Every time a vehicle is sold, its manufacturer sets aside enough funds to finance the amount of warranty work they expect it to require over the life of its warranty. The surprising thing is how widely these accrual rates vary worldwide.

Usually, we calculate accrual rates as a percentage of revenue. This week, we'll do that in addition to calculating the average accrual rate per vehicle sold, comparing four European OEMs, two Japanese OEMs, and two American OEMs.

Let's start off with the four European automotive OEMs: Volkswagen AG, Daimler AG, BMW AG, and Fiat S.p.A. In the chart below, we've plotted their respective accrual rates from 2002 to 2011, calculated by dividing their total reported accruals by their automotive revenue.

Volkswagen at the Top

As was discussed in last week's newsletter, Volkswagen has always spent the greatest share of its revenue on warranty costs, with its decade-long accrual rate varying between 4.9% and 5.8% of revenue. Each of the other three have shared second place, with BMW there from 2002 to 2004; Daimler (as DaimlerChrysler) there from 2005 to 2009; and Fiat in second place in 2010 and 2011.

Note that since all four companies report in the euro currency, these are "apples-to-apples" comparisons, in the sense that we're comparing each of their annual accrual totals, in euro, to each of their annual revenue figures, in euro. And as we again noted last week, while BMW's and Daimler's accrual rates have trended downward over time, Fiat's has trended upwards. VW has remained at the high end, staying close to its long-term average.

Of course, each company's product lines are different, and have changed over time. Daimler and BMW are known for their luxury sedans, but Daimler also makes trucks and BMW also makes motorcycles. VW has always been the "people's car," and with its success in China has become even moreso. Fiat has acquired Chrysler while Daimler has divested the American carmaker.

Units Sold & Average Selling Price

In addition to their revenue and accruals, these automotive OEMs also report the number of units sold each year. This makes it possible to derive two additional metrics from their data: average revenue per vehicle sold, and average accruals per vehicle sold.

Again, the differences between them show up in these metrics. Of course, the luxury brands have a higher selling price. For its Mercedes cars, Daimler commanded revenue of upwards of 47,000 euro per vehicle in 2010 and 2011. In those same years, BMW got upwards of 37,000 euro per vehicle for its cars, and 12,000 euro per motorcycle.

Fiat and VW were more diverse. While Fiat's Ferrari brand sold for roughly 300,000 euro per vehicle and its Maserati brand sold for about 100,000 euro, its Fiat brand was closer to 13,000 euro per vehicle. VW doesn't break out revenue by brand, but we suspect its Bentleys sold for more than its SEATs, with Volkswagen and Audi somewhere in the middle. Overall, its average selling price per vehicle was close to 17,000 euro in 2011.

The reason why this matters can be seen in Figure 2. We took the accrual rates from Figure 1 and applied them to average selling price of the OEM's entire product line. For instance, if VW had an average selling price of 17,000 euro, and if its accrual rate was 5.3%, then its average accrual per vehicle was 900 euro.

In other words, VW's actuaries are expecting the company to spend an average of 900 euro on warranty work for a 2011 model over the life of its warranty. Theoretically, they set aside that amount of money each time they sell a vehicle, so when they've sold 8.4 million units they've accrued 7.5 billion euro.

It doesn't matter whether the warranty claims come in during 2011, 2012, or another year. The company expects to spend an average of 900 euro per vehicle by the time all the 2011 models are out of warranty.

Accruals vs. Claims

It is for this reason that we're tracking accruals rather than claims this week. What we want to show is the expectation of the company's planners as to how much their warranties will cost them, based on how many vehicles they sold and how much they accrued per year. If we tracked claims, we couldn't map the data back to a given sale, because some of a given vehicle's warranty work will be done during the year it was sold, while some will be done in subsequent years.

But anyway, what the data shows is that Daimler now accrues the most per vehicle, as it has for the past five years. In 2006, VW took the lead, while in 2002-2005 it was BMW.

Again, all four companies report in euro, so these are "apples-to-apples" comparisons. All four companies sell vehicles outside the euro zone, so that's a factor to consider. For instance, Mercedes and BMW command a high dollar price per unit in North America, while VWs sell for relatively low prices in China. And now Fiat has to account for Chrysler's sales as well as its own.

