April 5, 2012

Automotive Warranty Report:

While suppliers seem to have gotten a reprieve from escalating pressure to pay a greater share of warranty costs, OEMs are enjoying fast sales growth and a return to old levels. Meanwhile, Ford has decided to begin reporting warranty and recall costs together.

Warranty expenses in the automotive industry are getting back to levels they last saw in 2008, after massive sales-related declines in 2009 and 2010.

Automotive suppliers, meanwhile, seem to have caught a bit of a break after suffering through multi-year efforts by their OEMs to increase warranty reimbursements. Their costs are no longer rising, though they're also not falling.

It's an industry in which sales gains led declines by a 6-to-1 ratio, yet nearly 6-out-of-10 manufacturers managed to reduce their warranty accrual rates. But more than anything, it's an industry that's still getting back to "normal" after a rough couple of years.

Ford's Warranty Accounting

Before we get to the industry's totals and averages, first we need to attend to a little business with the second-largest automotive warranty provider on our list. Beginning with its 2011 annual report, the Ford Motor Co. has begun including the cost of product recalls alongside its warranty coverage. Up until the third quarter, they were separate. Now they're together. So we need to make some adjustments to our charts.

General Motors Co. has always counted warranty+recalls together. Toyota used to count them separately, but then in the fiscal year ended in March 2011 it began to count them together. And it included both before and after data in its annual report, which we covered in detail in the June 30, 2011 newsletter.

Fortunately, Ford also included some year-ago data in its 2011 annual report that allows us to compare its original 2010 warranty-only figures to its 2010 warranty+recall revisions. Toyota included warranty+recall and recall-only figures in its most recent annual report, which allowed us to derive warranty-only figures for the last three years. However, Ford did not include any warranty-only figures for 2011, so we have to treat the new data a little differently.

Old & New Data

In Figure 1 below, we've charted the reported annual warranty claims payments made by Ford from 2003 to 2010. We've also charted the new data, consisting of the additional $299 million paid for recalls-only in 2010, and the $2.799 billion paid in 2011 for warranty+recalls.


Figure 1
Ford Motor Co.
Amounts Paid for Warranty Claims & Recalls
(in US$ millions, 2003-2011)

Figure 1


To look at it another way, Ford reported that the cost of warranty+recall costs rose from $2.475 billion in 2010 to $2.799 billion in 2011, a 13% increase. We don't know the recall-only amounts for 2003-2009, so we don't know if this was an unusually large increase.

It's the same story with warranty accruals. In Figure 2 we've charted the reported warranty accruals-only amounts for 2003-2010, and the warranty+recall data for 2010 and 2011.

Changes in Accruals

The warranty-only accrual amount for 2010 was $1.522 billion. The warranty+recall accrual amount was $1.801 billion. We charted the difference, which was $279 million. And then we charted the reported combined amount for 2011, $2.215 billion.


Figure 2
Ford Motor Co.
Amounts Intended for Warranty Accruals & Recalls
(in US$ millions, 2003-2011)

Figure 2


This time, the difference between 2010 and 2011 was 23%, which would be a hefty annual increase in accruals for any reason. The problem is, since it was the annual increase for the combination of warranty+recalls, we don't know if Ford is predicting just higher warranty costs, just higher recall costs, or both.

Accruals had been decreasing for three years in a row, and the increase in 2007 was barely noticeable. So a 23% increase is not typical for Ford. And we wanted to show it to you in this way so it would be understood that it's a 23% jump in warranty+recall accruals, which predicts what Ford expects in the near future.

Ford's Own Words

There are few clues as to why they were combined, or why there was such a big increase in the combination last year. In its 2011 annual report, Ford stated that it accrues the estimated cost of basic warranty coverages for each vehicle at the time of sale, as it has always done. "We establish estimates using historical information regarding the nature, frequency, and average cost of claims for each vehicle line by model year. Where little or no claims experience exists, we rely on historical averages," the company said.

"Separately, we also accrue at the time of sale for potential product recalls based on historical experience with similar actions," the company added. "Product recalls are distinguishable from warranty coverages in that the actions may extend beyond basic warranty coverage periods."

And then in another section, the company states, "Estimated warranty costs and additional service actions are accrued for at the time the vehicle is sold to a dealer, including costs for basic warranty coverage on vehicles sold, product recalls, and other customer service actions."

