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June 5, 2014

Consumer Electronics Warranty Report:

The traditional radio and TV makers are gone, and even laptops are giving way to smartphones. So it's no surprise to see the bulk of the industry's warranty expenses shift from Hi-Fi to Wi-Fi. But that expansion also drags in lots of business-to-business sales as well as heavily-exported product lines into the analysis.

The problem with consumer electronics is it's always changing. By the time the typical CE product's warranty is up, it's out of style. But the biggest problem with consumer electronic warranty expenses is its worldwide scope -- there's so much being imported and exported that an analysis of just one national market is bound to mislead.

Still, as we begin to wind down our annual survey of the warranty expenses of American manufacturers, we need to include something about consumer electronics. The problem is that all manufacturers release only their worldwide warranty expense figures, and don't break them down by product line, customer type, or national origin.

We began this year's analysis with a list of 84 U.S.-based manufacturers whose products we found for sale in top consumer electronics retail outlets. And by using that shortcut, we avoided any questions such as "What is a consumer electronics product?" Simply put, under our working definition, a consumer electronics product is an item sold to consumers by a consumer electronics retailer.

That solved lots of problems regarding whether to include such dual-use items as navigational devices, home office equipment, or data networking gear. If it's filled with electronics and it's sold by Wal-Mart, Target, Bass Pro Shops, or Best Buy, it must be a consumer electronics item. However, we could not avoid an even bigger problem. Because these consumer electronics retailers now sell lots of information technology-oriented products, our definition pulled in some of the biggest U.S.-based warranty providers of all.

Besides the passenger car and heavy equipment makers, computer manufacturers are among the companies with the highest warranty expenses in the world. And any one of the top computer makers generates almost as much warranty expense as the entire roster of traditional television, radio, and entertainment electronics manufacturers combined.

Hi-Fi Becomes Wi-Fi

In terms of computer networking equipment, the U.S. manufacturers are dominant worldwide. They export tremendous amounts of products, and their eight- and nine-figure warranty expense reports reflect their worldwide reach. And what they make is what consumers want to buy these days instead of radios or televisions.

Meanwhile, in terms of "traditional" consumer electronics, the U.S.-based companies manufacture relatively little these days. All the big name brands are Asian or European, and their products are imported into the U.S. So their warranty expenses, if known, are denominated in yen or euro (no major Korean, Taiwanese or Chinese electronics manufacturer is known to disclose its warranty expenses publicly).

Therefore, any credible analysis of U.S.-based consumer electronics would have to include some of these U.S.-based computer network and wireless equipment manufacturers. But because of their worldwide success, and because of the parallel fade-out of once-iconic brands such as Zenith and RCA, the new guys are going to dominate the charts.

With that in mind, we divided the list of 84 U.S.-based manufacturers into two groups: 19 makers of computers, smartphones, data storage systems, and data communications equipment aimed at consumers, and 65 companies that make everything else: from the most awesome noise-canceling headphones to the most sensitive fish-finding sonar.

The first group, we'll call the "Consumer IT" faction. It is dominated by five companies: Apple Inc.; Cisco Systems Inc.; Hewlett-Packard Co.; Seagate Technology plc; and Western Digital Corp. And then there are three up-and-comers: Extreme Networks Inc.; Netgear Inc.; and SanDisk Corp. And there are a few now-extinct companies that were around when we began collecting this warranty data back in 2003, such as Gateway Inc. and Palm Inc. And then there are a handful of smaller startups and others.

The second group, which we'll call the "traditional" Consumer Electronics sector, has more members but is much smaller in terms of both revenue and warranty expense. It also crosses over into several other industry sectors such as automotive, telecom, appliances, aerospace, and even medical equipment.

