April 11, 2013

Supplier Recovery:

If all the warranty expenses that were caused by suppliers were paid by suppliers, what would the industry split be between them and the OEMs that they supply? And are the OEMs now recovering a quarter of what they could, half of what they could, or three-quarters of what they could?

A reader asked a question that turned out to have both a simple and a complex answer: In terms of warranty costs, how much of what the OEMs could actually recover from suppliers is actually being recovered now?

With ten years of warranty data in hand for all U.S. manufacturers, we figured we could answer that question for both the automotive and the electronics industries. It would be too complex and convoluted for the aerospace, homebuilding, or appliance industries, because we wouldn't have as good a split between the OEMs and the suppliers as we do with automotive and electronics.

The simple answer was somewhere between half and three-quarters. In the automotive industry, we reckon that the OEMs are about halfway there, collecting about half the reimbursements they could ever expect to get. In the electronics industry, however, they're already about three-quarters of the way there, collecting well over half of the reimbursements they could ever expect to get.

Who Gets the Warranty?

But there was also a complex answer, even just for those two industries. First, we've always organized our categories by what kind of product a company makes. To answer that question, we'd also have to consider what kind of customer they sell it to, because it's asking about actual vs. potential recoveries of cost by companies that sell to end users, from companies that sell to other companies.

It's not so simple then. Some companies make parts, but sell them directly to consumers. Some parts companies also make complete products that they sell to consumers. Some OEMs also make parts for other OEMs. Some products, such as engines, tires, disk drives and printers, can be sold to OEMs and to end users. It all comes down to who gets the warranty? An end user or another manufacturer?

We looked first at the automotive industry, where we've always classified all the companies as either OEMs or suppliers. But even there, we had to make some changes, because of how the warranties are issued.

Before we did the number crunching, we moved four companies from the supplier to the OEM category. For instance, Cummins Inc., though it supplies primarily diesel engines for trucks, does so in a way that it ends up issuing its product warranty directly to the end user truck buyer. Similarly, Standard Motor Products Inc. is in the business of making auto parts, but it sells them through the aftermarket to repair shops and vehicle owners. So it's more like an OEM than a supplier, at least in terms of how its warranties are issued.

And then there are two automotive product retail chains, which for some products go above and beyond what the manufacturer's warranty offers, incurring the additional liability themselves. Advance Auto Parts Inc. and The Pep Boys -- Manny, Moe & Jack (yes, that's their official company name) are therefore moved from the supplier to the OEM category.

Changing the Categories

We'll still call them OEMs and suppliers, but think of them more as companies that issue warranties to users and companies that issue warranties to other vendors. The important thing is who ultimately paid the cost of the claim: the OEM or one of its suppliers?

We are going to propose a theory, and then see if it is supported by the data. Our theory is that in a perfect world, where every warranty claim that's caused by a supplier is paid by a supplier, that the best the OEMs could ever hope for is a scenario where they pay 75% of the industry's total warranty bill and their suppliers pay 25%. In other words, if the total annual bill is $10 billion, in an ideal world the OEMs would pay $7.5 billion and the suppliers pay $2.5 billion.

Some people say the split should be 80/20. Others say 70/30, or even 60/40. For this exercise, we're going to say 75/25, and see where it takes us. But we're eager to hear from other readers who think it's something different.

Figure 1 contains the same data as was seen in the April 4 newsletter, with just the four companies noted above switching sides. The only other changes are that it's quarterly data instead of annual, and that it's expressed as a percentage of 100% instead of in dollars, as it was in last week's newsletter.

We've drawn a line across the chart at 75%, and what's above this line we're saying is the excess, the lost opportunity -- the part of supplier recovery that wasn't actually recovered from the suppliers. Instead, it was paid by the OEMs.

Figure 1
Automotive Product Warranties
Claims Paid by U.S.-based Companies
(as a percent of the total, 2003-2012)

Figure 1

As can be seen from the chart, the wasted opportunity amounts to 4% to 14% of the total in any given period. In other words, the user-facing automotive group has paid out between 79% and 89% over the past decade. But their share never fell below the 75% level, which supports our theory that this represents the maximum success rate.

The wasted opportunity, meanwhile, averages out to 9.5% of the total, meaning that the user-facing automotive group has paid an average of 84.5% of the automotive industry's total warranty bill over the past decade, while the vendor-facing suppliers averaged 15.5%.

In a perfect world, the split could have been 75/25. But in our world, it's a little more weighted towards 85/15 instead. Often, people try to use these percentages as a measure of a company's performance. After all, it’s a simple calculation: money recovered divided by money spent. However, the percentage of warranty costs recovered from suppliers is heavily dependent on specific aspects of a business, making it very dangerous to compare between companies or between different divisions of the same company.

Across the industry, the maximum might be 25%. But inside a given company, the maximum might be 10%. Or it could be 40%. And to get such a benchmark, one would need to consider other factors such as:

  • What percentage of the warranty spend is purchased from suppliers vs. manufactured in-house? And is the in-house portion accounted as 100% recoverable or 0%?

