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May 31, 2012

Average Warranty Costs per Industry:

One can get a good idea of the industries where warranty is most important by looking at both the amount they pay and the percentage of sales that those payments represent. And the data suggests that automotive, computers and appliances are at the top of the list.

What industry sectors dominate the warranty industry? There are warranties on everything from airplanes to air conditioners, but which products generate the most warranty expense?

There are at least two ways to measure this. One is by dollars spent, and for that we can count up the warranty claims payments reported by nearly a thousand U.S.-based manufacturers. The other is by the ratio between sales revenue and warranty expenses, and for that we look to the accrual rates that can be calculated from the figures in those financial statements.

Usually, we divide the world of manufactured goods into 14 fairly broad product categories. But over the past 11 weeks we've further segmented some of those categories to show the differences between OEMs and suppliers, or how the use of certain technologies impacts typical warranty costs.

24 Segments in Three Groups

Therefore, this week we're going with 24 different segments in three groups. There are four segments in the "vehicles" group; 12 segments in the "high-tech" group; and seven in the "building trades" group; plus the ever-present "other" category for everything from construction shoes to conveyor belts.

In Figure 1, we've charted the annual claims totals for the vehicle group segments, although labels for the dollar amounts fit onto only the two automotive categories. Additional information on the aerospace categories can be found in the March 29 newsletter.


Figure 1
U.S. Vehicle Warranties
Total Claims Paid per Sector
(in US$ millions, 2003-2011)

Figure 1


As is plain to see, claims payments bottomed out in 2010, a year after the recession ended. This is to be expected, given the lag time between when a product is sold and when it needs warranty work. And as detailed in past newsletters, the recession was most intensely felt in the auto and new home industries (and perhaps worst of all by the home-on-wheels manufacturers).

High-Tech Electronics

In Figure 2, we've tabulated the annual claims payment totals for the 12 sectors within the high-tech group. Realistically, only seven or eight are visible, but there's data behind all of them. And readers puzzled by the appearance and disappearance of the consumer electronics wedge should immediately skip down to Figure 9 below.


Figure 2
High-Tech Electronics Warranties
Total Claims Paid per Sector
(in US$ millions, 2003-2011)

Figure 2


If the vehicles category is dominated by the automotive OEMs, then the high-tech category is dominated by the computer OEMs. In fact, the warranty claims payments of just six current computer makers and about 18 former manufacturers accounts for well over half the high-tech warranty spending and more than 20% of all warranty claims paid by any manufacturer of anything.

Building Trades

In Figure 3, we've included the seven categories that fall under the umbrella of the building trades. Until the May 17 newsletter, we were counting appliances and HVAC together. And until the May 24 newsletter, we were counting fixtures, furniture and building materials as a single category.

Even so, it's clear that HVAC and appliances dominate the group, exceeding even the net claims payments by the builders themselves. Part of the reason is the builders' crafty management of their subcontractors. And part of the reason is the still-healthy replacement and renovation market with existing homes.


Figure 3
Building Trades Warranties
Total Claims Paid per Sector
(in US$ millions, 2003-2011)

Figure 3


In addition, as a reader recently pointed out, government regulations and the quest for lower operating costs are driving a whole cycle of upgrades to more energy-efficient appliances and heating/cooling systems. Ironically, because electrical demand is rising even faster, there's also a thriving market for everything from steam turbines to solar panels. That's the reason for the inclusion of the power generation wedge, which by the way was larger than the appliance category last year.

The thing is, Figures 1 through 3 show where the money is going. But without unit sales or dollar revenue figures, we cannot know at what rate it's getting there. For instance, the makers of the machines that actually manufacture semiconductors and printed circuit boards don't pay as much as a group as the makers of telephone equipment. But they pay out a far higher percentage of their revenue, or at least they used to.

Warranty Costs vs. Sales

To measure the degree of pain, we need something to compare with. And since unit sales figures are rare outside the passenger car and new home industries, we've defaulted to product revenue, as measured in dollars. By comparing warranty costs to sales revenue, we can differentiate between the relative pain of a warranty bill that consumes 19% of sales, 1.9% of sales, or 0.19% of sales.

Let's start with the four industry sectors that we know have the highest warranty costs, as determined by their average accrual rates, calculated over nine years by dividing total accruals by total product revenue. It's an OEM-heavy group, which includes not only the top passenger car and computer manufacturers, but also the top appliance makers.

