July 2, 2009

Worldwide Auto Warranties, Part One:

Why do Japanese automakers and heavy equipment manufacturers seem to have such low warranty costs? Though sales are down since last year, warranty costs remain under control, according to annual reports filed recently by Toyota, Honda, Komatsu and others.

Sometimes, the fourth of July falls on the third of July, as it does this year in America. And that in turn means that American offices begin to empty out around teatime the day before, which tells us to expect a record number of "Out of Office" notifications as we broadcast this newsletter this evening.

Every year, during the week that our American subscribers clear out to celebrate their Independence Day holidays, we traditionally take a deeper look at warranty spending patterns reported by some of the top European and Asian manufacturers.

In last year's pre-holiday roundup, telecom equipment and consumer electronics companies dominated, so this year we'll look deeper into automotive and heavy equipment companies. And since so few European automotive companies say anything at all about their warranty costs, this will end up being mostly about the Japanese nameplates.

Worldwide Warranty Spend

Warranty Week estimates that worldwide warranty spending last year came in around US$72 billion, of which around US$28.7 billion was spent by U.S.-based companies and US$43.3 billion was spent by companies based elsewhere. Where the estimate lands this year depends not only on the degree that worldwide manufacturing and consumer spending recover, but also on the exchange rate trend for the U.S. dollar. In other words, we're not venturing any guesses for 2009 just yet.

In these calculations, we're using ¥98.2 = $1.00 = €1.39 as our exchange rates for last year, so our worldwide warranty spending estimate could also be expressed as ¥7 trillion or €51.7 billion. We base those conversions not on the rates quoted by the corner shop or by some online source on some arbitrary date, but by the figures used by Toyota and Nokia in their respective annual reports.

We estimate that roughly 53% of the worldwide warranty spending arises from claims in the automotive industry, if one adopts a broad definition for that grouping so that it includes not only passenger cars and motorcycles but also heavy trucks, buses, recreational vehicles, and some construction vehicles. Around 20% arises from computers and electronics, while around 17% has to do with the building trades, and 10% comes from other industries such as aerospace, mining, and sports equipment.

Within the U.S., however, the automotive slice of the pie is around 46% of the total for all industries, while in the rest of the world it is closer to 60%. This is because more than a third of all U.S. warranty spending comes from computers and electronics, while in other geographies vehicles and buildings predominate.

We should note that these geographies are established based upon the home office of the manufacturer, not upon the location of the factory or the customer. So all of Toyota's vehicles are assigned to the Asia column, even those made in Kentucky by an American workforce. And all claims paid by Ford and General Motors are assigned to the U.S., even if they're for cars sold in Europe and repaired in the UK.

Daimler With & Without Chrysler

In Figure 1 below, for instance, we're tracking the past six years of warranty spending for Daimler AG, which we're counting as a European manufacturer. During the years 2003 to 2006, the company was called DaimlerChrysler AG and its worldwide warranty spending also included U.S. and Canadian claims for Chrysler, Dodge and Jeep vehicles. In 2007 and 2008, the company's name was changed to Daimler AG and the warranty spending of the divested Chrysler unit was not included.

Notice that the claims rate did not change noticeably after the divestiture. Claims rates at DaimlerChrysler ranged from a high of 5.2% to a low of 2.7%. The claims rate at Daimler alone has remained well within those extremes during the past two years. It was 4.6% in 2007 and 3.5% in 2008.

The surprise comes in Daimler's accrual rate. This is the amount a company sets aside based on its expectations for future warranty costs. So as it rises or falls, a company is in effect telegraphing its predictions of future product quality. If it sees trouble ahead, accrual rates will rise. If it predicts lower costs, accrual rates will fall.

In the years 2003 to 2006, DaimlerChrysler gradually reduced its accrual rate from 5.0% to 3.4%. The claims rate (in red) at first fell far below, and then rose far above the accrual rate (in green), before stabilising and nearly intersecting at the 3.4%-3.6% level, just before Chrysler LLC was spun off.

Then in 2007, Daimler raised its accruals as claims rose. In 2008, however, Daimler cut its accruals to their lowest level since at least 2003, as its claims rate fell to its lowest level since 2004.

