April 4, 2013

Automotive Warranty Report:

Automotive manufacturers are cutting their warranty costs to the lowest levels of the decade. Sales are recovering from the depths of the recession but warranty expense rates are remaining low. However, some of the suppliers are paying more as the OEMs get better at seeking reimbursements.

The network of automotive companies based in the U.S. have been through some tough times over the past decade. But in terms of warranty expenses, they have been among the most successful cost-cutters of all.

Every year since 2003, we have collected warranty expense reports from all the major manufacturers and have then looked for trends in the data. We collect figures for warranty claims paid, accruals made, and the resulting balance in each company's warranty reserve fund, as well as the corresponding figures for warranted product sales. And for several years running, the automotive OEMs and their suppliers have managed to reduce the cost of warranty as a percentage of sales. In fact, for some of them, warranty costs have never been lower.

Part of the reason is the increasing quality of the vehicles. They don't break as often, and the repairs are not as costly. Part of the reason is better data, which allows manufacturers to find and eliminate patterns of failure, long before there's a need for a recall or a warranty campaign. And part of the reason is that the same data lets the OEMs more efficiently pass the blame (and the cost) on to their suppliers.

Four years after hitting bottom during the Great Recession, it's becoming clear that while sales volumes are returning to normal, warranty expenses are not. They're not reverting to "business as usual." They're working smarter, doing better, and saving money. And through the data contained in the following six charts, we hope to tell at least a part of that story.

Automotive Warranty Claims

Let's start with warranty claims payments. In 2012, all 151 of the U.S.-based automotive companies that we track together reported just over $10 billion in claims paid, of which about 85% was paid by the 46 OEMs and about 15% by their 105 suppliers.

This industry-wide total was down about seven percent from the corresponding 2011 figures, though the OEMs saw their net claims payments fall by much more than did their suppliers. As we will see in more detail in next week's newsletter, this is likely a sign that the OEMs are improving their ability to force their suppliers to pay a larger share of the total, increasing their reimbursements and reducing their net cost.


Figure 1
Warranty in the Automotive Industry
Claims Paid by U.S.-based Companies
(in US$ millions, 2003-2012)

Figure 1


It used to be worse. Back in 2009 and 2010, the suppliers paid about 16% of the total, while the OEMs paid 84%. And it also used to be better. Back in 2004, the suppliers paid only 11% of the industry's annual bill for warranty claims, while the OEMs paid 89%. So it seems as if the OEMs are relenting just a little bit now, after tightening up perhaps a little too much during the worst years of the recession.

Warranty expenses remain low, even as sales rates recover. For the OEMs, 2012's claims total was the second lowest of the past decade, with only the recessionary year of 2010 coming in lower. For the suppliers, 2012 was merely the lowest since 2005 -- back in those years before the OEMs improved their supplier recovery skills.

Warranty claims metrics always show some lag time between when a product is sold and when it needs warranty work. When sales take a downturn, it takes claims an extra year or two to bottom out. And that's what we see in Figure 1, with claims hitting bottom in 2010, more than a year into a recession that began with the Lehman Brothers panic of September 15, 2008.

Automotive Warranty Accruals

Warranty accruals, on the other hand, should rise and fall in proportion to sales. If the average accrual is $500 per vehicle, that amount would be set aside when a vehicle is sold. If it's not sold, the money isn't set aside. So the accrual rate remains $500 per vehicle. Changes in product pricing, vehicle reliability, and repair cost also can change the ratio between sales and accruals. But the factor that is most important when determining the amount to accrue is the number of products sold times the expected cost of their warranties.

This is the pattern in Figure 2. Because the panic began late in the year, we see a slight drop in 2008 accruals, followed by a big drop in 2009, then a gradual recovery in 2010 and 2011. It's hard to tell from the chart below, but the industry total was actually down by $8 million dollars in 2012, from $10.138 billion in 2011 to $10.130 billion in 2012. And since by now all but a handful of OEMs and suppliers have published their annual reports, it doesn't look like that $8 million decline is going to be reversed by late-arriving data.