All the big names are represented here: Ford, GM, Apple, HP, Dell, IBM, Whirlpool, Caterpillar, Deere, and Navistar. And like a magnet, these ten companies attract warranty cost to their well-known brand names at an incredible rate. In fact, these ten companies accounted for 57% of the total for all companies last year. But they also had the most sales. So what Figure 4 does is divide their reported warranty expenses by their reported product revenue.


Figure 4
Far Above Average
Warranty Accrual Rates, 2003-2011
(as a % of product sales)

Figure 4


Notice that when warranty expense reporting began in 2003, the computer manufacturers were setting aside an average of four percent of their product revenue to finance warranty costs. The makers of semiconductor manufacturing equipment weren't far behind, averaging 3.5% accrual rates. And the automakers were still above 2.5%.

But then something happened: some of the top consumer-facing brands began to really pay attention to warranty costs, and began to reduce inefficiencies, change business processes, and implement early warning systems that used current warranty data to reduce future warranty expenses. And it really worked!

By 2011, the computer OEMs were under 2.5%, and both the automotive OEMs and the makers of semiconductor manufacturing equipment were under two percent. The only exceptions -- at least on this chart -- are the appliance OEMs, which despite shorter warranties and better transaction processing systems, saw their warranty expenses continue to rise. Accrual rates were lower for that group in 2011, but were high in both 2010 and 2007.

Business-to-Business Products

Next we have four electronics categories, but they're not as consumer-facing as many of the brands covered by the sectors in Figure 4. Instead, these are manufacturers that provide lots of business-to-business warranties -- medical imaging systems, phone switches, routers, etc. However, they also make some of the hottest high-tech consumer items: mobile phones, navigation gadgets, Wi-Fi hardware, etc.

But again, three out of the four categories show clear progress towards the goal of reducing warranty expense. The exception here is satellite/microwave, which tends to intersect with aerospace and defense and which apparently had a few rough years starting in 2008. But they're now back down to the midpoint of the range they traversed in 2003-2007.


Figure 5
Above Average
Warranty Accrual Rates, 2003-2011
(as a % of product sales)

Figure 5


All of the industry sectors in Figures 4 & 5 are typically saddled with higher-than-average warranty costs. Some, such as the appliance OEMs and the satellite/microwave companies, were below the average years ago but have seen their warranty costs rise more recently. Other sectors, such as telephone/mobile and data storage, have been wavering above and below the average.

Interestingly, the industry average itself has been dropping. In Figure 6, the dark line represents an average accrual rate for all 994 manufacturers that have reported making warranty accruals since 2003. And it's apparent that it too has declined, from 1.8% in 2003 to 1.6% in 2006 and 1.4% in 2009. The lowest-ever average warranty accrual rate for all U.S.-based manufacturers was the 1.3% seen in the second quarter of 2011.


Figure 6
A Little Below Average
Warranty Accrual Rates, 2003-2011
(as a % of product sales)

Figure 6


The reason we're dwelling so long on the topic of warranty accrual rates is because they're much less susceptible to recessionary sales declines. Unless there's been a measurable change in either the frequency of product failures or the cost of repairs, accruals and sales should rise and fall together. So the half-a-percentage-point reduction seen from 2003 to 2011 is a tremendously positive story line for U.S.-based manufacturers.

There are several reasons accrual rates can decline. Accrual rates can fall when product reliability rises, because fewer repairs will be necessary. They can fall when the inefficiencies of the warranty process are reduced, or when companies learn how to use warranty data to affect design and production. They can fall when OEMs improve their rate of reimbursements by suppliers, shifting the blame to the companies causing the cost. And they can fall when manufacturers decide to "make their numbers" by manipulating their accounting assumptions.

Managing Accrual Rates?

The only industry sector where there was evidence of the latter was among the homebuilders. In some months, every home they sold was perfect, requiring no warranty accruals! In others, they had to double or triple their accruals per home sold when things no longer seemed so perfect. So let's hope the reason for falling rates in other sectors is more noble -- not that they're just better at covering their tracks.

In Figure 7, we have four industry sectors where the warranty accrual rates have never exceeded the average for all manufacturers. In fact, they've never exceeded 1.2%, a characteristic they share with the homebuilders and aerospace OEMs tracked in Figure 6. These are the below-average sectors. We would have included them all on a single chart except the resulting tangle would have left them illegible.


Figure 7
Below Average
Warranty Accrual Rates, 2003-2011
(as a % of product sales)

Figure 7


Notice that none of the four sectors tracked in Figure 7 have shown any improvement since 2003. The only exception might be the HVAC segment, which was at least able to flatten out its average in 2008 by tying its accruals closer to sales. The others seemed to end 2011 at about the same level as they began 2003, with nothing but the seasonal oscillations of the construction business leaving their mark on their accruals.

