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August 21, 2014

Supplier Recovery Efforts:

Are the automotive OEMs paying a growing or shrinking percentage of the warranty costs of their industry? Are the warranty costs of their suppliers rising or falling as a result of their efforts to make them split the bill?

When it comes to the supplier recovery efforts of the automotive OEMs, their best days may now be behind them. The OEMs are seeing their warranty expenses soar while their suppliers are seeing their own expenses fall. It certainly seems to be a reversal of the trend seen just a few years ago.

Five years ago we noticed that the automotive OEMs were paying a smaller and smaller share of the overall automotive industry's warranty claims, suggesting they were successfully shifting more and more of their costs onto their parts suppliers. But that trend seems to have stopped in 2012, and to have switched direction in 2013 and the first half of 2014.

We think it's partially because of some big-headline warranty calamities, specifically Navistar's problems with dirty diesel engines and General Motors' recent safety recalls. But it also could be due to the OEMs letting loose a bit on the grip they once had on their suppliers, and letting some recoverable expenses go unretrieved. Or it could be a little of both.

Let's start with a chart that should be familiar to steady readers of Warranty Week. Figure 1 tracks the claims payments of 49 U.S.-based automotive OEMs and 119 of their U.S.-based suppliers over the past 11-1/2 years. But rather than track those payments in terms of dollars, we're assigning them a percentage market share.

If, in a given year, the automotive industry pays out $10 billion in warranty claims, and the OEMs pay $9 billion while their suppliers pay $1 billion, then their respective market shares would be 90% and 10%. But since we're measuring the claims payments quarterly in Figure 1, they'd be paying 90% of $2.5 billion ($2.25 billion) and 10% of $2.5 billion ($250 million) four times per year, respectively.

Supplier Recovery from 2003 to 2014

The dollar amounts aren't that important. What we're looking for is the change in market shares over time. As can be seen in Figure 1, back in 2003 to 2005 the OEMs' share was indeed close to 90% of the total. In fact, from 2003 to 2007 their share remained primarily within a range of 87% to 90%.

That means their suppliers were paying roughly 10% of the total bill. Well, to be precise, their share ranged from 10% to 13% from 2003 to 2007. The annual bill for the industry as a whole grew from $11 billion in 2003 to $12.9 billion in 2007. And since all the companies are reporting their net expenses (payments minus reimbursements) we know this is more or less the total for the U.S. automotive industry (though it does not include imports).

Then something changed. The OEMs began shifting more and more of their warranty expenses onto their suppliers. In 2009, the OEMs' share fell below 85%, and touched a new low of 82.7% in the middle of 2012. That's an enormous shift of responsibility from the OEMs to their suppliers. For those poor suppliers, going from 10% responsibility to 17% responsibility implies a 70% increase in their share of the bill!


Figure 1
Automotive Product Warranties
Claims Paid by U.S.-based Companies
(as a percent of the total, 2003-2014)

Figure 1


But then notice what happened after that new low was struck in the middle of 2012. In 2013, the OEMs went back up to 85%. And by the midpoint of 2014 their responsibility was back up to 88%. So in essence, we're right back to where we were seven years ago, as if the tightening had never happened.

Most automotive OEMs, when they talk about it, suggest that in an ideal world they could shift 30% or even 40% of their total warranty expenses back onto their suppliers. So far, the best they have ever done was 17.3% in the middle of 2012. And the worst they've ever done was the 10% mark set in the middle of 2004.

We don't know what the true figure might be. Perhaps it's 20%. Maybe it's 30%. But it's probably not 40%. The suppliers account for 35% of the revenue. It's hard to imagine they'd account for a higher share of the expenses. It's much easier to believe it's lower than 35%.

Guessing 25%

Let's pick 25% as a round number estimate. Let's assume that in a perfect world, the OEMs would be able to shift 25% of their warranty claims payments back onto their suppliers. So what we've done in Figure 1A is to take the same data from Figure 1, and to add a new line at 75%.

Everything below that line is and forever shall be the responsibility of the OEMs. They'll never be able to get their share down below 75%, nor can they get their suppliers' share above 25%. That's the maximum.

And then everything above 75% is up for grabs. As mentioned, the shares are now back up to 12% and 88%, where they were for most of 2003 to 2007. But they've been as low as 17.3% and 82.7% in 2012.

In Figure 1A, the light blue section represents the successful supplier recoveries. The dark blue section above 75% represents the lost opportunities -- the supplier recoveries that were theoretically possible but that didn't happen for one reason or another.


Figure 1A
Automotive Product Warranties
Claims Paid by U.S.-based Companies
(as a percent of the total, 2003-2014)

Figure 1A


Again, the data is the same in Figures 1 and 1A. It's the vertical scale that's different. And, the addition of the line at 75% is new. Readers who sincerely believe that 30% or even 40% supplier recoveries are possible can move that line down. We just don't think it's possible, given how dealers charge the OEMs for labor as well as parts, and given how many "No Trouble Found" claims they make each year.

For the OEMs, there's good news and there's bad news in Figure 1A. The good news is that they're still shifting about half of what's possible to their suppliers. If 25% is the theoretical maximum, then at 12% to 17% they're successfully shifting at least one-half and sometimes five-eighths of the maximum to their suppliers.

The bad news is they're still leaving billions on the table. Last year, the OEMs shifted 15% of the $10.13 billion industry total onto their suppliers. But that means they left more than a billion dollars on the table (the difference between 15% and 25%). So far this year, they've shifted only 13% of $5.55 billion onto their suppliers. And that means they're losing ground.

Gap Between Expense Rates

In Figure 2, we've measured the claims rate and accrual rate of the 49 automotive OEMs and 119 of their suppliers over the past 46 quarters. It's a simple weighted average, calculated by adding together all their claims paid and accruals made, and dividing those totals by their product sales revenue figures.

