April 29, 2008

Five-Year Warranty Trends, Part Five:

American manufacturers now keep $41.1 billion in their warranty reserves, equal to 17 months' worth of claims paid. And it's been more or less steady at that capacity level for the past five years. Meanwhile, average accrual rates have stayed close to 1.7%, although different industries accrue for warranty at different rates.

While warranty reserve balances have been steadily growing over the past five years, the ratio between the amount kept in the reserve and the amount paid out in claims has remained rather steady at around 17 months.

That means the typical average warranty is about 17 months long, if one assumes that American manufacturers are setting aside exactly the amount they expect to spend over the term of the warranty. Individual companies might guess high or guess low, but as a group they're quite consistently guessing right.

We measured the warranty reserve balances reported by some 894 different companies at the end of each of the 20 quarters of 2003 through 2007. Some companies closed shop or were acquired during those years, while others went public and began reporting their warranty expenses for the first time in the middle of that five-year period. So there were never 894 reporting at one time.

We also measured the amount each company set aside as warranty accruals, and converted those amounts into percentages by comparing them to product sales. And then we measured the capacity of each warranty reserve fund by dividing the balance by the amount paid in claims per month.

Growing Warranty Balances

Let's start with the warranty reserve balance. At the end of 2003, American manufacturers reported $35.5 billion in warranty claims. By the end of 2006, that balance had grown to $39.4 billion and by the end of last year it had topped $41.1 billion. The quarterly figures are charted in Figure 1 below, using a stretched vertical scale that highlights the increases.

Figure 1
U.S. Transportation Manufacturers
Warranty Reserves, 2003 to 2007
(capacity in $ billions & months of claims)

Warranty Reserves in Dollars and Months, 2003-2007

Notice also that there is a line above the warranty balance data. That line is equal to the number of months that the corresponding warranty balance would last given the current rate at which claims are being paid. In other words, if a company has $10 million in their warranty reserve and they're paying claims at the rate of $1 million a month, the capacity of their warranty reserve is 10 months. If they have a $500,000 reserve and they're paying claims at the rate of $25,000 a month, their reserve has a capacity of 20 months.

In this case, all American manufacturers ended 2007 paying claims at the rate of just under $2.5 billion a month, so that collective $41.1 billion balance would have a capacity of around 16.7 months. Over the past 20 quarters, that ratio has twice hit 17.7 months and once hit 16.3 months, but has been between those extremes at all other times. So while the dark blue line might look a little wavy, that's only because of the stretched vertical scale we used to highlight the changes.

Next we chopped up the 894 companies into one of 14 different industry segments -- same as has been done in the past four newsletters. The members of each of the 14 categories is consistent week to week, so the data should be comparable. All companies were assigned to one and only one category, based on the source of the majority of their warranted product sales. Any companies that didn't fit into one of the 14 categories was placed in the catch-all "other" category.

Consistent Color Codes Used

Keep in mind that for the past four newsletters, we've also used the same color code in all of the charts, and we're continuing to do that this week. So all the transportation sectors are shades of blue, all the building sectors are greenish, and all the high tech sectors are reddish.

Figure 2 presents the data for the three transportation categories: Automotive OEMs, Auto Parts Suppliers, and Aerospace. The vertical scale tracks the capacity of the warranty reserve in months. The horizontal scale tracks the percentage of sales set aside each quarter as warranty accruals. The dotted lines that divide the graph into four quadrants represent the averages for all manufacturers.

Figure 2
U.S. Transportation Manufacturers
Warranty Reserves vs. Accruals, 2003 to 2007
(as a percent of sales and number of months)

Transportation Warranty Reserves & Accruals, 2003-2007

Notice how in each case, the 20 measurements form a tight cluster. This means the members of each of those industry groups collectively have spectacularly good aim when it comes to predicting and reserving for future warranty expenses. Individual companies might be all over the map, so to speak, but on balance the group is fairly accurate.

It also means that although the average warranty reserve has a capacity of 17 months, different industries might be above or below that level. If they're above 17 months, they likely provide warranties that have an average duration that's longer than 17 months. For instance, the automotive OEMs and auto parts suppliers are clustered around the 20-month level. That may seem short compared to the three- and five-year warranties provided on today's cars and trucks, but remember that some warranties expire on mileage alone while most expire when the vehicle is sold.

The Building Trades

In Figure 3, we've included three of the four building-related industry groups. We shifted the turbine and electrical power equipment industry to Figure 6 because, as we shall see, that group is much less consistent than the three below. Here, we've included the new home builders, appliance and HVAC manufacturers, and the companies that make building materials that range from roofing to carpets, and everything in between.

Figure 3
U.S. Building Manufacturers
Warranty Reserves vs. Accruals, 2003 to 2007
(as a percent of sales and number of months)

Building Trades Warranty Reserves & Accruals, 2003-2007

What's striking about these three groups is how almost everything is located between 10 and 20 months, even though the accrual rates have varied between 0.66% and 1.83% over the past five years. And each is in a relatively tight cluster -- building materials most of all -- so one could assume that as a group they're all constantly adjusting their accruals to match product sales increases and decreases.

