While the aerospace industry has had its good and bad years, it never experienced a contraction quite like what the automotive industry went through in 2008-2009.

And so, this sector of the warranty-providing realm has rarely seen any wild gyrations in its warranty metrics. Its manufacturers are careful and conservative, and have always been that way. And their warranty metrics reflect that approach.

To be sure, the numbers have changed over the past eight years that we've been making warranty measurements, but change comes much more slowly to this sector than it does to others. In Figure 8 of the April 1 newsletter, we showed how aerospace warranty claims have hovered just above the $1 billion mark for the past three years.

There was actually more volatility earlier in the decade. Warranty claims in this sector fell by 10% in 2004-2005 and rebounded by 23% in 2005-2006. But in the last two years, they've declined by only one or two percent per year, to $1.02 billion in 2009 and to $1.003 billion in 2010.

Increasing Accruals

Warranty accruals have also been falling for years in this sector, but the accrual total for all aerospace manufacturers was actually up slightly in 2010. After declining 6% to $994 million in 2008, and then declining another 9% in 2009 to $908 million, accruals grew by 2% in 2010 to $927 million. Those totals can be seen in Figure 1 below.

The claims and accrual totals were then divided by sales. This turns the dollar amounts into percentages, with the claims rate representing the percentage of sales that goes to paying warranty claims, and the accrual rate representing the percentage of sales that's set aside to pay future warranty costs.

If the warranty reserve fund were a savings account, the accruals would be the deposits and the claims would be the withdrawals. The claims and accrual rates would then be the percentage of take-home pay that's put into or taken out of the account. And the warranty reserve capacity would be the number of months the reserves would last if deposits ceased but withdrawals continued.

No Gap Between OEMs and Suppliers?

We looked for a noticeable gap between the claims and accrual rates for the airframe makers and their suppliers, but didn't really find one. In contrast, in the automotive industry we found a two percent gap between the OEMs and their suppliers, which has narrowed considerably in recent years. But in the aerospace industry, the lines were never far apart.

In fact, the charts for the two groups overran each other to such an extent that we had to display them separately, in Figures 2 and 3 below. What this suggests is that warranty consumes a similar percentage of an aerospace manufacturer's revenue, whether they're a customer-facing OEM or an OEM-facing supplier.

In Figure 2, we're tracking the eight makers of airplanes, helicopters, rockets and satellites, which we're referring to as the aerospace "OEMs," in an effort to make a comparison with the automotive companies detailed in the April 7 newsletter last week. By far, the dominant player is Boeing Co., but Textron Inc. and General Dynamics Corp. aren't too far behind it on the list.

For most of the past six years, aerospace OEMs have kept both their claims and accrual rates between 0.6% and 1.0%. That big drop seen in early 2005 was almost entirely caused by Boeing, which saw its claims rate fall from 1.2% at the end of 2004 to 0.7% at the beginning of 2005.

Claims and accrual rates closely tracked each other for the next few years, before diverging again in mid-2008. This divergence, we suspect, was caused by a sales slowdown, but it was nothing like the 40% drop in revenue seen by the automotive OEMs.

Boeing, for instance, saw commercial airplane sales drop from $33.4 billion in 2007 to $28.3 billion in 2008, before rebounding to $34.1 billion in 2009. Claims, meanwhile, jumped from $220 million in 2007 to $253 million in 2008, before falling back to $237 million in 2009.

Aerospace Suppliers

In Figure 3, we're following 44 companies that supply systems and parts to airframe and fuselage manufacturers such as Boeing, Textron, and General Dynamics. To make it more representative of the full breadth of the industry, we're also including partially aerospace companies such as United Technologies Corp., Garmin Ltd., and Harris Corp., which we might otherwise classify as appliance, consumer electronics, or telecom equipment companies.

United Technologies, for instance, also is quite heavily into the HVAC and building materials industries through units such as Carrier Corp. and Otis Elevator Co. Indeed, the company also could fit into the aerospace OEM category through its ownership of Sikorsky Aircraft Corp., the world�s largest helicopter company. But this week we'll classify it as a supplier, primarily because its Pratt�& Whitney jet engine operation is about twice as large as its Sikorsky unit.

What Figure 3 reveals is that this group of suppliers has rather consistently managed to cut its warranty claims and accrual rates since 2003 -- almost in a straight line from 1.4% eight years ago to 0.9% in 2010. There have been annual and seasonal variations, but year to year the direction has almost always been downwards.

Notice also how close the claims and accrual averages have been through the years. This means that the amount of claims paid has always been close to the amount of accruals set aside, and that sales have neither soared nor plummeted to such an extent that it affected the averages.

Aerospace Warranty Reserves

One would expect that if claims and accruals were relatively close, and if sales and warranty expenses were relatively stable, that the balance in the warranty reserve funds of all 52 aerospace manufacturers would change rather slowly. And in fact, that is what we see in Figure 4.

