May 18, 2017

Telecom Equipment Warranty Report:

Claims and accruals have fallen dramatically in the past decade, both in terms of dollars and as a percentage of sales. Mergers and bankruptcies were a major factor, but so were cost-cutting efforts. Now, however, expenses are rising again and sales aren't, so expense rates are creeping upwards.

Telecommunications equipment manufacturers were consistently reducing their warranty expense rates until about four years ago. It was one of the best examples of warranty cost-cutting we could find, outside of the automotive industry. But since then, their expense rates have begun to climb back up to where they were a decade ago. And this trend seems to be widespread, with numerous companies and industry sub-groups reporting higher claims and accrual rates.

To tabulate this week's results, we first started with a list of 205 U.S.-based companies that manufacture telecommunications equipment and report warranty expenses in their financial statements. We then broke the list into four smaller groups:

  • Internet/Datacomm Equipment (65 companies)
  • Landline/Mobile Phone Equipment (59 companies)
  • Broadcast/Cable TV Equipment (48 companies)
  • Satellite/Microwave Equipment (33 companies)

Each of the 205 telecom equipment companies was placed into one and only one of the smaller groups, even if they could have qualified for two or more. In those cases, the group that accounted for the largest share of their revenue was chosen.

The Datacomm Group was led by companies such as Cisco Systems Inc.; Netgear Inc.; Juniper Networks Inc.; Itron Inc.; and Extreme Networks Inc.; and in past years by 3Com Corp. (which HP acquired). The Phone Group was led by companies such as Ciena Corp.; Valmont Industries Inc.; Adtran Inc.; and Plantronics Inc.; and in past years, by a myriad of other telecom network equipment suppliers that are now gone.

The TV Group was led by companies such as Arris International; SPX Corp.; Infinera Corp.; Polycom Inc.; and until recently, by Broadcom Corp. (which was acquired in 2016 by Avago Technologies). And the Satellite and Microwave Group was led by companies such as Garmin Ltd.; ViaSat Inc.; Iridium Communications Inc.; Orbcomm Inc.; and Harris Corp.

Warranty Metrics

We then gathered four essential metrics for each of the 205 companies over the past 14 years: the amount of claims paid, the amount of accruals made, the amount of warranty reserves held, and the amount of products sold. For the latter metric, we excluded all service and finance revenue, and other non-warranted revenue sources, so that we could use the data to calculate two rates: claims as a percentage of product revenue, and accruals as a percentage of product revenue.

In Figure 1 we're tabulating the claims paid per year by members of the four groups. What's immediately obvious is that the Internet/Datacomm Group is the only one experiencing any long-term expansion, while the Landline/Mobile Phone Group has nearly collapsed. That's because while we're not counting important handset manufacturers such as Apple Inc. in this week's report, we are counting dearly departed firms such as Nortel Networks Corp., Lucent Technologies Inc., Avaya Inc., and 3Com., which along with Cisco and Motorola, used to dominate these markets a decade ago.

Claims paid by all four groups peaked at $2.2 billion in 2006, and exceeded $2 billion in only one other year: 2008. In 2016, claims paid by all telecom equipment makers totaled $1.2 billion, and that was up by about $94 million from the 2015 total.


Figure 1
Worldwide Warranty Claims Paid
by U.S.-based Telecom Equipment Manufacturers
(in US$ millions, 2003-2016)

Figure 1

Most of the increase came from the Internet/Datacomm Group, which saw its claims payments rise by $69 million to $931 million in 2016. The Landline/Mobile Phone Group saw claims rise by $16 million to $62 million. The satellite/Microwave Group saw claims rise by $15 million to $100 million. But the Broadcast/Cable TV Group saw claims paid fall by $6 million to $107 million.

Netgear saw one of the largest increases in claims payments last year. Its annual bill rose from $68 million in 2015 to $110 million in 2016. Sales barely increased, so its claims rate soared from 5.2% to 8.3%. That's the highest the company's claims rate has ever been, though it almost hit eight percent in early 2009.

Cisco saw claims rise by $19 million in 2016, but that represented a small fraction of the $706 million it paid in 2015. Garmin saw claims rise from $42 million to $55 million, and Arris International (cobbled together from bits of Motorola, Broadcom, Pace plc, and the Arris Group) saw claims rise from $44 million to $57 million. And then those increases were partially offset by claims payment declines at SPX, Itron, and Ciena, among others.

Warranty Accruals

It's much the same story with warranty accruals, which as can be seen in Figure 2, peaked for the industry as a whole in 2006 at a height of $2.3 billion. Meanwhile, 2014 remains the low year, when accruals fell to just over one billion dollars.

In 2015, accruals rose by $89 million, and in 2016, they rose by another $104 million, to a five-year high of $1.2 billion. Once again, most of that increase was due to the contributions of the Internet/Datacomm Group, which saw accruals rise by $122 million in 2015 and $88 million in 2016.

