April 11, 2007

Product Warranty Claims, 2003-2006:

Signs are emerging that suggest a peak in warranty spending by American manufacturers. Is it better management? Shorter warranties? Or could it be nothing more than sales rising faster than costs? With four years of data to examine, there's evidence for each scenario.

Could it be? American manufacturers seem like they're getting a handle on their warranty spending, slowing the rate of increase and making sure there's enough set aside to avoid earnings surprises.

US-based manufacturers have so far reported $28.1 billion in product warranty claims during calendar 2006, an increase of 2.6% over the previous year. Accruals actually fell by $400 million to $28.4 billion, the first time that's ever happened since warranty expenditures became public information.

In fact, the traditional fourth quarter peak in warranty spending, seen in 2003 and the again in 2004, simply failed to materialize in the latest accounting. Claims paid during the fourth quarter of 2006 were actually slightly below the $7.1 billion total seen in the third quarter, suggesting that perhaps we've reached something of a plateau.

Waiting for the Late Filers

However, we've yet to hear from Dell Inc., Navistar International Corp., UTStarcom Inc., Armstrong Holdings Inc., and roughly 30 other warranty providers, so that total is expected to go higher as their now-past-due financial reports are filed with the US Securities and Exchange Commission. What we've done for the time being is to use place-saving estimates for each company, until the actual figures become available.

Figure 1 only begins to tell the story. As the blue columns illustrate, warranty claims failed to increase during the fourth quarter of 2006, leaving the third quarter's total of $7.13 billion as the highest ever recorded. And while warranty claims as a percentage of product sales was up just a bit, it remains significantly below the claims rates seen in 2003. Part of the reason is increasing sales, but there also must be some increased efficiency in that equation.

Figure 1
US-Based Manufacturers:
Warranty Claims & Accruals, 2003 to 2006
(in $ Millions and % of Product Sales)

Warranty Claims and Accruals

Notice also that warranty claims and accrual rates are now virtual mirrors of one another, after diverging for all of 2004 and 2005. This means that manufacturers on the whole are setting aside virtually the same amount as they're spending, implying that their collective warranty reserve balances are more or less unchanged.

As Figure 2 details, this is indeed the case. The warranty reserves of some 800 manufacturers stood at $39.7 billion at the end of 2006, slightly below where it was at Sept. 30 and slightly above where it was at June 30. In the chart below, the purple bars represent the closing balances of all US-based warranty-providing manufacturers.

Figure 2
US-Based Manufacturers:
Warranty Reserves, 2003 to 2006
(in $ Millions and months)

Warranty Reserves

Measured a different way, the capacity to pay claims is actually now at the low end of the range it has seen over the past four years, as detailed by the dark blue line in Figure 2. Let's assume that manufacturers are paying claims at a rate of $2.37 billion per month. That would mean their capacity to pay claims is now below 17 months, computed by dividing $2.37 billion into $39.7 billion. It's dipped below 17 months a few times during the last four years, but it's never remained there for two consecutive quarters.

Annual Claims & Accruals

Figure 3 takes these quarterly totals and adds them into a simplified annual chart. The dark blue bars represent warranty claims paid for products already in the field, while the green bars represent the accruals made for products just sold. Notice that while accruals have always been a bit higher (reflecting increased annual sales), they've never been closer than they were in 2006.

However, sales for these 800 manufacturers were up 6% in 2006 while warranty claims were up only 2.6% and accruals were actually down 1.5%. So something is happening, and we suspect it's better warranty management. In 2005, sales were up 8.5% while claims were up 8.0% and accruals were up 4.8% In 2004, sales were up 10% while claims were up 4.7% and accruals were up 11%.

Figure 3
US-Based Manufacturers:
Warranty Claims & Accruals, 2003 to 2006
(in $ Billions per Year)

Warranty Claims and Accruals per Year

Now let's take the annual claims totals reported in Figure 3 and chop them up by industry. This time out, we've placed each manufacturer into one and only one of 13 rather broad industry categories, or if none of them fit, into the "other" category.

We carved out a new power generating category, which is where General Electric's turbines make their best fit, along with the offerings of companies such as Capstone Turbine Corp. and Power-One Inc. That reduces the "other" category significantly, leaving it with a mix of sports equipment, petrochemical equipment, and assorted consumer electronics items.

Where Is Consumer Electronics?