Far Below Average Rates

In Figure 8, we see four more industry segments in which average accrual rates are far below the average for all manufacturers. But here, at least three of the segments are showing some progress with the reduction of their accrual rates.

The only one to end 2011 at the same accrual rate that they started at in 2003 is auto parts, but they did so in the face of incredible pressure from their OEMs to increase reimbursements. The other three -- aerospace parts, medical equipment (that doesn't use X-rays or lasers), and broadcast/cable TV equipment -- are doubly fortunate to have both well-below-average and declining warranty costs.


Figure 8
Far Below Average
Warranty Accrual Rates, 2003-2011
(as a % of product sales)

Figure 8


Now we are left with four industry sectors that for one reason or another didn't fit into any of the other charts. Two are here because the structure of the industry they're in is such that their own sheer size dominates the data. And two are here because their data is so chaotic that it simply didn't fit.

In Figure 9, we have the two giant companies. General Electric Co. has said that most of its warranty expense arises in its turbine line of business, though we suspect some also belongs in the airplane engine, appliance, and medical device categories. But if we put all of GE's warranty expense into the power generation industry sector, we find that it inundates all the other makers of electrical generators, batteries, windmills, and solar panels. And we find that the big decline in 2005 is entirely caused by the way GE segments its turbine revenue, and has nothing to do with warranty.

Domestic Consumer Electronics?

And then there's the so-called consumer electronics category. Because the only companies we're counting are those that are based in the U.S., and because so much CE is imported from Europe and Asia, this category ends up utterly dominated by the game console product line of Microsoft Corp. See that huge spike in 2007? That's the Xbox 360 manufacturing debacle, which became front-page news almost five years ago.

Sure, there are numerous makers of other electronic gadgets. But most, like Panasonic and Sony, are based outside the U.S. Some, like Apple, Jarden and Kodak, are counted in other categories. So that leaves Microsoft, some navigation and radar detector companies such as Garmin and Cobra, plus some audio manufacturers such as Harman International and LRAD Corp. But the data is dominated by the Xbox.


Figure 9
Consumer Electronics & Power Generation
Warranty Accrual Rates, 2003-2011
(as a % of product sales)

Figure 9


And then in Figure 10 we have the last two categories, which look more like seismometers after a tremor and less like warranty accrual averages. The timeline of the semiconductor data looks like the opposite of HVAC: from order comes chaos. And the computer peripheral chart seems defective. Could it be too diverse a category, blending low-warranty items such as monitors with high-warranty items such as printers?


Figure 10
Semiconductors & Peripherals
Warranty Accrual Rates, 2003-2011
(as a % of product sales)

Figure 10


By the way, before any readers complain, the reason that printers have such high warranty costs has little to do with their reliability, and much more to do with their pricing. Manufacturers make the most money supplying customers with consumable ink and toner, so they sell the actual hardware at relatively low prices, and give generous warranties to keep their clients happy. That translates into a relatively high accrual rate per dollar of product revenue -- it's been as high as 19% for Lexmark International!

Warranty Reserves Market Share

Finally, as we close out this year's analysis of all the trends in product warranty claims and accruals, we wanted to include a graphic that shows no trend at all. In Figure 11, we've divided up the warranty reserves held by all the manufacturers in all the industry sectors and categories into three giant groups: vehicles, high-tech, and buildings.

Although some appliances have operating systems and some furniture has wheels, we hope these labels are self-explanatory. Vehicles includes planes and boats. High-tech includes all electronics. And the building category includes all the systems and appliances in addition to the structures themselves.

The point we wanted to make was that as much as things change, they also stay the same. The approximate ratio between the three sectors has been stable: a little more than half in vehicles, a little less than a third in high-tech, and the balance in the building trades.


Figure 11
Vehicle, High-Tech & Building Warranties
Share of Reserves Held by U.S.-based Companies
(in percent of total, 2003-2011)

Figure 11


Burrowing down one level deeper, it's clear from Figures 1 and 4 that the vehicle segment is dominated by the passenger car companies. The high-tech category is dominated by the computer OEMs, as can be seen in Figures 2 and 4. And the building category is dominated by the appliance OEMs and the HVAC system makers, as can be seen in Figure 3 and 4. As the infamous bank robber Willie Sutton once said, "That's where the money is."

Ninth Annual Product Warranty Reports

As we begin to wrap up 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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