The makers of telecommunications and data communications equipment aimed at both network operators and end users have never paid out a smaller percentage of their product sales to honor warranty claims than they have in 2010.

Claims paid by some 76 telecom and data communications equipment companies are down by 15% so far in 2010, from a total of $1.09 billion in the first nine months of 2009 to only $924 million so far this year. And this decline comes in spite of the fact that Cisco Systems, the sector's largest warranty provider, showed virtually no change in its claims total from last year to this year.

In Figure 1 below, it's clear that an industry-wide decline is under way. The peak came in early 2006 at a level of $555 million per quarter. The deepest part of the trough actually came this year, at $301 million in the second quarter. That surpassed the 2003 low of $315 million, as well as the $335 million low mark set in 2009.

So what's causing the decline? Part of it is the unrelenting pace of mergers and acquisitions, in which companies outside the telecom industry, and sometimes outside the U.S. as well, are taking over the major players. For instance, in 2010 we lost 3Com to HP. In 2009 we lost Nortel Networks Corp. to a bankruptcy-driven sell-off. In 2008 we lost Avanex Corp.; Centillium Communications Inc.; Foundry Networks Inc.; Proxim Wireless Corp.; Radyne Corp.; and Vyyo Inc.

But even the companies still in the industry are paying less. Of the 76 still-current companies we're tracking in this sector, a total of 22 telecom equipment companies saw their nine-month claim total fall by 25% or more, including CommScope Inc.; Powerwave Technologies Inc.; UTStarcom Inc.; Tellabs Inc.; and Arris Group Inc. Another 16 companies saw their claims totals fall by 1% to 24%. Only nine of those 38 companies that saw a claims decline also saw a sales decline.

Falling Accruals

The accruals total, meanwhile, peaked three times in 2005-2007, with the third peak coming in the highest, at $686 million. So far in 2010, telecom equipment providers have set aside $942 million in accruals, about $37 million less than they did in 2009 during the same three quarters of the year.

Of the 76 active companies, 34 reduced their accruals totals, of which 20 reduced them by 25% or more. And of those 34 companies, 25 saw sales increases. So it's not a reduced number of products sold that's driving the reduced need for accruals.

As Figure 2 shows, only four of the last 31 quarters have seen less than $320 million in accruals made by telecom equipment companies. And two of those quarters came in 2009, while two came in 2010. That clearly suggests the effects of a recession. But then there's also the effects of mergers, acquisitions, and bankruptcies, which in some cases took the product lines off the chart.

In Figure 3, however, we're compensating for this attrition. The percentage figures compare the warranty claims of Figure 1 and the warranty accruals of Figure 2 to the sales of all the active companies. So when the claims and accruals of companies such as 3Com and Nortel drop out of the top of the fraction, their sales also drop out of the bottom of the fraction.

Clearly, something else is at work here. Neither the industry's claims rate nor its accrual rate has been above 1.7% since 2007. The smoothed-out industry averages haven't been that high since 2006. Claims rates have never been lower than they are now, and the accrual rate has been at or below 1.3% during five of the last seven quarters. Someone must be reducing their warranty costs, not only in dollar terms but also as a percentage of sales.

Cisco Hits a Plateau?

This time around, it doesn't look like Cisco is the responsible party. Yes, the company has been reducing its warranty costs for multiple years. But from the looks of Figure 4, it appears that the sponge has now been wrung out. The big declines of 2003-2007 have flattened out to smaller increments in 2008-2010.

Then again, the 1.35% claims rate Cisco reported in its fiscal year ended July 31 was its lowest ever. The 1.45% accrual rate for the fiscal year was its second lowest ever. So although the rate of decline has slowed, there's still a decline under way.

And now that 3Com and Nortel are gone from the sector, Cisco accounts for a full 36% of the claims and 38% of the accruals. Back in 2005-2006, its "share" of the telecom sector's warranty costs was under 20%.

So really, what we're seeing in the data of Figures 1 through 3 is the effect left behind by the exit of several major players, combined with the continued cost reduction by the one remaining major player.

Other Datacom Companies

Motorola, we should note, hasn't yet provided any 2010 data, so we're continuing its presence at 2009 rates. Last year, it reported $311 million in claims, so we're figuring its three-quarter year at $233 million, until the annual figures are available in March.

There are still a few independent companies competing against Cisco in the data communications equipment business. Chief among them are Extreme Networks and Juniper Networks, which we shall now spotlight.