Combining Warranty+Recalls

The third metric we track is the warranty reserve fund balance. Because the formerly separate funds for product warranty and product recalls is now reported as a single fund, those balances were added together for 2011. but once again, Ford gave us a year-ago figure for 2010, which we compared to the warranty-only figure listed in the 2010 annual report.

Ford's warranty-only balance at the end of 2010 was reported as $2.646 billion. The warranty+recall balance was $3.855 billion, so the difference was $1.209 billion. And then the warranty+recall balance for 2011 was $3.915 billion.


Figure 3
Ford Motor Co.
Amounts Held as Warranty Reserves & Recalls
(in US$ millions, 2003-2011)

Figure 3


The increase in the warranty+recall balance was only 1.6% from 2010 to 2011, but that's the first increase after five consecutive years of decreases in the warranty-only balance. So while it's only a small increase, it's also the reversal of a pattern. But again, we don't know Ford's recall-only costs for 2003-2009.

The other metric we track but don't chart is the company's automotive product sales total. We use this data to figure out what percentage of sales is being spent on warranty, or as we will now do going forward, on warranty+recalls.

New and Higher Rates

In Figure 4 we charted the warranty-only data for 2003 to 2010, and then added a pair of new lines for the warranty+recall data in 2010 and 2011. Those new lines are in the upper right corner of the chart. And we hope they help to put the data in Figures 1, 2 & 3 into better perspective. There were not only large jumps in dollar terms. There were also large increases in percentage terms.


Figure 4
Ford Motor Co.
Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2011)

Figure 4


As can be seen in Figure 4, the warranty-only claims rate for 2010 was 1.8%. The warranty+recalls claims rate was 2.1% that same year. And then in 2011 the warranty+recalls claims rate rose to nearly 2.2% of revenue.

The warranty-only accrual rate, meanwhile, ended 2010 a bit under 1.3%. But the warranty+recalls accrual rate was a bit over 1.5% at the same time. And then the warranty+recalls accrual rate rose to 1.7% by the end of 2011. These numbers will change as 2012 data is released.

Industry Trends

So with all that as preparation, we can report that all the warranty metrics for the automotive OEMs saw increases in 2011. Ford of course is a big reason for that, but there are 27 other active OEMs on our list, making everything from motorcycles to heavy trucks. Ford saw a big jump in claims, but Navistar International Corp. saw an even bigger jump. And both Paccar Inc. and Thor Industries Inc. weren't very far behind.

Figure 5 shows that claims payments have once again begun to rise, but from an unusually low level set in 2010. Also, notice that the increase for the parts suppliers was rather small. It rose by only $6.5 million from 2010 to 2011 -- an increase of only 0.4%. But once again, it's the reversal of a trend: suppliers' claims payments had fallen during the two previous years.


Figure 5
Warranty in the Automotive Sector
Claims Paid by U.S.-based Companies
(in US$ millions, 2003-2011)

Figure 5


In Figures 5 & 6, we've charted the claims and accrual amounts reported by all U.S.-based automotive OEMs and their parts suppliers. The names come and go due to acquisitions and divestitures, but over the years there have been 153 different companies on the lists.

And then there are dozens of others that have a stake in the automotive market, but are primarily in other industries, such as A.O. Smith Corp.; Harman International Industries Inc.; Honeywell International Inc.; Ingersoll-Rand plc; and Textron Inc. Two of those were part of the aerospace industry covered in last week's newsletter. The others will be part of the appliance, HVAC and consumer electronics coverage we plan for the weeks ahead.

Small Changes

In Figure 6, there's a slight modification in the trends seen in Figure 5. First, it's the second consecutive year of rising accruals, after manufacturers hit bottom in 2009. Second, the total for accruals made by the parts suppliers actually fell a bit in 2011, continuing a multi-year trend and representing the smallest amount accrued per year since 2004. But look closely at the numbers embedded in the graphics: Supplier accrual totals haven't changed much over the past three years.


Figure 6
Warranty in the Automotive Sector
Accruals Made by U.S.-based Companies
(in US$ millions, 2003-2011)

Figure 6


Suppliers such as TRW Automotive Holdings Corp. and Cummins Inc. saw big decreases in their claims and accruals in 2011, while OEMs such as Navistar, Paccar, and Oshkosh Corp. saw big increases. And those plus Ford supported a trend where the OEMs generally saw costs rise a lot. But with the suppliers, there was much less change overall.

