November 15, 2005

Automotive Warranties:

As seen by its third quarter financial statements, Ford is catching up to GM, both in terms of revenue and warranty spending. Ford has now become only the second American manufacturer to ever pay out $1 billion or more in warranty claims per quarter. Meanwhile, other U.S.-based vehicle manufacturers have their own warranty ups and downs to report.

Forget Toyota. General Motors Corp. is in danger of being overtaken by the Ford Motor Co., both in terms of worldwide automotive sales and warranty costs. For the nine months ended Sept. 30, Ford declared automotive revenues of $112.7 billion, only 3% less than GM's $116.5 billion worldwide total for the same period. In addition, Ford's warranty costs are also rising. The company's warranty expenses finally surpassed $1 billion per quarter during the third quarter of 2005, after flirting with that level for more than a year.

Now there are two U.S.-based manufacturers who spend $1 billion or more per quarter on warranty: GM and Ford. This is not a club anyone wants to join.

Meanwhile, GM continues to spend more than 3% of its automotive revenue on warranty claims, a level it first breached during the first quarter of 2005. Ford, meanwhile, is now spending close to 2.7% -- the highest it's been since details first became a routine part of the financial statements filed with the U.S. Securities and Exchange Commission.

DaimlerChrysler AG, meanwhile, although it's technically now a European-based manufacturer, is still frequently included as part of Detroit's "Big Three." And so, for comparison's sake only, we'll note that the company continues to reduce its warranty expense from the disconcertingly above-5% level seen in early 2005, though it continues to outspend either GM or Ford.

For the third quarter, we estimate DaimlerChrysler's warranty claims at 1.36 billion euro, down from levels that were in excess of 1.4 billion euro in the first and second quarters, but still close to US$1.6 billion at current exchange rates. In terms of the percentage of sales spent on warranty claims, DaimlerChrysler is now at 4.4%, which is the lowest it's been since 2004.

Other Automotive OEMs

Elsewhere among the major automotive OEMs -- companies making everything from motorcycles to huge trucks -- warranty claims are actually on a downward slope. Of the 34 top automotive OEMs, only the Oshkosh Truck Corp. has yet to file a financial statement covering the third quarter (we expect their annual report in a week or two). So, using placeholder estimates just for them, we reckon that the 32 auto OEMs besides GM and Ford spent $577 million on warranty claims during the third quarter, down from $583 million in the second quarter and $602 million in the first quarter.

For the first nine months of 2005, warranty spending by GM, Ford, and the 32 other auto OEMs has totaled $8.34 billion, up more than 10% from the $7.56 billion tallied by this time a year ago. Most of that $780 million surge comes from GM and Ford, as we will detail further down this page. But even without those two, however, the 32 other auto OEMs have seen their warranty claims rise 19% for the year to date -- from $1.48 billion in 2004 to $1.76 billion in 2005.

Three months from now, we'll have the data needed to complete a third complete year of warranty claims trends for the automotive industry. Of course, it's dangerous to project the full year based on only nine months of data. However, what we can tell you is that if current trends continue (they never do), U.S.-based automotive OEMs are on track to spend in excess of $11 billion on warranty claims for 2005, roughly 7% or 8% more than they did in 2004. In comparison, claims grew by only 5.2% from 2003 to 2004.

Charting the Trends

We'll give you three charts to illustrate these trends: one time series each for GM and Ford, and one for the 32 other automotive OEMs. Then we'll finish up with a fourth time series chart showing totals for all 34 U.S.-based auto OEMs (including GM and Ford) for the past 11 quarters.

Let's start with GM. The company continues to be the largest American-based warranty provider, accounting for 18% or 19% of the total for all manufacturers. However, as mentioned above, GM has been outspent by DaimlerChrysler for years, no matter what conversion rate is used for the dollar and euro. So in fact, GM has not been the world's largest warranty provider since at least 2002. Toyota, of course, spends less on warranty than any of the current of former Big Three. Depending upon the yen-dollar conversion rate used, we would estimate that Toyota is spending roughly US$425 million to US$450 million per quarter worldwide on warranty claims.

Back to GM. In the chart below, one can see how the dollar amount spent on warranty claims had been falling since the peak at the end of 2004. However, there was a slight uptick in the third quarter of 2005. In percentage terms, though, there has been little change since the second quarter, because sales were also up slightly. In fact, a year ago GM's claims rate was at 2.9% versus 3.0% now, so there has been relatively little change.

General Motors Corp.
Warranty Claims & Accruals
in % of Sales & $m per Quarter
1Q 2003 to 3Q 2005

Meanwhile, GM's warranty reserve fund has actually begun to shrink in size. It stood at $9.315 billion at the beginning of the year and was at $9.304 billion as of September 30. That's still an enormous amount of money, and is actually equivalent to the amount of claims GM would pay in the next 24 months at current rates.