Figure 1
DaimlerChrysler & Daimler AG
Warranty Claims & Accrual Rates, 2003-2008
(as a percentage of product sales)

Figure 1

In the chart above, the blue bars represent quarterly spending on warranty claims, denominated in millions of euros per quarter. In the years 2003 to 2006, DaimlerChrysler reported its warranty expenses four times per year, so those figures are quarterly, as reported. In 2007 and 2008, however, Daimler AG has included warranty expense figures in just its annual report, so we derived quarterly estimates by chopping the annual figures into four equal pieces.

For instance, in 2008 Daimler reported €3 billion in claims paid, €2.26 billion in accruals made, and €86.6 billion in turnover from warranted automotive product sales. That produces a claims rate of 3.5% and an accrual rate of 2.6%. Total turnover was €95.87 billion, but we're excluding all finance income and non-warranted product sales from our calculations.

Ultimately, the differences in currencies drop out of the calculations. No matter where the vehicle is sold or where it is fixed, the income and expenses are translated back into the currency of the home office. Therefore, though Figures 1 and 4 are in euro and Figures 2 & 3 and 5 & 6 are in yen, so are the sales figures used to turn these amounts into percentages of sales.

Divestiture Outcomes

After Ford divested Jaguar and Land Rover, its claims and accrual rates initially fell but have lately risen again. After Daimler divested Chrysler, its claims and accrual rates initially rose but have since fallen. We're not sure if those outcomes have any relationship to the cost of warranty at either the parent or at the divested company. But at least we've noted the patterns. Any suggestions from our readers?

Now, let's move on to a pair of Japanese manufacturers, both of which end their fiscal years on March 31 and both of which report their warranty expenses just once a year, denominated in Japanese yen. In Figures 2 and 3 below, that annual data has been converted into four equal quarterly slices, resulting in a staircase-like look to the six-year time series.

At Toyota, annual spending on warranty claims has risen steadily for at least six years. But because sales were also rising, the claims rate rose more slowly, or actually fell slightly, as they did in 2005-06. Then in 2008 the recession hit, and Toyota's product sales fell 23%, while claims rose 4%. The result was that the claims rate rose from 1.6% last year to 2.0% in the most recent fiscal year.

Figure 2
Toyota Motor Corp.
Warranty Claims & Accrual Rates, 2003-2009
(as a percentage of product sales)

Figure 2

Spending on warranty claims topped ¥337,863 million, or US$3.44 billion. That represented an increase of ¥13,753 million from the previous year. Warranty accruals, meanwhile, fell by ¥25,745 million to ¥366,604 in the year ended March 31, 2009. But since sales fell faster, the accrual rate also rose.

We're not sure what conclusions can be drawn from that either. Since Toyota's traditional accrual rate has been around 1.5%-1.6%, one would have expected that if sales fell 23%, accruals would also fall 23%, so that the accrual rate remained steady. If product quality and repair costs remain unchanged, the company should have accrued the same amount per vehicle sold.

The opposite effect can be seen in the Honda data in Figure 3. Product sales fell 21%, but accruals fell 42%. The accrual rate therefore decreased by more than a quarter, from 1.2% to 0.9%. First, we're not sure if that accrual reduction arose from future cost estimates made for the Honda motorcycle, passenger car or portable generator product line. Second, we're not sure in what geography it occurred. And third, we can't be sure it wasn't entirely due to exchange rate changes, having nothing to do with products.

Figure 3
Honda Motor Company Ltd.
Warranty Claims & Accrual Rates, 2003-2009
(as a percentage of product sales)

Figure 3

The baffling thing is that the change in accruals wasn't confirmed by a reduction in claims. In fact, claims behaved as one would expect during a sales decline. Outlays fell from ¥137.6 billion to ¥123.5 billion, a 10% decline. But because sales fell faster, the claims rate rose from 1.2% to 1.4%.

Much the same thing happened at GM and Ford. Claims fell, but sales fell faster. As a result, GM was most recently sporting a 4.1% claims rate, while Ford rose to 3.0%. But their accrual rates, which should remain proportional to sales, have not followed. At Ford, in fact, the accrual rate is way down in the first quarter of 2009, to only 1.6%, suggesting that the company expects claims costs to be low for the next few years.

No Data for Chrysler

We have no data for Chrysler. And, unfortunately, we have no recent data for Fiat either. Non-U.S. companies are not required to release any warranty data whatsoever, and most don't. That's why we have no European automaker data from anyone but Daimler, and why Nissan, Hyundai, and several other Asian manufacturers remain an enigma when it comes to warranty costs.