Industry Crossovers

From the telecom equipment industry we have Polycom Inc. and Plantronics Inc. Garmin Ltd. supplies the aerospace industry with navigational equipment. Skullcandy Inc. is a relatively new market entrant into the headphone industry. Singing Machine Co. Inc. makes karaoke machines. Cobra Electronics Corp. has its roots in two-way radios for both trucking and boating, and has evolved its product line to also include dash cams and portable solar chargers. Harman International Industries Inc. provides home entertainment and car audio systems through the Harman Kardon, JBL, and Infinity brand names. And Microsoft Corp., though it is best-known for its Windows and Office software, also has a hardware product line that includes both the Xbox game console and the Surface tablet.

In Figure 1, we've identified the two groups as Consumer IT and Consumer Electronics. This chart tracks the warranty claims paid worldwide by these U.S.-based companies from 2003 to 2013. So for some of the export-intensive companies such as Apple and HP, much of this warranty expense is paid abroad as well. And none of the product warranty claims paid by importers such as Samsung or Panasonic is included.

Figure 1
Warranty in the Consumer Electronics Industry
Claims Paid by U.S.-based Companies
(in US$ millions, 2003-2013)

Figure 1

Note that while the claims payments by the consumer IT group continued to rise to nearly $7.5 billion by 2013, the claims payments by the consumer electronics companies peaked in 2008, and fell to their lowest-ever level in 2013. These trends reflect the rising fortunes of the Apple iPhone, and the unusually high repair rates for the Microsoft Xbox 360. And because Microsoft no longer reports its warranty expenses in its financial statements now that the Xbox crisis has subsided, the company's claims payments are not part of the data for 2013, helping to make that the least-costly year ever for claims payments.

But also note that the $493 million claims total for 2013 is several hundred million dollars less than any other year. That's not all merely from Microsoft's exclusion. It's also because some of the other once-large members of this group, such as Eastman Kodak Co., are still reeling from bankruptcy reorganizations, while other top manufacturers such as Harman International and Garmin are reducing their claims costs the old-fashioned way: by selling more and repairing less.

Diminishing Accruals?

The same patterns can be seen in terms of warranty accruals. In Figure 2, we can see the peak in 2007 accruals for the traditional consumer electronics folks, and we can once again pin that spike on the Microsoft Xbox 360. We can also see the surge in 2013 for accruals by the consumer IT group, and we can pin that on the growth of the Apple iPhone. The timing and the magnitude of the spikes is a little different, but they're cause by the same two products: the iPhone and the Xbox 360.

Figure 2
Warranty in the Consumer Electronics Industry
Accruals Made by U.S.-based Companies
(in US$ millions, 2003-2013)

Figure 2

The decline in 2013 accruals by the consumer electronics group is a bit harder to pin on any one company. Sure, Kodak reduced its accruals from $95 million in 2012 to only $18 million in 2013. But Polycom and Plantronics reduced their accruals by only a few million each, and most of the other major players increased their accruals considerably. For instance, Harman International boosted its annual accrual total from $54 to %76 million last year.

It's just one of those things where the sum of the declines overshadows a handful of increases. For as we said at the outset, the traditional consumer electronics industry is waning in the U.S., while the wireless and computer-networked industries are soaring. And the shift towards consumer IT products shows up not only in the product warranty and sales data, but also in the extended warranty and service contract sales data. It's amazing that some of the larger CE retailers didn't see that coming.

Warranty Expense Rates

In Figures 3 and 4, we've taken the claims and accrual data from Figures 1 and 2 and combined it with product sales data to calculate percentage rates for these warranty expenses. In Figure 3, for instance, we can see the accrual rate soaring for the consumer electronics companies in 2007. That's the Xbox. Then the claims rate rises in 2009. That's primarily, the recession, though Garmin did run into some trouble with rapidly rising claims costs.

Figure 3
Consumer Electronics Manufacturers
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2013)

Figure 3

The good news is, both the group's claims rate and accrual rate has declined since 2009. The 1.2% rate seen at the end of 2013 was the lowest since 2005. But the market is so small that whenever a single domestic manufacturer runs into trouble, be it Microsoft or Garmin, it shows up in the industry average.