Does this mean the recovery is over? Not at all. Product revenue was up by about 2.2% in 2012 for the OEMs and was up by about 6.1% for the parts suppliers. So it wasn't a drop in sales that caused accruals to fall last year. Instead, we suspect it was a boost in reliability and a drop in repair cost -- welcome news for an industry that has been trying to cut its warranty expenses for years.


Figure 2
Warranty in the Automotive Industry
Accruals Made by U.S.-based Companies
(in US$ millions, 2003-2012)

Figure 2


Note that while the industry's total accruals were down slightly last year, the OEM total was actually up by $28 million. In contrast, the suppliers were down by about $36 million, and that was enough to cause the overall industry total to fall by $8 million. Also note that 2012 was the second year in a row that the suppliers saw an accrual decrease while the OEMs saw an accrual increase. In contrast, back in 2009-2010, they both saw increases, as the recovery took hold, and sales rebounded.

Automotive Warranty Reserves

Our third warranty metric is the year-ending balance in all the warranty reserve funds of the companies we track. As can be seen in Figure 3, the automotive industry total hit a peak in 2007, before bottoming out in 2010. Since it's merely a mathematical addition of accruals made minus claims paid, the timing of this is no surprise. While there's some lag time between sales and reserves, it's not as great as it is between sales and claims.

In Figure 3, the 2012 warranty reserve total for the industry as a whole is $18.7 billion. And that's up by about 7.6% from the 2011 total. The reason for this increase (since both claims and accruals fell) is a combination of changes in the value of foreign currencies and some unusual additional accruals made by manufacturers for problems that arose in previous years. In other words, it's something that can't be seen in these charts.

There were some huge additional accruals required last year, however. For instance, General Motors had to add $539 million to its warranty reserves last year, in addition to its regular accrual of $3.394 billion. Navistar International had to add $404 million extra, in addition to its usual $571 million. Other OEMs that had to make sizeable upwards changes in estimate included Spartan Motors, Harley-Davidson, and Toro Co. And those extra accruals helped drive up the year-ending totals seen in Figure 3.


Figure 3
Warranty in the Automotive Industry
Reserves Held by U.S.-based Companies
(in US$ millions, 2003-2012)

Figure 3


The typical reason for making an upwards change in estimate is the discovery of a shortfall in previous years. For instance, you predicted a vehicle's warranty cost will be $500, and you accrued that amount when it is sold. But a year or two later it turns out the real cost is closer to $550. So you need to add $50 in accruals per unit sold to make up for that past mistake.

To put it another way, your product's reliability didn't turn out to be as good as you hoped when you made your original accrual estimate. Most companies don't admit this publicly, but in this case the numbers make the announcement for them. The reasons behind Navistar's sizeable warranty excursion is well-known. For the others, there's still some mystery. But at least now, we know something bad happened.

The irony is that the overall industry has never seen lower warranty expense rates than it has in the past few years. The amount of dollars spent is one thing. Expenses as a percentage of sales is something else. As can be seen in the green line in Figure 4, the OEMs have kept their accrual rate close to 1.9% for the last three years, as their claims rate (the red line) continued to descend to that level. Apparently, the financial planners knew what was coming, cut their accruals rates, and confidently waited for their claims rate to catch up.


Figure 4
U.S.-based Automotive OEMs
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2012)

Figure 4


Keep in mind that the giant spike in claims in 2009 was caused by the recession. Sales plummeted, but claims fell by less (see Figure 1). Therefore, the ratio between claims and sales soared to a peak of 3.3% in early 2009, meaning that the OEMs paid out a net $3.30 for every $100 of product revenue for warranty work. Last year, as sales continued to grow and claims continued to fall, that net claims rate hit a new low of 1.87% in the second quarter of 2012.

Notice we slipped the word "net" into the statement above. That's because the OEMs' total payments were a little bit higher than $3.30 per $100 in early 2009 or $1.87 per $100 in the middle of 2012, but the true total was offset in part by reimbursements from their suppliers.

