September 18, 2014

Appliance & HVAC Warranties:

Expenses are down in early 2014, partially because of lower product sales and partially because of effective cost-cutting programs. But GE is leaving the business and the other top manufacturers are among the best cost-cutters. So expenses are likely to keep falling.

In our recent cross-industry probe of the warranty expenses of OEMs and their suppliers, we avoided the major appliance industry, despite its hefty share of the overall claims total. The reason is we don't think it can be done.

We began with a list of 39 U.S.-based manufacturers of major appliances such as washers, dryers, refrigerators, and stoves, and parts for those units, and 39 manufacturers of heating, ventilation, and air conditioning units and HVAC parts. And we quickly realized there were three major obstacles to an OEM vs. supplier comparison.

First, there are too many OEMs and not enough suppliers to make any comparative analysis possible. For the most part, the top OEMs are their own suppliers, so there's not as much of a split between the two as there is in the computer or automotive industries.

Second, as with the aerospace, power generation equipment, medical equipment, and building material industries, there is a major player that is so big that it distorts the rest of the data. In this case, however, there are two, with General Electric Co. distorting the appliance totals, and United Technologies Corp. distorting the HVAC totals.

The problem is, each company reports only its top-level worldwide total warranty expenses, and doesn't break them out by division or product line. So we can't separate out just GE Appliances or just Carrier Corp., and we end up having to also count warranty spending by GE Healthcare and Sikorsky Aircraft Corp.

Our third problem is that these 78 appliance and HVAC manufacturers are among the best-run and longest-running warranty providers in the country, and things don't change all that fast or all that much over time. Simply put, there's not much drama here, even though these 78 companies paid out almost $3 billion in claims last year.

Kitchen/Laundry vs. Heating/Cooling

So here are our solutions to these problems. Rather than separate the companies into OEM vs. supplier, we'll separate them into HVAC systems vs. other major appliances. And rather than risk allowing GE and UTC to distort the data with their size, we'll consider them separately. And as for the drama, we'll try to make some up as we go along.

In Figure 1 we're looking at the claims paid by GE and 38 other appliance manufacturers over the past 11-1/2 years. But since GE discloses its warranty expenses only once a year, we've made its first-half 2014 claims total identical to its first-half 2013 total, just so there's no hole in the data. By the way, that once-a-year reporting schedule is also why GE's data looks like a series of plateaus in the horizon.


Figure 1
Major Appliance Product Warranties
Claims Paid by U.S.-based Companies
(in millions of dollars per quarter, 2003-2014)

Figure 1


All 39 appliance companies paid out $1.65 billion in claims in 2013, up from $1.59 billion in 2012. However, so far this year, claims cost is declining. Just the 38 appliance companies (excluding GE) paid out $422 million in the first half of 2014, down from $454 million in the first half of 2013. But their sales were also down slightly, so that decline in expenses is to be expected.

Notice that mid-2007 spike in the claims totals for the other appliance makers. That's caused by Whirlpool Corp., which we'll spotlight in Figure 8. And that sudden spike also turned out to be part of the quarterly peak in claims for the group as a whole.

The annual peak for the group as a whole came a little later, in 2009. But as is obvious from the chart above, there really hasn't been much of a decline in claims payments since then. Even GE is paying about the same amount as it did four or five years ago. There's just not much drama in the data.

Quiet Times in HVAC Warranty Costs

In Figure 2, it's clear that the lack of drama extends to the 39 HVAC companies as well. They had their peak year in 2007 and have seen their claims payments slowly decline ever since. But most of that decline is caused by United Technologies.

The 38 others besides UTC paid out $1.07 billion in 2007 but have remained within 7% of that total ever since. UTC, meanwhile, has cut its claims payments almost in half, from $531 million in 2007 to $277 million in 2012 and $287 million in 2013. Therefore, as can be seen in Figure 2, it looks like all the HVAC companies besides UTC/Carrier are paying about the same amount as they always have.


Figure 2
HVAC Product Warranties
Claims Paid by U.S.-based Companies
(in millions of dollars per quarter, 2003-2014)

Figure 2


As for drama, that sudden decline in claims payments -- the notch in the early 2012 data -- was caused by Emerson Electric Co., which didn't reveal why its expenses plummeted so dramatically during that particular quarter. However, its claims payments later in the year were a little above normal, so we suspect it was just a matter of timing.

In the first half of 2014, the HVAC companies besides UTC paid $525 million in claims, up slightly from the $508 million they paid out during the same period in 2013, and more or less in proportion with a slight gain in product sales. However, some companies such as Johnson Controls Inc. actually saw slight decreases in their claims totals, while others such as A.O. Smith Corp., LSB Industries Inc., and Modine Manufacturing Co. were basically unchanged.

Both the major appliance and the HVAC companies are heavily tied to new home construction rates for sales, so it's no surprise that their peaks are long behind them. However, both industry segments also sell into a replacement market, where the owners of existing homes upgrade and replace the units they started with. And that has served to moderate the decline much more than was seen in last week's newsletter covering warranty expenses in the new home industry.

Decreasing Expense Rates

In Figure 3, we've taken the data from Figures 1 & 2 and added it all together and set the total to equal 100%. But except for those sudden excursions in 2007 and 2012 caused by Whirlpool and Emerson, respectively, there's not much drama in this chart either.