In Figure 4 we're tracking the much larger consumer IT industry. It's much larger because it includes huge manufacturers such as Apple, HP and Cisco. But of course, this is really just another way of looking at the companies we covered in the May 1 report on the computer industry, and to a lesser extent, the data communications section of the telecom equipment report.

The End of Warranty Cost-Cutting?

So it's no surprise we're seeing ski-jump-shaped curves for these companies, where the cost-cutting seems to have bottomed-out a few years ago. That's what we also saw for the PC and datacomm industries as a whole. Their lowest warranty expense rates are now behind them, though the latest rates are still low compared to a decade ago.

Figure 4
Consumer IT Equipment Makers
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2013)

Figure 4

What we're seeing is a combination of trends. Some companies such as Apple are being forced by regulators to lengthen their warranties, which drives up their warranty costs. HP continues to cut warranty costs, but its hardware revenues are also falling. Others such as Cisco are finding there's little cost left to be cut, while sales are flat. Seagate and Western Digital are moving more firmly into sales of entertainment systems such as digital media players, and they're finding that the higher warranty costs seen in the retail channel are balanced by even higher sales gains.

So it's a mixed picture. However, the biggest reason for the rise in the average accrual rate to a level above three percent at the end of 2013 is Apple. The smartphone maker set aside more than $5.75 billion in warranty accruals in calendar 2013, more than General Motors and Ford combined.

Longer Warranties, Plentiful Reserves

The thing is, when regulators in Europe and China forced Apple to lengthen its product warranties to two years, it didn't show up in the financial statements as only an increase in accruals. It also appears as an increase in reserves, as well as an increase in the ratio between claims payments and reserves. For instance, in December 2013, at the end of its first fiscal quarter, Apple's warranty reserves stood at $3.98 billion, equal to what it paid in claims in 11 months (it was paying about $355 million a month in claims at the time). That balance was up from $2.97 billion at the end of September, when its reserves were equal to what it paid in claims in 8 months (when it was paying about $379 million a month in claims).

The warranty reserve data in Figure 5 cuts off at the end of calendar 2013. But in the first calendar quarter of 2014, Apple raised its reserves to $4.37 billion, which was equal to what it paid in claims in 15 months. That's nearly a doubling in the ratio between claims and reserves in only six months. And that most recent ratio, we note, is closer to the average length of its product warranties worldwide after factoring in the actions of the regulators.

Figure 5
Warranty in the Consumer Electronics Industry
Reserves Held by U.S.-based Companies
(in US$ millions, 2003-2013)

Figure 5

Figure 5 also shows the same Xbox effect on warranty reserve balances in 2007 and 2008, and also shows a record decline in 2013. Were it not for the parallel growth in computer IT warranty reserves, one could look at these declines as proof that the industry is in decline.

But, as we've said, it's not a decline. It's a sign of the shift from the traditional media -- radio, television and records -- to the Internet, where one needs computers, hard drives and routers to play. And increasingly, tablets and smartphones are replacing keyboards and monitors.

Not all the warranty expenses we've identified as consumer IT are indeed coming from sales to consumers. Small businesses can shop at Staples and Radio Shack too. And much of the warranty expense these manufacturers report actually comes from their exports, not domestic sales. So it's not even all sales to U.S.-based entities.

Higher Warranty Expense Rates?

However, we'd suggest that even after adjusting the totals downward to account for sales to businesses and sales to customers abroad, the IT part of the retail consumer electronics industry generates more warranty expenses per dollar earned than the traditional sectors ever did. For IT products, two-to-four percent expense rates are normal. For traditional CE products, even one percent is high.

As we'll see in a few weeks when the leading Japanese manufacturers file their annual reports and detail the warranty expenses, radios and televisions aren't nearly as repair-prone as laptops and smartphones. The traditional entertainment appliances and their modern-day descendants -- the Blu-ray Disc players and the flat screen TVs -- have relatively low actual warranty expense rates, although that hasn't slowed sales of extended warranties.

Assurant Solutions Shed The Light
Global Warranty Group
Global Warranty And Service Contract Association

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