As the data from past issues demonstrates, individual companies might not be so quick to react. And especially in the current environment of declining home sales, a tough job is getting only tougher. Keep in mind, however, that for both the vertical and the horizontal quantities, the dollars are divided by dollars, so there are no currency units. That makes the ratios comparable for both the very big companies and the very small companies.

Computer Industry Averages

In Figure 4, we're charting three computer-related industry segments: the computers themselves, their data storage devices, and the semiconductor and printed circuit boards that make up their innards. In Figure 2 and Figure 4, the OEMs are furthest to the right while their suppliers are to the left. That's not the case in Figure 3, where the homebuilders are in between the makers of the building materials and the heating, cooling, and cleaning appliances. We suspect that has to do with their superior ability to bill back their warranty expenses to their suppliers, compared to companies in the automotive or computer industries.

Notice that we also had to widen our horizontal scale somewhat to accommodate the computer OEMs. At the beginning of 2003, these companies set aside almost 4% of their product revenue to finance future warranty claims. Last year, that accrual rate dipped as low as 2.3%, primarily because of higher product quality and more efficient claims processing, but secondarily because several warranty-intensive laptop and handheld product lines were either sold off to foreign companies or discontinued altogether.

Figure 4
U.S. Computer Manufacturers
Warranty Reserves vs. Accruals, 2003 to 2007
(as a percent of sales and number of months)

Computer Warranty Reserves & Accruals, 2003-2007

In Figure 5, we've charted three more high tech manufacturing categories: telecom equipment, computer peripherals (monitors, terminals, pointing devices, printers, etc.), and medical and scientific equipment. Two groups are in a tight cluster while the peripherals group seems to have a significant horizontal spread. We suspect that has a lot to do with the interplay between warranty-intensive product lines such as printers and the lower warranty expenses associated with other peripherals. As the product mix changes, so does the average accrual rate.

Figure 5
U.S. High Tech Manufacturers
Warranty Reserves vs. Accruals, 2003 to 2007
(as a percent of sales and number of months)

High Tech Warranty Reserves & Accruals, 2003-2007

The telecom equipment companies are clustered very close to the overall averages, with accrual rates remaining between 1.6% and 1.8% and warranty reserve capacity staying between 10 and 19 months. If there was a way to plot the timeline, one would see that the high reserve capacities all happened in 2003 and 2004 while the lower capacities occurred in 2006 and 2007. We think this has a lot to do with the acquisition of Lucent by Alcatel, and its subsequent departure from the group (foreign-owned firms are not included).

Data storage manufacturers are also close to the medians, with accruals remaining within a range of 1.4% to 2.6% and reserve capacity staying between 10 and 19 months. But as an eyeball comparison of Figures 4 and 5 suggests, the data points of that group are not as tightly packed as are the 20 data points for telecom equipment.

The Opposite of Orderly

At the other extreme, consumer electronics and electrical power equipment averages are all over the place. We've placed both into Figure 6 to illustrate how unlike they are from the other 12 industry groups. In each case, the reason is traceable to one company. For consumer electronics, it's the Xbox 360 warranty experience of Microsoft. For electrical turbines and power generating equipment, it's the changing revenue segmentation provided by General Electric.

Figure 6
U.S. Electronics & Power Equipment Manufacturers
Warranty Reserves vs. Accruals, 2003 to 2007
(as a percent of sales and number of months)

Electronics & Power Equipment Warranty Reserves & Accruals, 2003-2007

Before the Xbox 360 appeared, consumer electronic accrual rates were as low as 0.2%. But in the quarter in which Microsoft set aside almost $1 billion in warranty accruals, the rate jumped up to 9.4%. However, keep in mind that none of the game console warranty data of Sony or Nintendo is included, not to mention other foreign-based brands such as Panasonic, Hitachi, Canon, and Thomson.

Most of the American-made consumer electronics products are speakers, projectors, car audio, radar detectors, and musical instruments, none of which generate much in the way of warranty expense. Were it not for the Xbox, we'd probably have merged the consumer electronics data into the "other" category.

Likewise, were it not for GE constantly rearranging its divisions into ever-expanding clusters, the power equipment category would probably have ended up in the "other" category as well. But because GE's warranted products are being shuffled into larger and larger sectors, and because GE represents such a large portion of this segment, the overall accrual rate for power equipment has plummeted from 4.5% to 0.8% over the past five years -- without any meaningful change in the accruals themselves.

The irony is that the "other" category -- consisting primarily of material handling equipment, oil drilling and mining equipment, non-vehicle farm equipment, sporting goods, jewelry, and both guns and bullet-proof gear -- is much better behaved than either of the two named groups included in Figure 6. Accrual rates have remained around 0.5% to 0.8% while reserve capacity has stayed close to the average for all manufacturers.

Go to Part One
Go to Part Two
Go to Part Three
Go to Part Four
This Is Part Five
Go to Part Six

AMT Warranty Corp.
Fulcrum Analytics
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