Figure 3
Appliance & HVAC Product Warranties
Claims Paid by U.S.-based Companies
(as a percent of the total, 2003-2014)

Figure 3


GE and the other appliance makers account for between 50% and 60% of the total, and UTC and the other HVAC companies account for the rest. The HVAC companies briefly accounted for more than half the claims at times before the market peak in 2007, and the appliance makers went over 60% in 2012 when the HVAC makers saw their claims briefly plummet (thanks to Emerson).

There is a bit of drama in Figure 4, which tracks the claims and accrual rates of all 78 companies at once, from the start of 2003 to the middle of 2014. However, we're sorry to say that both the wide swings in rates seen in 2003 and 2004 and the declines seen since 2012 are largely due to the weight and size of GE and UTC.


Figure 4
U.S.-based Appliance & HVAC Manufacturers
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2014)

Figure 4


Back in 2003 and 2004, GE advised that its product warranty expenses were primarily related to GE Power Systems, or to GE Energy after some units were renamed. So in those years, its expenses were compared only to the revenues of GE Power Systems or GE Energy.

In subsequent years, GE ceased detailing the source of its warranty expenses and revenues so finely. And it made some acquisitions, particularly in the medical equipment field, which broadened the scope of its warranty-bearing product line. Therefore, we had to widen the amount of revenue under consideration, which both lowered and flattened the expense rates from 2005 onwards.

Higher Expense Rates

Back in 2003, we calculated GE's claims expense rate at 4.1%, comparing its $749 million in expenditures just to the revenues of GE Power Systems. And then in 2004 we calculated a 4.8% rate, based on $838 million in expenditures compared to the revenues of GE Energy. But ever since, we've calculated GE's expense rates based on a much wider slice of the company's business units, which cut its claims and accrual rates to near one percent.

In Figure 5, we've detailed the calculated claims rates of GE from 2005 to 2013. Even though the company's annual claims payments climbed as high as $917 million (in 2008), those totals never amounted to much more than one percent of its industrial product revenue. But we don't want to leave the impression that GE radically reduced its warranty costs, when all it really did is reshuffle its revenue segmentation. Therefore, we're leaving out the 2003 and 2004 data points which now look like they don't belong. However, they're probably closer to the true cost of warranty than is the data below.


Figure 5
General Electric Co. (including GE Appliances)
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2005-2013)

Figure 5


Fortunately, GE Appliance is going to have to reveal its true warranty expense rates soon, because as was announced on September 8, Electrolux AB is expected to buy the GE Appliances business unit sometime next year. So GE is likely to report some amount of warranty reserves it eventually sends off with its divestiture.

Electrolux, based in Sweden, controls appliance brands such as Eureka, Philco, Kelvinator, Gibson, Frigidaire, and Faure. And it is a member of a short list of European manufacturers that discloses its warranty expenses in its financial statements. While, it's not expected to separate the expenses it generates through its existing brands from those it acquires from GE, when the annual report for 2015 is published we'll be able to measure the increase and estimate how much came from GE Appliances. And, at the same time, we can measure how much GE's remaining warranty expenses decline.

Electrolux Warranty Data

In Figure 6, we're repeating the warranty data published for Electrolux in the August 7 newsletter. The point we want to make is that GE and Electrolux aren't very different when it comes to the percentage of revenue they spend on warranty. Therefore, we expect to see a big change in the warranty expense totals, but little change in the expense rates, when the acquisition paperwork is finally published in early 2016.


Figure 6
Electrolux AB
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2013)

Figure 6


In Figure 7, we're repeating a chart from the August 28 newsletter that details the dramatic decline in warranty expense rates seen at United Technologies Corp. As we said in that newsletter, we don't know if the expense rates declined at Carrier, Sikorsky, Otis, Pratt & Whitney, or at some other business unit. But we suspect the trend was company-wide.


Figure 7
United Technologies Corp. (including Carrier)
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2014)

Figure 7


Whatever its source, the expense rate reduction has resulted in literally hundreds of millions of dollars in savings over the past decade. Back in the first half of 2003, the company paid $238 million in claims and made $356 million in accruals, against $10.7 billion in product sales. In the first half of 2014, United Technologies paid $168 million in claims and made $121 million in accruals, against $23.7 billion in product sales. And expense rates have fallen from around 2.3% to around 0.6% as a result.

Whirlpool Warranty Data

Finally, towards the top of this newsletter we mentioned a dramatic spike in warranty expenses at Whirlpool, and we wanted to show that in chart form. Actually, as can be seen in Figure 8, the company's claims rate spiked just once, in 2007, but its warranty accrual rate spiked twice, in 2007 and again in 2010.


Figure 8
Whirlpool Corp.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2014)

Figure 8


On the flip side, both expense rates fell dramatically in late 2004 and again in late 2005. But those were mere blips in a long-term trend that's seen the world's leading appliance manufacturer reduce its expense rates slowly but surely over the past decade.

When Warranty Week first began collecting product warranty data back in early 2003, Whirlpool's expense rates were 3.5% (accruals) to 3.7% (claims). In the first half of 2014, Whirlpool's claims rate was 2.1% while its accrual rate was under two percent of product revenue.

So perhaps if one looks closer at some of the individual companies, there is a bit of drama in the data. While some large manufacturers such as GE contribute to the constant flatness of the charts, others such as United Technologies and Whirlpool have found ways to dramatically reduce their warranty expenses.





GWSCA First Annual Conference on Service Contracts
AMT Warranty Corp.
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