The End of Warranty Cost-Cutting?
For ten straight years, manufacturers steadily reduced their warranty expense rates from over 1.8% of their sales revenue to under 1.3%. But in the eleventh year, the declines stopped coming. Could it be that there's no more left to cut? And have manufacturers instead begun to spend more on the customer experience?
Now that most U.S.-based manufacturers have filed their annual reports with the Securities and Exchange Commission, it's time to look for trends in the product warranty data they've included in those financial reports since 2003.
Year after year, we've reported that manufacturers have once again cut the percentage of sales revenue they spend on product warranty expenses -- squeezing another bit of inefficiency out of their overhead and making products that break a little less often. But we can't report that this time.
In 2013, it seems, manufacturers spent a little more on warranty, not by letting inefficiencies creep back into their processes, but by letting the quality of the customer experience rise a little. And that takes money, which hopefully pays for itself down the road in terms of rising levels of satisfaction, customer loyalty, repeat purchases, and ultimately higher revenue.
Each year, we tout the number of companies that have reduced either their claims rate, their accrual rate, or both. The numbers for this year are less impressive than they've been in the past. Out of the top 100 U.S.-based warranty providers, as measured by the amount of claims they paid in 2013, only 49 managed to reduce their claims rate from where it was in 2012, while only 51 reduced their accrual rates.
We began with a list of the 100 largest claims payers of 2013. However, there were some problems. Eastman Kodak Co. has not yet filed its annual report for 2013. Dell Inc. went private in October, and has therefore ceased making reports to the SEC. And Xerox Corp. did not file the required warranty data with the SEC, so comparisons are not possible.
So we removed those three from our list, and substituted in Itron Inc., Ciena Corp., and Tempur-Pedic International Inc., which each reported making warranty claims payments of around $23 million across the four quarters of calendar 2013. For Itron, that was a huge reduction from 2012 levels, while Tempur-Pedic went through a merger with Sealy Corp. that raised its claims payments considerably.
Claims Divided by Sales
As we mentioned, less than half of these top 100 companies managed to reduce their claims rates in 2013. Of those, only 28 managed to pay out less in dollars than they did in 2012. And then for an additional 21 of them, while claims payments rose, sales rose faster, so the claims rate (claims divided by sales) declined at least a bit.
We can't compare companies directly, because different products in different industries generate different rates of warranty spending. A two percent claims rate might be good for a car company or a computer OEM. But it would be bad for a semiconductor manufacturer or a medical device maker. And even within a single industry, one company might have linger warranties or more responsive customer service, which would drive their rates higher than the competition's. But would that necessarily be a bad thing?
Therefore, what we do is compare each company to itself over time. Rather than saying a certain percentage rate is good, we're saying that cutting that percentage rate in half in a year is really good. So in the tables below, the 10 companies with the largest expense rate declines in the past year are listed. So they're the best cost-cutters, at least in 2013. But in the past year, the rate reductions haven't been all that huge. Only seven companies were able to cut their expense rates by a third or more.
In Figure 1, we've highlighted the 10 largest claims rate reductions, starting with Delphi Automotive, which was the only member of our top 100 that managed to cut its claims rate by half or more. At the end of 2012, it was paying out 1.1% of sales for warranty claims. By the end of 2013, that rate was down to 0.4%, a reduction of 0.7% (nearly two-thirds). The automotive parts supplier was able to reduce its claims payments by $103 million (from $171 million in 2012 to $68 million in 2013) and also enjoyed a 6% increase in sales. So there was much for it to celebrate.
Top 100 U.S.-based Warranty Providers:
Top Ten Claims Rate Reductions,
Calendar Year 2013 vs. 2012
(claims as a % of product sales)
|Company||Dec '12||Dec '13||Year Ago|
|First Solar Inc.||1.8%||1.0%||-0.8%|
|D.R. Horton Inc.||0.8%||0.5%||-0.2%|
Source: Warranty Week from SEC data
For all the U.S.-based warranty providers that we track, claims rose from $24.7 billion in 2012 to more than $26.3 billion in 2013. And claims rose a little faster than product sales, because the average claims rate rose ever so slightly from 1.23% at the end of 2012 to 1.25% at the end of 2013.