As can be seen in the chart below, the OEMs have generally been reducing their claims and accrual rates over the past 11-1/2 years, except for the recessionary chaos of 2009, and the peculiar upturn this year. Their suppliers, meanwhile, have generally remained flat in a range of 0.5% to 0.7%, again except for the recessionary chaos of 2009.


Figure 2
U.S.-based Automotive Companies
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2014)

Figure 2


Another way of looking at Figure 2 is as a measure of the gap between the typical warranty expense rates of the OEMs and their suppliers. From 2003 through 2008, the gap was generally around 1.9%. From 2010 to 2013, the gap averaged 1.4% for claims and 1.3% for accruals.

But then in the first half of 2014 the chaos returned. As the OEMs' average claims and accrual rates spiked, the gap widened to 1.6% for claims and 2.5% for accruals. As we mentioned, we think that has lots to do with the misfortunes of two large OEMs: General Motors Co. and Navistar International Corp.

Warranty Accruals

In Figure 3, we're looking at the industry data from the other direction: warranty accruals. From this perspective, the story is only slightly different -- the schedule is merely time-shifted forward by a year or two.

From 2003 to 2005, the OEMs made between 86% and 91% of the industry's total accruals. In 2006 and 2007, their share briefly dipped below 84%. But then in 2009, the OEMs' share bottomed out under 80%. And their share remained low in 2010 and 2011.

The ratio remained close to 85% in 2012 and 2013. But then in the first half of 2014 it skyrocketed, hitting a new high of 93% in the spring of this year.


Figure 3
Automotive Product Warranties
Accruals Made by U.S.-based Companies
(as a percent of the total, 2003-2014)

Figure 3


The reason for this tremendous recent reversal may be the misfortunes of two large OEMs: General Motors Co. and Navistar International Corp. GM is of course the largest passenger car manufacturer, and Navistar is a top manufacturer of trucks, buses, and their diesel engines.

In Figure 4, we've charted the warranty expense rates of General Motors Corp. from 2003 to 2009, and General Motors Co. from 2009 to June 2014. Legally, they're separate entities, but we'll treat them here as one.

The source of the chaos seen in Figure 2 for the year 2009 is easy to spot in Figure 4. GM is sufficiently large -- accounting for 40% to even 50% of the OEM totals in any given quarter -- that it can easily move the averages up or down. And from 2003 to 2008, and again from 2010 to 2013, the direction was down. But in 2009, and again in 2014, the direction was up.


Figure 4
General Motors Co.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2014)

Figure 4


That is not a math error in 2014. GM's accrual rate really is 5.1% for the first half of 2014. It set aside nearly $3.8 billion in accruals against $74.8 billion in product sales revenue. That was up from $1.7 billion in accruals against $74.6 billion in sales during the same period a year ago.

Recall Expenses

GM explained in its most recent quarterly financial statement that almost $2.5 billion of that $3.8 billion went towards recall campaigns and courtesy transportation expenses, while $1.3 billion was for traditional product warranty expenses. It never before separated out the recall expenses from the warranty expenses. But it said that a year ago, during the first half of 2013, only a fifth of its total accruals went towards recall expenses. This year, during the same period, recalls accounted for almost two-thirds of the accruals.

The other recent warranty misfortune is Navistar. We spotlighted the company's misfortune earlier this year in Figure 2 of the March 27 newsletter, explaining how the company was seeing its "regular" accrual rate rise rapidly while its "pre-existing warranty adjustments" rose even faster. In fact, we drew in an additional line to show both the old and the new accrual rates.


Figure 5
Navistar International Corp.
Warranty Claims & Accrual Rates
With and Without Changes of Estimate
(as a % of product sales, 2003-2014)

Figure 5


Well, there's great news to report about Navistar. The company's accruals -- both the regular kind and the adjustments, are once again falling back to what could be called a normal range. Regular accruals were back down to 3.1% in the first half of fiscal 2014, while the accrual rate including adjustments was down to 5.7%.

Navistar ends its fiscal year on October 31. So its first quarter of fiscal 2014 covers the months of November 2013 to January 2014, and its second quarter is February through April. And in those two quarters, the company has clearly turned a corner, reducing its warranty expense rates from the heights they hit in 2012 and 2013.

However, its claims rate is still high at 5.6%. But remember, there's a significant time lag between when accruals are made and when claims are paid. Think of the accrual rate as a leading indicator of where the claims rate is headed in the future. So in Navistar's case, if the accruals being made now truly reflect expectations of future trends, then the claims rate is headed back to four or five percent next year or perhaps even later this year.

Industry Totals

On a combined basis, however, what Navistar and GM have done is to drive up the industry total for claims and accruals, as well as the OEMs' share of those totals. As mentioned, the industry total for claims paid during the first half of 2014 was $5.55 billion. That was up from just under $5 billion in the first half of 2013.

The growth in accruals is even more dramatic, thanks to GM. During the first half of 2013, our 49 OEMs and 119 suppliers set aside $5 billion in warranty accruals. So far this year, that total is up to $7.4 billion. And the GM recalls are ongoing, though their financial cost has probably peaked.

Bottom line, because of the GM recalls in 2014, and Navistar's engine trouble in 2012 and 2013, we can't tell whether the recent trends in the warranty expense rates of the OEMs and their suppliers represent the reversal of a long-term trend, or like 2009, a temporary detour caused by unprecedented one-time factors. However, the data is clear in the sense that there's been a change in the trend. What we don't yet know is whether or not it's a permanent change.





GWSCA First Annual Conference on Service Contracts
AMT Warranty Corp.
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