For the other three groups, accruals made in 2015-16 represented reversals of the 2014-15 patterns. The Landline/Mobile Phone Group saw accruals fall by $15 million in 2016, after rising by $11 million in 2014-15. The Satellite/Microwave Group saw accruals rise by $19 million in 2016, after falling by $8 million from 2014 to 2015. The Broadcast/Cable TV Group saw accruals rise by $12 million to $109 million last year, after falling by $36 million from 2014 to 2015.


Figure 2
Worldwide Warranty Accruals Made
by U.S.-based Telecom Equipment Manufacturers
(in US$ millions, 2003-2016)

Figure 2

With this warranty metric, the biggest annual increase was reported by Cisco, which increased its accruals by $38 million to $741 million. Arris was close behind, with a $33 million increase, followed by Netgear with a $29 million increase. However, because of its smaller size, the increase impacted Netgear the most, with its accrual rate rising from 6.2% to 8.2%. For Arris and Cisco, the increase in accruals raised their respective accrual rates by only 0.4% each.

And then there were a few companies that reduced their annual accruals significantly. Valmont reduced its accruals from $29 million to $10 million, and reduced its accrual rate from 1.1% to 0.4%. Infinera Corp. cut its accruals by $6 million and reduced its accrual rate from 4.1% to 3.3%. Both companies, we should note, also saw slight sales declines.

Warranty Reserves

Besides claims and accruals, there are several other factors that contribute to changes in the balance left in the warranty reserve funds of the telecom equipment companies. First, there are the entrances and exits caused by acquisitions, mergers, and bankruptcies. In 2016, Polycom Inc. was taken private, while Broadcom Corp. was acquired by semiconductor manufacturer Avago Technologies, and Checkpoint Systems Inc. was acquired by the Canadian firm CCL Industries Inc. In 2015, Cobra Electronics went private, and Aruba Networks was acquired by Hewlett Packard Enterprise.

Second, there are numerous adjustments that need to be made because of fluctuations in the exchange rates of the world's major currencies (telecom equipment is a huge export market for the U.S., except in the case of mobile phone equipment), and because of past over- or under-accruals. Itron, Infinera, and Harris Corp. were among the companies reporting the largest adjustments in 2016.

With few exceptions, however, the trend in year-end warranty reserve balances followed the same pattern as was seen with claims and accruals: they're gradually rising now after years of declines. The biggest difference with this metric is that balances were highest in 2003 and 2004, and were lowest in the past three years. Warranty reserves grew by $57 million last year to $1.03 billion, after falling by $54 million from 2014 to 2015.


Figure 3
Worldwide Warranty Reserves Held
by U.S.-based Telecom Equipment Manufacturers
(in US$ millions, 2003-2016)

Figure 3

Warranty reserves grew for three of the four telecom sub-groups as well. Reserves were up by $58 million for the Internet/Datacomm Group; were up by $7.2 million for the Broadcast/Cable TV Group; and were up by $5.8 million for the Satellite/Microwave Group. Reserves fell by $14 million for the Landline/Mobile Phone Group.

Arris reported that its reserves grew by $39 million because of acquisitions and mergers. Netgear's reserves rose by $15 million, and Juniper Networks saw its balance rise by $13 million. Among the largest decliners, Cisco was down by $20 million, Itron was down by $11 million, and Valmont was down by $10 million last year.

Warranty Expense Rates

In several industries, we've detected a worrying trend, where we've seen the average warranty claims and accrual rates that we began measuring in 2003 fall for a decade before beginning to rise again. Telecommunications equipment seems to be one of these industries.

It isn't as simple as increased sales bringing with them increased expenses. By our estimation, industry product sales revenue was up by less than one percent last year. And sales were actually down for the data network and phone groups. So warranty expenses, if they were remaining proportional, would also be declining. But instead, they're rising, both in dollar terms and as a percentage of sales.

In Figure 4, we've taken the claims and accrual totals from Figures 1 and 2 and divided them by the corresponding product sales figures of the 205 telecom equipment companies that we're tracking. As is plain to see, the group's average claims and accrual rates bottomed out in 2013 at 0.8% and 0.9%, respectively, before beginning to rise again. In 2016, they were back to just under 1.5% -- back to where they were in 2008.


Figure 4
U.S.-based Telecom Equipment Manufacturers
Average Warranty Claims and Accrual Rates
(as a % of product sales, 2003-2016)

Figure 4


Obviously, the lower the expense rate, the better, and falling expense rates are better than rising, so the trend in Figure 4 looks good from 2003 to 2013, and bad from 2013 to 2016. The question is, whose fault is this?

Data Network Equipment

Unfortunately, there's no clear answer in the data. In Figure 5, we're looking at the warranty expense rates of the Internet and data network vendors. Depending on the metric, this group accounts for between 60% and 80% of the entire industry's total warranty spending, so it's likely to have the largest effect on the overall trends as well.