We would say that product mix also is a factor, except we're not sure it really is. For instance, Daimler has a significant stake in the sale of trucks, vans and buses. And one would assume this would skew the figure for average selling price per unit. But in recent years, the revenue per unit figures for the larger vehicles were less than their luxury sedan cousins.

We also have to consider whether sales of smaller vehicles, and indeed, whether sales of non-vehicles skews the comparisons. For instance Daimler's Detroit Diesel unit sells truck engines. Fiat spun off its truck and farm equipment businesses, but it retains its powertrain line of business, in addition to Magneti Marelli, Teskid, and Comau.

Japanese Trends

Over in Japan, Honda Motor Co. has a significant stake in the motorcycle business, and also makes both generators and boat engines. So while we can be sure that the company as a whole had an 0.8% accrual rate in the fiscal year ended March 31, 2012, we cannot say for certain whether this rate applied equally to the motorcycle, boat engine, generator, and car businesses.

In Figure 3, we add to the uncertainty by plotting warranty accrual rates for Toyota Motor Co. in two ways. From fiscal 2003 to fiscal 2011, the company reported figures for its product warranty spending only. But for 2009 to 2012, it reported warranty and recall expenses together. And as the headlines in recent years have noted, recalls have become a significant expense for the company, especially in the U.S.

Honda, meanwhile, has managed to cut its accrual rate significantly over the past decade, from a high of 2.0% in fiscal 2004 to a low of 0.8% last year. Over that period, motorcycles have taken a bigger share of total revenue, while cars have fallen to a new low of 78% of total revenue in fiscal 2012. There's a more detailed description of this trend in the June 28 newsletter.

Since the accrual rates are calculated using a given company's total product revenue, what we could be looking at in Figure 3 is the effect of these changes in Honda's product mix. If, for instance, cars require a higher accrual rate than motorcycles, then the company-average accrual rate would drop as Honda sells relatively more motorcycles and less cars.

Then again, because cars have accounted for 78% to 83% of Honda's total revenue, they must also have been the determining factor in how its planners decide how much to accrue. So let's assume for a second that generators, boat engines and motorcycles had absolutely no warranty expense at all. In other words, let's assume that the 60 billion yen that Honda accrued in fiscal 2012 was 100% for its cars.

Given that the company's overall accrual rate is 0.8%, and given that cars accounted for 78% of sales, this would mean that the company's accrual rate for just its cars could not have been higher than one percent of its car revenue, even if its motorcycles and generators never needed a repair. In much the same way, we don't think VW's Bentleys, Fiat's Ferraris, or Daimler's trucks could have swayed their company's overall averages by much.

Warranty Costs in Yen

So let's move on to the next step. In Figure 4, we've plotted the figures for average accruals per vehicle for both Honda and Toyota. The figures are all in yen, so one would assume that overseas sales would have affected both companies in a similar fashion. For while the claims are paid in the local currency where the warranty work is performed, it has to be converted back into yen for the annual report.

Notice that Toyota's accrual bill per vehicle sold fell significantly to 59,425 yen in fiscal 2012, from 80,490 yen the year before. In dollar terms, using the prevailing exchange rates at the time, the accrual per vehicle dropped from $968 to $723. This happened despite only small gains in worldwide unit sales, and a two percent drop in product revenue.

Toyota's accruals per vehicle sold have been significantly higher in the last four years than they were in the preceding six. This is due primarily to the inclusion of recall expenses in those figures since 2009. We don't have warranty-only data for fiscal 2012. But in fiscal 2011, our calculation for warranty-only accruals per vehicle was 31,674 yen -- less than half the total for warranty+recalls. In fiscal 2010, warranty-only accounted for 54% of the warranty+recall total.

American Warranty Costs

And finally, we turn to the U.S. market. We still don't have any Chrysler data, though it looks like Fiat will add the company's warranty costs to its own next year. But we do have a limited amount of data for Tesla Motors Inc., which over the last four years seems to have brought its accrual rate down considerably.