  • Are the warranty coverage periods the same?

  • Do the warranty coverage periods of the company match those of the supplier?

  • How much of the product design is the complete responsibility of the company, i.e. proprietary system designs, and how much is the responsibility of the supplier?

  • Does the warranty spend only include standard warranty costs, or does it also reflect company internal part profits, campaigns or purchased coverage?

Only after getting the data aligned for all these questions can we be sure that company-to-company comparisons of supplier recovery rates are accurate and useful for constructive benchmarking.

Half and Half?

We also looked at accruals using the same methodology, and the same 75/25% line as our theoretical maximum. In Figure 2, the short-term changes are a bit more volatile, but they're more or less within the same range. The user-facing automotive group makes between 76% and 88% of the automotive industry's total accruals, and the vendor-facing suppliers account for the remainder: 12% to 24%.

Here, the vendor-facing group got within a hair of 25% during one of the past 40 quarters, but again they never exceeded it. If they had, well, it couldn't be the maximum if it was ever exceeded. Meanwhile, if 25% is indeed the accurate maximum, the wasted opportunity for the user-facing group to get reimbursements has varied from one percent to 13%, and has averaged 7.7% over the past decade. So in round numbers, then, we're looking at half the potential actually recovered from suppliers, and half of it a lost opportunity.

Figure 2
Automotive Product Warranties
Accruals Made by U.S.-based Companies
(as a percent of the total, 2003-2012)

Figure 2

With both the claims data in Figure 1 and the accrual data in Figure 2, it appears that the user-facing group is wasting a larger percentage of their supplier recovery opportunity in the past few years than they did in earlier years. In fact, for both claims and accruals, the user-facing group hit their peak in the third quarter of 2006.

But remember, all we're looking at here so far is who paid the bill. We're taking the industry's totals -- $10.02 billion in claims paid and $10.13 billion in accruals made by U.S.-based automotive companies last year -- and saying that the user-facing companies paid about 87% of both. Had they been as good as they could possibly be at getting reimbursed, they could have cut that bill down to 75% of the total.

Compared to Product Revenue

Another way of looking at supplier recovery trends is to compare those claims and accrual totals to product revenue. Again, we did that in the April 4 newsletter, but now we're moving around Cummins and the retailers.

In Figure 3, the percentages are therefore a little bit different than in last week's newsletter. We've also charted both pairs of claims and accrual rates on the same scale.

Two trends stick out: First, except for the recessionary bump, both pairs of expense rates are declining. Second, the gap between them seems to be narrowing.

Figure 3
U.S.-based Automotive Companies
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2012)

Figure 3

Back in the years 2003 to 2007, the gap was usually close to two percent. The user-facing group was usually around 2.5%, while their suppliers were around 0.5%.

During the recession, the user-facing group saw its expense rates soar, and the gap widened to as much as 2.7% at one point in 2009.

Ever since, the gap has not once exceeded 2.0%, and in fact it's dipped to as little as 1.5%.

We think this is evidence that the user-facing group is cutting its warranty expenses through a mixture of increased product reliability, decreased warranty repair costs, and increased supplier recovery efforts. But we couldn't begin to chop up the cost reduction further than that without more data.

How to Calculate Your Own Rate

For any particular OEM, the way to make a comparison of your own data to the industry average would be as follows: Get three totals from your own data, for net claims you paid, net accruals you made, and product sales you reported. And then get two totals for each of your suppliers: how much you paid them for products, and how much they paid you in warranty expense reimbursements.

With those five data points, you can calculate your own claims and accrual rates, and each of your suppliers' claims rate (facing you). You won't know their claims rate facing all their customers, and you won't know their accrual rate. But you can at least calculate the gap, and see how much it is above or below two percent.

Now, let's run the electronics industry through the same analysis. It's a little more complex, because we've previously divided that segment into seven categories. Four were what we'll call electronics OEMs: the computer makers, the telecom equipment makers, the medical and scientific equipment makers, and the consumer electronics makers. And three were suppliers: disk drive manufacturers, semiconductor and printed circuit board manufacturers, and computer peripheral manufacturers.

We've taken the four OEM categories, united them and called them the "user-facing OEM manufacturers" of the electronics industry. And the three supplier categories are their "vendor-facing suppliers," in recognition of the way they issue their product warranties to other manufacturers rather than to end users.

Electronics Imports?

This time, we didn't shift any companies from one category to the other. That's because many electronics companies function as both suppliers and OEMs for different parts of their product line. So they're already crossing categories. And indeed, there's a huge hole in our data since only the worldwide warranty spending of U.S.-based companies is being considered here. Imports are not represented at all, which skews the consumer electronics figures in particular.

However, in the other three OEM categories, the U.S. is a net exporter. And in some, the U.S. accounts for more than half the total world production. So we'll just have to assume that there's a rough balance between the OEMs who also supply, and the suppliers who also sometimes sell directly to end users. in other words, for every external disk drive a supplier such as Seagate sells to a consumer at retail, an OEM such as Motorola provides some other manufacturer with a chip set or a circuit board.

