the last three years for each company -- the same data as in Figure 1 -- on a purely vertical scale, to show the maximum and minimum claims rates.

Figure 2
Warranty Claims Rates of the Big Five
2003 to 2006


On this scale, it's clear that Toyota has remained close to 1.3%, while Ford has remained close to 2.5% and GM has stayed close to 3%. And it's clear that DaimlerChrysler has generally remained within a 3.5% to 4.5% range, although it's been both above and below that level on occasion. Honda, meanwhile, is not always as low as Toyota, but is noticeably lower than the others.

Now, let's take the latest figures for problems per 100 vehicles taken from the J.D. Power and Associates 2006 Initial Quality Survey. But rather than plot them from lowest to highest, let's divide them up into six groups of nameplates: the GM and Ford families, DaimlerChrysler, Toyota/Lexus/Scion, Honda/Acura, and everything else.

Representative Samples

As mentioned, the five groups and their 30 nameplates accounted for 80% of U.S. sales and 75% of North American sales. And the latest J.D. Power survey is based on responses from 63,607 purchasers and lessees of new 2006 model-year cars and trucks surveyed after 90 days of ownership. So although we're comparing accounting data with survey data, each set is somewhat representative of the market as a whole.

Figure 3
J.D. Power and Associates
2006 Initial Quality Survey for the Big Five


There are some problematic points in this graph, but in general it seems to follow the warranty data show in Figure 2. The GM cluster is slightly above Ford's, and the DaimlerChrysler cluster is slightly above both. But each has its problem brands. For the GM family it's Suzuki, Hummer, and Isuzu, with 169, 171, and 191 problems per 100 vehicles, respectively. For Ford it's Land Rover with 204 problems, the highest rate of any brand. And for DaimlerChrysler it's Jeep, which sticks out at 153 problems per 100 vehicles.

Full Results Available

The average for all surveyed brands, by the way, was 124 problems per 100 vehicles. The full chart is available at the http://www.jdpower.com/ Web site.

Even Toyota has its problem brand. While Toyota and Lexus were among the lowest at 106 and 93 problems per hundred, respectively, Scion was above average at 140. Honda and Acura were below average at 110 and 120 problems per hundred vehicles, respectively. Of course, the lower the number, the higher the initial quality of the vehicle.

On that basis, then, there does seem to be a faint correlation between the calculated warranty claims rates of Figure 2 and the tabulated quality survey results of Figure 3. The GM and Ford brands are close to average quality, and we'd suspect also close to average in terms of warranty costs. The DaimlerChrysler brands are a little above, and the Toyota and Honda brands are a little below.

Furthermore, of the brands that aren't part of the five families detailed above, based on their showing in the J.D. Power survey, one could reasonably predict that Porsche, Hyundai, and Nissan have lower than average warranty costs, and BMW, Subaru, and Volkswagen have higher than average warranty costs. We'd suspect that if the Big Five together account for $18.5 billion in warranty costs, that the other brands together account for another $9 billion in warranty costs, for a worldwide total of $27.5 billion spent per year on auto warranty claims.

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