Delphi had only the third largest claims decline when measured in dollars, however. General Motors Co. saw claims fall by $330 million. Hewlett-Packard Co. saw claims fall by $309 million. But GM saw only a small rise in auto sales and HP's product revenue actually fell by 7%, so their claims rates didn't decline as impressively as did Delphi's.
At the other extreme, Boeing Co., Deere & Co., and Navistar International Corp. each saw claims payments rise by $100 million or more in 2013, and each also saw its claims rate rise significantly. But the biggest shock was Apple Inc., which saw its claims payments rise by more than two billion dollars in calendar 2013!
However, Apple also illustrates what we think we're seeing in terms of the end of warranty cost-cutting. The company's claims and accrual rates were lowest in 2009, when sales of the iPhone were hitting their stride and sales of the iPad were about to begin. Those rates stayed low until mid-2012, but then began to rise significantly.
Why did Apple's warranty expense rates rise so dramatically in 2013? Part of the reason is the fragility of expensive and complex handheld devices. But most of the reason, we believe, has to do with the longer warranties the company was forced to provide in Europe, China, and elsewhere, and the better customer experience it chose to provide worldwide.
The End of Negative Publicity?
Remember all those stories there used to be about allegedly false positives on Apple's moisture indicators? Remember all those class action lawsuits that used to revolve around this or that aspect of Apple's warranty policy? There aren't so many of them now. Very quietly, Apple has improved the customer experience. And that costs money.
In terms of warranty accruals, Apple has gone even further. In two of the four quarters of calendar 2013 (we write it this way because the company's fiscal year actually ended on September 28, 2013, so we're looking at the second, third and fourth quarters of that fiscal year and the first quarter of fiscal 2014), Apple's accrual rate was close to four percent, the highest it's ever been. Since accruals are made to finance future warranty spending, Apple must be planning to pay out an increasing percentage of its revenue in the future to cover its warranty costs.
Apple is now the world's largest warranty provider, having eclipsed GM, Ford and HP in recent years. In fact, in calendar 2013, it set aside more than $5.7 billion in warranty accruals, an increase of more than $3 billion since calendar 2012. And although sales revenue is also soaring, both the company's claims and accrual rates were up by almost half by the end of 2013, compared to the end of 2012. And we think that has less to do with the quality of the product and more to do with the quality of the warranty program.
In Figure 2, we've organized all the warranty providers we track into one of 14 different industry categories. Then we added together all the warranty accruals they reported making during an eleven-year stretch from 2003 to 2013.
For all the U.S.-based warranty providers that we track, accruals were up from $25.3 billion in 2012 to nearly $27.8 billion in 2013. But as we just mentioned, Apple's increase was even larger than that $2.5 billion increase. In other words, were it not for Apple, accruals would have declined in 2013.
In the chart below, it's clear that the largest industry sectors when it comes to warranty expenses are automotive, computers, telecom equipment, and appliances/HVAC equipment. Of those, computers grew the most, followed by telecom equipment. Appliance and HVAC accruals grew only slightly. And automotive accruals were actually down a bit. We're still classifying Apple as a computer company, however, so that's the reason why the red band grew in size so significantly last year.
Worldwide Warranty Accruals
of U.S.-based Companies
(accruals made in US$ millions, 2003-2013)
It's a little difficult to see the growth or decline in some of the smaller industry sectors, however, so here's a snapshot. Of the 14 industry sectors, 8 were up and 6 were down. Five industry sectors -- the computer OEMs, the homebuilders, the telecom equipment makers, the consumer electronics companies, and the power generation equipment makers -- each saw their accrual totals rise by 10% or more. It was the iPhone that caused the first; the recovery in new home sales that caused the second; and the growth of solar energy that caused the last. The other two we just don't know the reasons yet. The only sector to see a decline in accruals of 10% or more were the medical and scientific equipment makers. We haven't yet figured out a reason for that decline either.