Extreme Networks saw sales rise 36% in the quarter ended September 26. But claims remained about the same while accruals fell. The result is a massive reduction in the claims rate from 3.3% a year ago to 2.4% now, and a massive reduction in the accrual rate from 2.7% a year ago to 1.9% now.

Neither percentage is a new low record for the company, however. In fact, as can be seen in Figure 5, most of the data points since the middle of 2007 have been between two percent and three percent. So, as was seen with Cisco, the big reductions in cost came in 2003-2007. Now they're becoming harder to find.

Juniper Networks, on the other hand, had a positively awful warranty track record in 2003-2004, plus a spike at the end of 2008. But except for those anomalies, it has produced warranty costs mostly in the range of 1.5% to 2.5% of sales.

In Figure 6, the data shows that Juniper's claims rate has remained below two percent since the beginning of 2009, with the accrual rate jumping above that line only once in the past seven quarters. And if we could somehow average the trough and spike of the third and fourth quarters of 2008, we'd be within that 1.5-to-2.5% range for most of the past four years.

Juniper saw its product sales rise 26% in the quarter ended September 30, compared to the same quarter a year ago. Claims and accruals also rose, but not as quickly. So the claims rate fell from 1.9% a year ago to 1.7% now, while the accrual rate fell from 2.3% a year ago to 1.7% now. As Figure 6 shows, however, both the claims and accrual rate were a bit lower earlier in 2010.

Consumer-Facing Warranty Costs

Netgear is more into the consumer side of the datacom industry. Its network storage solutions as well as its gadgets for Internet and cable TV connectivity are aimed primarily at the home and small business. We mention that because we suspect it's part of the reason the rates in Figure 7 are so unusually high.

So far in 2010, Netgear has reported a 38% jump in sales, so business is good. But the company also reported a 31% jump in warranty claims, and a rise in accruals from $27 million in the first nine months of 2009 to $49 million in the first nine months of 2010. And Figure 7 is the result.

Normally, a claims or accrual rate over five percent is a cause for worry. But Netgear has seen its accrual rate drop below that level only once in the last five years. And its claims rate hasn't been below 5% since 2003. So whatever is keeping this company afloat, high warranty costs are evidently not a problem.

Another Exit

CPI International, meanwhile, is also in the digital video, Internet and broadcasting industry, but its customers are the network operators rather than the end users. CPI is the parent company of Communications & Power Industries Inc. It is making its first and probably last appearance here, thanks to an agreement with Veritas Capital to be taken private for $19.50 per share in cash.

In Figure 8, we see warranty expense rates mostly between one and two percent for the past eight years. There was a bit of a dip in both claims and accrual rates in the fiscal year ended October 3, 2008, and a bit of a rise in the early quarters of calendar 2010.

Tellabs, meanwhile, seems to be trying to answer the question of just how low a company can take its warranty expenses. After registering a claims rate just under two percent in the middle of 2003 and an accrual rate of 3.3%, the company has now turned in two quarters in 2010 in which both rates were under 0.5%.

Tellabs is also focused on the carrier and network operator market. Its broadband access solutions pass more than 5 million homes in North America, the company says. And its mobile Internet offerings are focused on enabling network operators to handle the expected demand for increased speed and bandwidth for their customers' wireless devices.

Product sales were up 10% in the quarter ended October 1, 2010. But both warranty claims and accruals were way below 2009 totals. In fact, the company has cut both its claims and accrual rates in half in the past year, to 0.3% and 0.4%, respectively. In fact, when the final figures are in for 2010, it's likely that Tellabs will have reduced its annual claims total for the fifth year in a row!

Happy New Year!

Speaking of years, this is the final newsletter of our eighth year of publishing Warranty Week. Coincidentally enough, our first-ever newsletter was published exactly eight years ago today, on December 23, 2002. In it, we noted that "Online retailers have different approaches to warranty law compliance." That's probably still the case today.

This is the eleventh in a series of industry-by-industry newsletters that examined product warranty claims and accrual trends in detail over the past eight years. Links to the other ten in the series are included below, in case you've missed any.

We'll skip a newsletter next week for the holidays, and will return on January 6, 2011 with the beginning of a series of newsletters about the sale of service contracts and extended warranties in the appliance, consumer electronics, mobile phone, and computer industries. That should carry us through the winter and into the spring, if not beyond.

In the mean time, we want to wish all our readers a very happy holiday period and a safe, healthy, and very prosperous new year!

Alison Griffiths, ALG Associates LLC and the Warranty Chain Management Conference are pleased to announce the official launch of the first ever on-line warranty management and service contract video streaming service.

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