Heavy equipment maker Case New Holland, however, is one of the very few non-U.S.-based companies that release their warranty cost data quarterly to the U.S. Securities and Exchange Commission. And they do so in U.S. dollars, despite CNH's affiliation with Fiat and despite having their home office in Amsterdam. But that probably has much to do with their sale of common shares on the New York Stock Exchange, as opposed to the American Depository Receipts (ADRs) that many other companies sell there.

Figure 4
CNH Global N.V.
Warranty Claims & Accrual Rates, 2003-2009
(as a percentage of product sales)

Figure 4

Their warranty data even looks American. It's not just that it's updated quarterly. The data in Figure 4 is quite comparable to what one would see on a chart for Caterpillar or John Deere. Claims and accrual rates between 2% and 3% would be quite normal for those companies and their industries (construction, farming, etc.).

And once again, we see the effect of falling sales reflected in rising claims and accrual rates. Claims fell from $78 million a year ago to $76 million in the first quarter of 2009. Accruals fell from $97 million a year ago to $92 million in the first quarter of 2009. But sales fell 26%, so the claims and accrual rates rose anyway, from 1.9% to 2.5% in the case of claims and from 2.4% to 3.0% in the case of accruals.

Japanese Tractors

Our last two Independence Day snapshots are also taken from the heavy equipment, industry, but they're representing the Japanese side of the family. Komatsu Ltd. and Kubota Corp. are deeply involved in both the construction and farm equipment businesses, where they compete against the likes of CNH, Caterpillar, Deere, and others.

In warranty terms, however, they're more like Toyota and Honda, turning in the relatively low rates seen in Figures 5 and 6. Kubota, in fact, saw its low rates fall even lower in the fiscal year ended March 31, 2009.

Komatsu is the larger of the two, reporting over ¥2 trillion in turnover and ¥26 billion in claims paid per year. As can be seen in Figure 5 below, both the company's claims and accrual rates have stuck close to a range of 1.0% to 1.4%, with the sole exception of the year ended March 31, 2007.

Figure 5
Komatsu Ltd.
Warranty Claims & Accrual Rates, 2003-2009
(as a percentage of product sales)

Figure 5

To be sure, the recession has also hit Komatsu, with sales falling by 10% in the most recent fiscal year. But accruals were cut almost exactly in proportion with sales, so the rate remained almost exactly the same. Claims, on the other hand, actually rose, both in terms of total cost and as a percentage of sales.

Kubota saw sales fall only 5% in the fiscal year ended March 31. At the same time, it reduced its outlays for warranty claims by 13%, from ¥4,565 million last year to ¥3,984 million in the most recent year. Therefore, its claims rate fell ever so slightly from 0.58% to 0.53%. The accrual rate fell almost imperceptibly from 0.61% to 0.60% over the same period.

Figure 6
Kubota Corp.
Warranty Claims & Accrual Rates, 2003-2009
(as a percentage of product sales)

Figure 6

We don't know why, but we note that the four Japanese companies in our Independence Day roundup are all reporting warranty costs towards the low end of the scale. Toyota and Honda are paying warranty claims at rates far below those reported by GM, Ford, or Daimler. And Komatsu and Kubota have warranty claims rates far below those turned in by CNH, Caterpillar, or Deere.

Is there something different about the dealer agreements? Do the import and sales arms of each company absorb some of the warranty costs, thus shielding the ultimate manufacturer from them? Is it in the currency? Is it in the way warranty costs are calculated? Is it because their product lines tend to be towards the compact end of the spectrum? Or are their products simply less likely to break and/or less costly to fix?

We suspect it's not the geography of the home office, because Nissan is also based in Japan and sources tell us Nissan has much higher warranty costs than either Toyota or Honda. And it can't be the geography of sale because all four of these Japan-based companies are selling worldwide through a complicated mix of their own subsidiaries and joint ventures.

We'll stop there, though, allowing others to draw qualitative conclusions from our quantitative observations. It's definitely not the currency, however, even though the yen has appreciated in value during the past year, thus making it easier for Japanese companies to pay euro- and dollar-denominated warranty claims. These are six- and seven-year trends that were observable even in the good old days when ¥121 was $1.00 or €1.14. It didn't just happen in the past few months.

AMT Warranty Corp.
Fulcrum Analytics
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