OEMs Dominate the Charts

In Figures 5 & 6, the OEMs always accounted for between 80% and 89% of the overall totals for the automotive industry, while the suppliers' share varied from 11% to 20%. The big reason for that is because the passenger car companies provide a bumper-to-bumper warranty to the consumer, and then try their best to collect reimbursements from their suppliers. But the reimbursements never quite cover all the costs.

In recent years, the passenger car companies have made additional efforts to increase these reimbursements, and the results really began to show up in 2009 and 2010. But because sales were falling at the same time, the trend wasn't so clear.

In Figures 7 & 8, we've taken the warranty data from Figures 5 & 6 and divided it by sales data to calculate the percentages of product revenue accounted for by claims and accrual totals. In both cases, there were unprecedented spikes in the claims rates in 2009, but they were caused not by surging warranty costs, but by falling sales. Then, as sales got back to normal levels, so did the claims rates.


Figure 7
U.S.-based Automotive OEMs
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2011)

Figure 7


Let's set aside the 2009 data, because that massive spike really has more to do with falling sales than anything warranty-related. It's not as if claims soared. Claims actually fell in 2009, to levels not seen since 2003. But sales fell to levels not seen in decades. So manufacturers had to fix last year's models with this year's money, and the percentages went crazy.

S

o let's try to forget 2009. In the years 2003 to 2008, warranty expenses for the OEMs averaged 2.3% to 2.5% of product revenue. For their suppliers, the average was always close to 0.6%. These, we would suggest, are the long-term averages for these industry segments. That's the "normal" baseline.

Closing the Gap?

By 2010, the gap was narrowing significantly. OEMs saw their costs drop, and suppliers saw their costs rise. It seemed as if the OEMs were gaining traction in their efforts to increase reimbursements. The gap, which had been around 1.9% to 2.0% for multiple years, suddenly narrowed to a range of 1.1% to 1.5%, depending on the period measured and the metric selected. Until early 2009, over 24 consecutive quarters, the gap had never before dipped below 1.7%.

By the end of 2011, however, it looked like things were returning to "normal," with reimbursements holding steady. The OEMs' claims rate was back up to 2.3%, and the suppliers' was back down to 0.6%. And the gap between them was again at 1.7% -- still a little below the long-term average, but not by as much as it had been.


Figure 8
U.S.-based Automotive Parts Suppliers
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2011)

Figure 8


The question is, are we measuring the reversal of a trend, or is Ford upsetting a continuing trend by adding its recall funds into its warranty account? More specifically, are the OEMs keeping up the pressure or are they backing off a bit in their reimbursement efforts?

That's why it was so important to detail the Ford numbers both before and after the accounting change. While it's a major change for Ford, and while Ford is a major part of the industry, the changes made by Ford are not big enough to produce the changes seen for the industry as a whole.

Reserve Fund Totals

Finally, we want to take a quick look at the warranty reserve balances reported by the OEMs and the parts suppliers. It provides yet another confirmation of a trend seen in Figures 5 & 6: Most of the change, and most of the money, is on the OEM side.


Figure 9
Warranty in the Automotive Sector
Reserves Held by U.S.-based Companies
(in US$ millions, 2003-2011)

Figure 9


In this case, the dominance of the OEMs actually obscures a trend: Year-end reserve balances haven't changed all that much for the parts suppliers during the past three years. The suppliers' balance grew from $2.796 billion in 2009 to $2.802 billion in 2010 but then fell to $2.724 billion in 2011. The OEMs saw much bigger changes, measured not only in dollars but also in percentage changes.

Getting Back to Normal?

So what does it all mean? Overall, it looks like 2011 was a year spent getting back to normal. Sales began to grow again, and so did warranty costs, but not as swiftly. OEMs continued to reduce their warranty costs, but then Ford changed the trend when it added in its product recalls.

OEMs cut their warranty costs primarily through quality improvements, but secondarily through increased efforts to extract reimbursements from their suppliers. It's difficult to tell if the quality improvements have ended, again because of Ford's change in accounting methodology. But it looks like at least the reimbursements have stopped increasing.

In 2009 it looked like auto suppliers would see their costs increase, both in dollars and as a percentage of sales. But then the dollars didn't rise much, while sales did, and so the percentages are now falling again. Last year looks a lot like 2008, while 2009 and 2010 look like the anomalies.

Ninth Annual Product Warranty Reports

As we continue with our annual survey of U.S.-based warranty providers, here are the links to the online editions of all the other parts of this series:

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.





AMT Warranty Corp.
Fulcrum Analytics
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