However, the point is that most of the changes in accruals were small, with eight of them well under 10% up or down, and some such as aerospace hardly changing at all. In future weeks we'll analyze each of those industry sectors in more detail. The conclusion for now is that the totals wouldn't have changed by much if not for the iPhone.
Top Accrual Rate Reductions
But let's get back to the top 100 warranty providers for a moment. In Figure 3 we've listed the top 10 accrual rate reductions we saw among the top 100. On our website home page, we've listed all 51 of the top 100 companies that cut their accrual rates in 2013.
As with claims rate reductions, the magnitude of these cuts is less than in years past. We think it's a sign that the era of warranty cost-cutting is largely now behind us. In 2013, only 51 of the top 100 warranty providers cut their accrual rate at all. Only 21 companies reduced their accrual rates by one-tenth or more. And only six managed to cut their accrual rates by one-quarter or more from the percentages seen at the end of 2012.
Top 100 U.S.-based Warranty Providers:
Top Ten Accrual Rate Reductions,
Calendar Year 2013 vs. 2012
(accruals as a % of product sales)
|Company||Dec '12||Dec '13||Year Ago|
|Helen of Troy||2.9%||1.7%||-1.2%|
Source: Warranty Week from SEC data
Seven of these top 10 in Figure 3 also reduced their claims rates. Only Itron and Pentair also made it into the table in Figure 1, however. FMC and First Solar just missed making the top 10 of Figure 3. And NetApp also would be on the list of top 10 claims rate increases, if we were including such a chart in this newsletter. While the data storage company cut its accrual rate from 2.7% to 1.5% last year, it also saw its claims rate rise from 1.2% to 1.9%. That is not a good combination. Both rates should rise or fall together, not go in opposite directions. And no company should be in two top 10 charts in opposite directions.
However, in the past year the expense rate reductions were less than impressive across all the manufacturers we track. In Figure 4, we've taken all the claims and accrual totals reported by all U.S.-based manufacturers in the 44 quarters since the start of 2003, and divided them by product sales figures to calculate the percentages for the claims and accrual rates. So there are a total of 88 data points in this chart.
The Recession Leaves Its Mark
There are two features that stick out. One is the big rise in the average claims rate seen during 2009. That's caused by the recession -- more precisely, it's caused by the phenomenon where sales fall precipitously but claims fall only a little. And that in turn is caused by worried customers holding onto their purchases for longer periods, and seeking repairs more often than they did during the good times. In other words, when the washing machine breaks during a recession, instead of shopping for a new one, more consumers call a repairman.
The other feature that sticks out is the "noise" we see in the 2013 data. From 2003 to 2012, except for that recessionary excursion in 2009, the direction of the data has more or less been trending downwards. Back in 2003, manufacturers spent an average of about 1.8% of their product revenue on warranty expenses. By 2010 or 2011, those rates were down to 1.4% or so.
Claims hit their minimum rate of 1.23% in the fourth quarter of 2012. The average accrual rate hit its minimum level of 1.28% four times in the last eight quarters. But at year end, both rates were above those minimums. And in the first and third quarters of 2013, those rates were significantly above where they've been for the last few years.
All U.S.-based Companies
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2013)
This, we believe, is the best evidence yet that the cost-cutting has ended. In Figures 1 and 3 we showed that the largest warranty providers aren't cutting their expense rates by as much as they did in the last few years (for details, compare the data above to the same charts in newsletters published one year ago or two years ago). In Figure 2 we showed that while the iPhone caused a big jump in accruals, without its contribution the totals would have changed only slightly for most industry sectors.
But in Figure 4, we see that something changed in 2013. The expense rates hit bottom, and started bouncing around. We think that's a sign that many manufacturers have stopped looking for ways to cut warranty expenses and have instead begun looking for ways to turn their spending into a better experience for the customer. More on that in the weeks ahead.