However, while we do see a recent upturn in the claims and accrual rates in Figure 5, what we don't see is a decade of decline followed by three years of increases. In fact, the lowest the group's expense rates have ever been was back in 2008, and their accrual rate was actually a bit higher in 2013 than it was in 2016.


Figure 5
U.S.-based Internet/Datacomm Equipment Manufacturers
Average Warranty Claims and Accrual Rates
(as a % of product sales, 2003-2016)

Figure 5


Also, warranty expense rates in the Internet/Datacomm Group have generally remained close to their 1.7% long-term average. That's somewhat higher than the 1.4% average of the industry as a whole.

Then again, many of the largest warranty providers in this group did see their expense rates rise by the end of last year. Cisco's claims rate rose from 1.7% to 1.9%, while its accrual rate rose from 1.5% to 1.9%. Netgear saw both rates rise above eight percent. Juniper Networks saw its claims rate rise from 0.8% to 0.9%, while its accrual rate rose from 0.8% to 1.2%. Itron, however, lowered its claims rate by 0.2% and kept its accrual rate the same.

Phone Equipment

The remaining U.S.-based manufacturers of landline and mobile phone equipment have a much better chance of being the cause of the downward-then-upward trend. As can be seen in Figure 6, their claims and accrual rate did in fact bottom out in 2013, after almost a decade of declines.


Figure 6
U.S.-based Landline/Mobile Phone Equipment Manufacturers
Average Warranty Claims and Accrual Rates
(as a % of product sales, 2003-2016)

Figure 6


However, there's no longer enough warranty expense in this group to sway the entire industry's averages significantly. While it accounted for half or even two-thirds of the industry's total expenses back in the days of Nortel, Motorola, and Lucent, now it accounts for only 5% to 10%.

Among the largest warranty providers within this group, there weren't as many expense rate increases either. By the end of 2016, Valmont saw its claims rate rise by 0.4%, but it cut its accrual rate by 0.7% anyhow. Ciena reduced both rates by small amounts last year, compared to 2015. And Plantronics saw a slight rise in its claims rate, but held its accrual rate steady anyhow.

Television Equipment

As can be seen in Figure 7, the broadcast and cable TV equipment companies only partially followed the overall industry trend. There was only a very slight decrease in expense rates from 2003 to 2012, though there has been a noticeable increase in expense rates in the years since. Still, this group has never spent more than one percent of its product revenue on warranty costs, so it definitely can't be responsible for raising the entire group's average to 1.4%.


Figure 7
U.S.-based Broadcast/Cable TV Equipment Manufacturers
Average Warranty Claims and Accrual Rates
(as a % of product sales, 2003-2016)

Figure 7


Although these companies tend to issue longer product warranties than the other three groups, and therefore to keep a relatively higher warranty reserve balance than the others, that doesn't necessarily mean they have higher annual expense rates. Set-top box manufacturer Arris International, for instance, generally keeps its claims and accrual rates below one percent, though its accrual rate did rise from 0.4% at the end of 2015 to 0.8% at the end of 2016. Optical network manufacturer Infinera Corp., meanwhile, generally has higher-than-average expense rates, but it was still able to reduce its accrual rate from 4.1% in 2015 to 3.3% in 2016.

Satellite & Microwave Equipment

Our fourth group could have been responsible for the downward-then-upward trend seen in Figure 4, if only it was a little bit larger. In Figure 8, we can see that the group's warranty expense rates peaked in 2008, plummeted until 2011, and then rose again through 2016.


Figure 8
U.S.-based Satellite/Microwave Equipment Manufacturers
Average Warranty Claims and Accrual Rates
(as a % of product sales, 2003-2016)

Figure 8


However, going back to Figures 1 through 3 again, this group also never accounted for much more than 10% to 15% of the overall industry totals. So it could never have moved the industry averages to the degree that the Internet or phone equipment companies could have.

Garmin Ltd. is the largest warranty provider in the satellite and microwave category. And while its claims rate rose 0.3% and its accrual rate rose 0.5% last year, companies such as Arris, Netgear, and Cisco paid out much more and sold more equipment. Plus, Garmin has managed to keep its warranty expense rates under two percent for most of the past six years, after a somewhat chaotic period from 2008 to 2010.

Arris has only become a major warranty provider in the last few years, so while it might be contributing to the recent upward trend, it didn't have much to do with the decade-long downward trend. Netgear, meanwhile, has seen its warranty expenses rise in 2015 and 2016, but its expense rates were just as high from 2006 to 2010.

The closest match we can find is probably Cisco. From 2003 to 2011, the company gradually drove its warranty expense rates down, from roughly 2.4% to under 1.4%. But then its expense rates began to rise again, though only back to roughly 1.9% by the end of 2016. It doesn't account for everything we see in Figure 4, and the timing is a little off, but it's the best candidate we can find that's capable of moving the industry averages down and then up.





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