Warranty reserves jumped 13% in 2007 to $2.73 billion, and then fell 4% to $2.63 billion in 2008. Reserves were up 1.1% in 2009, and then grew another 3.4% in 2010. But at the scale used in Figure 4, the balance looks rather level for all of the past four years.

While the claims and accrual rates of the aerospace OEMs and suppliers were relatively similar (as was seen in Figures 2 and 3), the same can't be said for their warranty reserve balances. And it's not so much the balances that are different as it is the amount of warranty expenses that those balances could cover.

Capacity to Pay Claims

Let's assume that every time a product is sold, the manufacturer places the correct amount of accruals in the warranty reserve to finance all the covered repairs expected during the life of the warranty. If the warranty is 12 months long, they set aside 12 months of accruals, to pay 12 months of claims. If the warranty is three years, they set aside three years of accruals, to pay three years of claims.

If this pattern is followed, the warranty reserve fund balance divided by the amount paid per month in claims should always equal the typical length of the company's warranties. If the balance is $60 million and claims are being paid at a rate of $5 million a month, then the capacity of the warranty reserve is 12 months.

As sales rise and fall, and the mix of product sales drives the average warranty duration up and down, these metrics will change. If the claims total suddenly falls to $4 million a month, the reserve's capacity would jump to 15 months, even if there was no change in the balance. If claims rose to $6 million a month, the capacity would change to 10 months. And so on. It's the finance department's job to monitor these changes and to adjust the balance when necessary.

OEMs Have Longer Warranties

The thing is, a customer-facing OEM is likely to offer longer warranties than an OEM-facing supplier. That's true not only in the aerospace industry, but also in automotive, computer, and appliance industries. And therefore, even if those warranties consume roughly the same percentage of revenue, one would expect the OEMs to keep relatively more money in their warranty reserves than their suppliers might. As can be seen in Figure 5, this is exactly the case.

The OEMs keep roughly 38 months worth of claims in their reserve fund, while their suppliers keep roughly 25 months. Over the past eight years, the OEMs have allowed their reserves to grow as large as 49 months and to shrink as small as 34 months. And their suppliers have seen their reserve capacity fluctuate from 22 to 28 months over the same period.

What this means is that the OEMs keep a relatively larger reserve fund balance, because they provide relatively longer warranties (some last 10 or even 12 years). On average, the OEMs keep the equivalent of an extra year's worth of funds in their reserve, to help them pay for the additional claims they can expect.

OEM & Supplier Examples

To see this trend in action on an individual company level, let's pick one OEM and one supplier. As mentioned, Boeing is by far the largest aerospace OEM, and is second only to United Technologies in the entire industry. But keep in mind that United Technologies is also paying claims on HVAC and elevators. So Boeing is probably spending the most on just aerospace claims -- OEM or supplier.

In Figure 6 below, we've taken 32 measurements of Boeing's warranty reserve fund balance over the past eight years, at the end of each quarter. We've also taken 32 measurements of the company's monthly claims total, and divided those figures into the reserve fund balance at the time. That yields two sets of figures: the balance of the fund (in dollars), and its capacity to pay claims (in months).

Boeing has kept roughly $1 billion in its warranty reserve fund since the middle of 2007. During this period, as claims payments have fluctuated between $17 million and $26 million per month, this balance has represented anywhere from 37 to 60 months worth of claims. The long-term average is 49 months.

In contrast, avionics manufacturer L-3 Communications has kept its warranty reserve fund balance between $92 million and $102 million since the middle of 2007. As claims have fluctuated between $3 million and $8.7 million over that period, the balance in the reserve fund has represented between 11 and 33 months worth of claims paid, with a long-term average of 24 months.

What this means is that in the case of an OEM like Boeing, the ratio between the reserve balance and the monthly claims total is roughly twice as large as is the case with a supplier like L-3 Communications. Boeing keeps the size of its reserve equal to about four years' worth of claims paid, while L-3 keeps its reserve closer to two years.

Eighth Annual Product Warranty Reports

Here are the links to the online editions of all eleven parts of this series:

• Top 100 Warranty Providers of 2010
• 2010 Warranty Totals & Averages
• Automotive Warranty Report
• Aerospace Warranty Report
• Computer Warranty Report
• Disk Drive & Semiconductor Report
• Telecom Equipment Warranty Report
• Medical & Scientific Equipment Warranty Report
• New Home Warranty Report
• Fixtures, Furniture & Building Material Warranty Report
• Appliance & HVAC System Warranty Report

Readers needing more detailed snapshots of individual companies in either a PowerPoint or Excel format are invited to view the list of charts and spreadsheets available on the Warranty Statistics page.