In Figure 5, we're not making an exact apples-to-apples comparison, however, because while General Motors has always included warranty+recall costs together, Ford Motor Co. began doing so only recently. There's more about that accounting change in the April 5 newsletter.

GM, meanwhile, continues to reduce its accrual rate year after year. In 2007 and 2008, it stood around 2.9%. In 2009, it slipped under 2.6%. By 2010, it was down to 2.4%. And last year, it was below 2.1%.

In a company with over $100 million in annual product revenue, this means significant cost savings. Having accrued more than $5.1 billion in 2007 and $4.3 billion in 2008, GM accrued only $3.1 billion last year. Spread across nine million vehicles, that translates into only $339 per vehicle. Back in 2007, the average was closer to $548 per unit sold.

Reducing Warranty Costs

In fact, as can be seen in Figure 6, both GM and Ford have reduced their warranty accruals per vehicle significantly in the last three years. Part of the reason, especially for GM, is the increase in sales of smaller and lower-priced units with shorter warranties, particularly in Asia. But undoubtedly, what the warranty planners of both companies are telling us is that they see less of a need for warranty work on recent models.

Now, let's take the data from Figures 2, 4 and 6 and unify it in a single chart. But because Figure 2 is in euro, Figure 4 is in yen, and Figure 6 is in dollars, we have to choose one and make some conversions.

We compared the warranty accruals per vehicle averages of all eight OEMs in all three currencies, using the companies' own foreign exchange calculations (they report their financial figures to the U.S. Securities and Exchange Commission in dollars). And since they're translating into U.S. dollars, so will we.

Choosing a Single Currency?

First, we have to note that the choice of currencies significantly alters the outcome. Back in fiscal 2007, the dollar was fetching 118 yen. Now it is barely over 82 yen per dollar. At that time, the euro was at $1.46. It averaged $1.30 per euro last year, and went below $1.22 this morning.

This impacts the OEMs in different ways. Back in 2007, it was very expensive for GM and Ford to pay for warranty work done in Europe, because the parts cost and labor rates were in euro. But it was relatively less expensive for them to pay for warranty work on whatever vehicles, if any, that they could sell in Japan. Now, it's expensive for the European OEMs to pay for warranty work in the U.S. in dollars, while it's a bargain for the Japanese OEMs, given the relative strength of the yen.

In other words, not all the rises and falls in Figure 7 are caused by the predicted frequency of warranty repairs. Some of it has more to do with the severity, but more specifically, with the predicted cost of the warranty work in the local currency, given the payer's native currency.

With that in mind, we've ranked the eight companies (treating the fiscal year ended March 31, 2012 as Toyota's and Honda's 2011) in descending order of warranty cost per vehicle for last year. European OEMs are at the top, as one might expect. But what's surprising is how far down the rankings the American OEMs are.

The European OEMs are ranked 1, 2, 3, 4, so the same rankings that applied in Figure 2 are more or less repeated here. BMW accrued the most per vehicle in 2002-2005, with VW taking 2006 and Daimler taking every year since. But as Daimler reduces accruals, and VW stays the same, it's possible there may be another change in the rankings when this year's final numbers come in next summer.

Twice As Much?

In 2010, Toyota was third-highest, followed by BMW then Fiat. Last year, Fiat was accruing slightly more ($9.40) per vehicle than Toyota. But both of them were accruing about twice as much per vehicle as GM and Ford.

Yes, let's say that again. Fiat, at $732, and Toyota, at $723, were accruing about twice as much as GM ($339) or Ford ($389). But Honda, at only $182 per vehicle, was half that again. And Daimler, at $1,581, was more than twice as high as Fiat.

The warranty planners who decide on accrual levels are taking into account local labor rates and parts costs, which as we've said can vary tremendously between markets and across currencies. And of course, even the duration of a warranty varies between markets, even on similar vehicles. But it's still amazing that over the life of their respective warranties, the planners apparently expect the warranty work on a Ford to cost twice as much as on a Honda; for a Fiat to cost twice as much as a Ford; and for a Mercedes to cost twice as much as a Fiat.

As a wise luxury auto dealer once told us, those free donuts aren't really free.

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