So far this year, GM has removed $110 million from the reserves during the first quarter and took out another $154 million during the second quarter. In the third quarter, it withdrew another $10 million from the warranty reserves. What's remarkable is how unremarked-upon this has been, considering how controversial it was when GM withdrew funds in 2003 after detecting an increase in quality and projecting a future drop in claims.

In its third quarter earnings release, Ford had to note the fact that it recently added funds to its warranty reserve to cover an unanticipated increase in warranty claims. However, Ford made this announcement in its third quarter financial statement. But it actually added $307 million in the second quarter and added $297 million more in the third quarter (plus $25 million in the first quarter), for a total of $629 million added so far this year. These funds were added in addition to normal accruals, which are depicted by the green line in the chart below.

Ford Motor Co.
Warranty Claims & Accruals
in % of Sales & $m per Quarter
1Q 2003 to 3Q 2005

Although it's not possible to indicate changes in the warranty reserve fund balance in these charts, Ford's warranty reserve is now in excess of $6.1 billion in size, equivalent to what it pays out in claims in about 17 months at current rates. Put another way, only six U.S.-based companies have set aside $1 billion or more to finance future warranty claims: GM and Ford, plus HP, Dell, GE, and United Technologies. Ford's total is now close to the total fund balance for the latter four combined, and is exceeded only by GM's balance. And together, GM's and Ford's balances comprise roughly 40% of the funds held in reserve by all U.S.-based manufacturers.

The most disturbing aspects of Ford's chart are the rises seen in both claims and accruals, as both a percentage of sales and as a raw dollar amount. Both have never been higher, at least not since warranty reporting began in early 2003. As previously mentioned, Ford has now joined the billion-dollar-per-quarter club, in which the only other member was GM. And if Ford's claims payouts climb by another $36 million per month (or if GM's fall by that amount), the company will overtake GM as the largest warranty provider in the U.S. It should be an interesting fourth quarter.

Elsewhere Besides GM & Ford

To arrive at a figure for U.S.-based warranty spending by all automotive OEMs, one would have to chop GM's and Ford's spending into U.S. and foreign components, and one would also have to estimate U.S.-based warranty spending by the European- and Asian-owned manufacturers (for both their U.S.-made and imported vehicles). We're not going to attempt that until at least the end of the year, but other sources have estimated the total to be around $12 billion.

With this nine-month data, all we're going to do is give you a time series. In the chart below, there are slices for 32 different automotive OEMs -- from the motorcycles of Harley-Davidson to the construction vehicles of caterpillar and everything in between: buses, trucks, emergency vehicles, golf carts, forklifts, and snowmobiles.

We've labeled the five largest slices: Cat, John Deere, Navistar/International, Paccar, and Textron. From there on down, Fleetwood Enterprises is the dark blue slice, Ingersoll-Rand is the lavender slice, and the next 25 are too small to even attempt to label. But they do add up. These 32 companies averaged $460 million in warranty spending per quarter in 2003; around $500 million in 2004; and just below $600 million per quarter so far this year.

Top U.S.-based Automotive OEMs
(not including GM or Ford)
Product Warranty Claims
in $ Millions per Quarter
1Q 2003 to 3Q 2005

Source: Warranty Week from SEC data

Caterpillar turned in two high quarters during the first half of 2005 but has since returned to more typical levels, with a third quarter payout of $144 million. Deere & Co., meanwhile, had its largest net claims payout of the past three years in the third quarter. However, that $119 million represented only 2.2% of sales, so it's far from a manufacturing crisis. Navistar and Paccar remain close to their historical levels.

Now let's put it all together. For numerous reasons stated above, any chart that includes GM and Ford is going to be dominated by GM and Ford. Passenger car manufacturers are not only the largest warranty providers among all auto OEMs; they're the largest warranty providers among all manufacturers. So, while auto OEMs account for roughly 40% of all warranty spending, just GM and Ford account for roughly a third.

So let's put GM and Ford back into the chart. We're keeping the color scheme for the others the same, though we're combining the smallest 21 into the gray "other" slide seen at the top of the pile.

Top U.S.-based Automotive OEMs
Product Warranty Claims
in $ Millions per Quarter
1Q 2003 to 3Q 2005

Source: Warranty Week from SEC data

As this chart shows, auto OEMs as a group were paying out roughly $2.3 or $2.4 billion per quarter in early 2003 to settle warranty claims. They've been paying between $2.5 billion and $2.8 billion per quarter ever since. This figure is of course inclusive of any reimbursements they receive from their suppliers, for instance the $240 million reimbursement Ford recently received from Bridgestone Firestone North American Tire. Therefore, although supplier recovery efforts continue to push warranty expenses back up the warranty chain at an increasing rate, payouts to customers are increasing at an even faster rate.

Back to Part One   Go to Part Three

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