Figure 4 contains all of the data included in the March 28 newsletter, as well as some data we've gathered but have yet to publish (telecom and medical equipment, for instance).

It's remarkable that in Figure 4, the amount of claims paid by the user-facing electronics companies sticks so close to 81% of the industry total over the course of the past decade, while the vendor-facing suppliers remain so close to 19% during that time. However, notice there was a distinct upturn at the very end of 2012, and in general the ratio has been rising slowly over the past decade.

Figure 4
Electronics Product Warranties
Claims Paid by U.S.-based Companies
(as a percent of the total, 2003-2012)

Figure 4

The user-facing group enjoyed their minimums back in 2003 and 2004. Since then, their share of the total has been below 80% only once, at the beginning of 2005. And it neared 84% in the fourth quarter of 2012. It's averaged 81% over the past 10 years.

If 25% is the theoretical maximum for the vendor-facing group within the electronics industry, then they have yet to come within three percentage points of that level, at least in terms of claims payments. In 2003 and again in 2004, they paid over 21% of the industry's total claims, but never more than that. For warranty accruals, however, it's a different story.

Close to the Maximum?

In Figure 5, we can see that in terms of accruals, the vendor-facing electronics companies have come awfully close to that 25% level a few times. In the third quarter of 2009, for instance, the user-facing group paid $1.651 billion in claims out of a $2.185 billion industry total, lowering their chare of the bill to under 76%. In 2008, they briefly got their share down to 77%. And at one point in 2010, they made 78% of the U.S.-based electronic industry's total accruals.

Therefore, if the ratio has already come close to 25/75 on three occasions, is it possible the true maximum is a bit higher than we'd assumed? After all, if the suppliers did once pay 24% of the total, and on other occasions paid 22% and 23%, how could the maximum be only 25%? Maybe it's really 30%? Or even 35%? We could rerun the numbers using those theoretical maximums, but they seem on the high side to some automotive and electronics executives we spoke with. So readers, we need some advice: What is the real maximum?.

Figure 5
Electronics Product Warranties
Accruals Made by U.S.-based Companies
(as a percent of the total, 2003-2012)

Figure 5

Over the past ten years, the user-facing companies have made an average of 82% of the accruals. And as can be seen in Figure 5, however, they've been at or above that level for the past two years. And again, there's a disturbing rise in the ratio right at the end of 2012, to a new high of almost 88%. In other words, rather than reducing their share to 75%, they're headed in the other direction.

Declining Supplier Recovery Success?

With just this data in hand, one might conclude that the user-facing companies are slipping in their ability to recover warranty costs from their suppliers. However, once again, a comparison with revenue suggests quite the opposite trend.

In Figure 6, we've taken the dollar amounts for claims paid and accruals made, and compared them to product revenue for both the user-facing and the vendor-facing electronics companies.

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

Figure 6

Compared to the automotive industry, the pairs of lines are closer together, meaning the gap is smaller between OEMs and suppliers in the electronics industry. That may be a sign that in the electronics industry there is more selling by suppliers directly to consumers, and more selling of parts by OEMs to other OEMs. In other words, the line between them is less distinct than it is in the automotive industry.

However, the trend is towards the gap narrowing. Back in 2003 to 2007, the gap was frequently at or above one percent. Since 2008 it has never exceeded one percent. The long-term average gap for both claims and accruals rate pairs is 0.8%. In the middle of 2012, the gap between the line pairs narrowed to only 0.5%.

The Simple Answers

So let's now answer that reader's question: In terms of warranty costs, how much of what OEMs could recover from suppliers is actually being recovered?

In the automotive industry, the size of the missed opportunity has ranged from $880 million in 2006 to nearly $1.5 billion in 2011. And the percentage of the industry's total claims payments that goes unrecovered has ranged from 6% to 13%.

In the electronics industry, in dollar terms, all but $400 to $800 million per year is being recovered from suppliers. Depending upon the year, the missed opportunity has been between 5% and 7% of the industry total claims payments that's gone unrecovered.

But let's put it a different way. Assuming that what the suppliers pay now is the current level of supplier recovery, and that the 25%/75% level actually is the maximum, then where are they now? In the space between no recovery at all and total recovery of all that's possible, where are these industries at the present time?

In the automotive industry, we figure they're about halfway there. In 2012, for instance, the OEMs recovered $1.37 billion from their suppliers, when we figure they could have recovered $2.7 billion. That's a 51% success rate. In 2011, they recovered $1.44 billion out of a possible $2.9 billion, for a 50% success rate. So they're getting reimbursed for about half of all that's possible.

In the electronics industry, they're actually already more than three-quarters of the way there. In 2012, the OEMs recovered $1.7 billion out of a possible $2.4 billion, for a 73% success rate. In 2011 they recovered $1.7 billion out of a possible $2.3 billion, for a 76% success rate. So they're about three-quarters of the way towards recovering all that's possible.

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!We Predict: Adventures of Warren T!

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