In Figure 5, we can see a much different pattern for those suppliers. They're now paying only 0.5% to 0.6% of their revenue for warranty costs, but that's about the same expense rate they had in 2011, 2007, and 2004. And in 2009 and 2010, because of the recession and because of supplier recovery efforts by the OEMs, the suppliers' warranty costs soared as a percentage of their revenue. In other words, they're getting back to where they were, but they're not showing much improvement over the course of the decade.


Figure 5
U.S.-based Automotive Parts Suppliers
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2012)

Figure 5


We will delve much deeper into the relationship between claims payments by the OEMs and by their suppliers in next week's newsletter. And we'll also make some comparisons with supplier recovery efforts within the computer industry. For now, let's just say that some of the automotive OEMs' reduced cost is quite literally coming at the expense of their suppliers. And part of the reason the suppliers can't cut their costs to new lows is the increasing demands for reimbursements coming from their OEMs.

Anything on Wheels

Finally, we wanted to include one more chart, spotlighting just the truck and heavy equipment makers. When we say "automotive," we mean much more than just passenger cars. Of course we include light trucks and motorcycles in that classification. But we also include heavy trucks, buses, recreational vehicles, vocational vehicles, forklifts, sweepers, emergency vehicles, construction equipment, mining equipment and even some farm equipment.

So our list of 46 automotive OEMs includes not only Ford and GM, but also the big guys such as Caterpillar, Deere, Navistar International, and Paccar. And that complicates the analysis somewhat, because Ford and GM account for almost two-thirds of the OEMs' claims, and the heavy equipment makers for only about a quarter.

So for the benefit of the many readers who want more detail on just the large vehicles and the heavy trucks, we've taken Ford and GM and all the small vehicle makers out of the totals, leaving behind just those big guys.

In Figure 6, we're charting the claims and accrual rates of just the 26 OEMs who make large vehicles. Actually, because the recession knocked out so many RV makers, there are really only 15 large vehicle OEMs left on the list now. But there used to be more.

As a point of reference, their claims payments totaled $2.64 billion in 2012, up from $2.49 billion in 2011. Their accruals increased only slightly over the same period, from $3.07 billion in 2011 to $3.09 billion in 2012.


Figure 6
U.S.-based Heavy Equipment OEMs
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2012)

Figure 6


Figure 6 looks much like Figure 4, showing the same sort of claims rate spike in 2009, caused by plummeting sales. And besides that anomaly, the general direction for the past decade is generally down, meaning that both the large and small vehicle manufacturers have gotten really good at reducing their warranty costs over the past decade.

However, there are a few notable differences as well. First, at no point is the claims rate for the heavy vehicle OEMs higher than it is for the OEMs in general. That doesn't mean that all truck warranties cost less than passenger car warranties, but it does mean that on average they do. And that's probably a function of the truck engine's warranty usually being separate from the rest of the vehicle, while a passenger car's warranty is usually bumper-to-bumper. And that, in turn, means that truck suppliers on average have higher warranty costs than passenger car suppliers.

Second, the heavy vehicle OEM sales data is more variable than the OEMs in general. Trucks and construction equipment have numerous booms and busts caused by everything from mortgage rates to environmental regulations. And, in fact, the accrual rates of the heavy equipment OEMs have been both above and below the all-OEM average, frequently within the same year. This is because the sale of capital equipment tends to rise and fall more frequently than the sale of consumer products.

It's also a function of the passenger car OEMs knowing more about how to anticipate the changes in product reliability and repair cost, and adjusting their accruals in advance. Simply put, they're the experts. And they've become experts at finding ways to pay their dealers less money for less warranty work, as well as finding ways to get their suppliers to pay them more for more of the warranty claims their parts allegedly cause. In contrast, the heavy equipment OEMs are still in school. But more on that next week.

Tenth Annual Product Warranty Reports

As we begin to wrap up our annual survey of U.S.-based warranty providers, here are some links to the online editions of all the previous parts of this series:

 

We Predict: Adventures of Warren T!



GWSCA First Annual Conference on Service Contracts
Assurant Solutions Shed The Light
Fulcrum Analytics
AMT Warranty Corp.
Pegasystems Inc. - PegaWorld
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