One would think that consumer electronics warranties would be a major category, and as measured at retail indeed it is. But the sad truth is that most of those products are manufactured abroad by foreign-owned companies, and so they're not among the 800 who regularly report their warranty expenditures to the SEC. Meanwhile, extended warranties are more the domain of the retailers and their insurance partners, leaving little in the way of product warranty claims for US-based consumer electronics manufacturers.

Figure 4
US-Based Manufacturers:
Warranty Claims by Industry, 2003 to 2006
(in $ Billions per Year)

Warranty Claims by Industry

Color Key

If the color scheme seems a bit peculiar, we have a good excuse: in Figures 5-8, we've tried to divide the product warranty world into three big families: vehicles, electronics, and buildings. And then there are subdivisions of each family. In the case of electronics, there were so many overlapping subdivisions that we broke it into two charts.

Each of the following four charts follows the same methodology: as in Figure 4, each of the 800 manufacturers was assigned to one and only one industry category. Then their warranty claims were totaled, and divided by their collective product revenue. The resulting ratios represent the percentage of product sales spent on warranty claims.

When it comes to major warranty providers such as Motorola Inc. and GE, the choice of categories weights the average considerably. But when choices had to be made, we looked into their revenue segmentation and made some back of the envelope guesses about the source of most of their warranty spending. Therefore, Motorola is in the telecom equipment category, and GE is in the power equipment group.

Vehicle Warranties

In Figure 5, the considerable warranty presence of Ford and General Motors is felt in the dark blue line for automotive OEMs. But they're far from alone. This is also the home for Caterpillar, Deere & Co., Navistar, Fleetwood Enterprises, and Paccar, along with roughly 30 other makes of everything from golf carts to fire engines.

The light blue line represents the average for some 90 or so of their US-based suppliers. As is readily apparent, there's quite a gap between their respective claims rates. The bad news is that the gap has usually been around 2%. The good news is that in 2006 it's fallen slightly to around 1.8%. However, both groups are seeing increasing rates.

Figure 5
US-Based Vehicle Manufacturers:
Warranty Claims Rates, 2003 to 2006
(in % of Product Sales)

Vehicle Warranty Claims Rates

Midway between the two are the manufacturers of airplanes and avionics. It's basically OEMs and suppliers together; blending the averages of United Technologies, Boeing, Textron, Honeywell, Rockwell Collins, Goodrich, and others. It's also one of only two industry segments to show sustained claims rate decreases over the past four years.

Computer Warranties

The other sustained decline is turned in by one of the four computing and communications industry segments detailed in Figure 6. Data storage system vendors, representing everything from huge RAID arrays to pen-sized flash memory units, are now at the low end of a sustained three-year decline in claims rates.

Figure 6
US-Based Computer Manufacturers:
Warranty Claims Rates, 2003 to 2006
(in % of Product Sales)

Computer Warranty Claims Rates

Notice that computer vendors as a whole are showing higher claims rates than even the automakers. And while companies such as Hewlett-Packard and Apple are seeing declines, others are seeing increases. And we really don't know what's going on with Dell, which has missed several SEC filing deadlines because of an investigation into its accounting practices.

At the other extreme are the peripherals manufacturers. Like the automotive suppliers, they generally suffer relatively low rates of warranty claims. However, keep in mind that this segment blends the generally high claims rates seen with printers with the generally low rates seen with terminals and monitors. If we were to divide up this segment even further, it would become clear why the shape of the trend line is so erratic.

In Figure 7, we've detailed two more high tech categories: medical/scientific equipment and semiconductors/printed circuit boards. Why are they separate? Because otherwise they would have crowded on top of the categories in Figure 6. For high tech warranty claims rates, there's a bit of a traffic jam between 1% and 2% of product sales, it seems.

Figure 7
US-Based High Tech Manufacturers:
Warranty Claims Rates, 2003 to 2006
(in % of Product Sales)

High Tech Warranty Claims Rates

Finally, we've included three categories in Figure 8, each of which is related to the building and/or furnishing of homes and offices. Note that while some tools vendors are included in building materials, many construction vehicles are included in the automotive category. HVAC is combined with appliances into one super-sized category for heating, cooling, washing, cooking, and refrigeration machinery, be it aimed at the home or the business customer.

Figure 8
US-Based Building Material Manufacturers:
Warranty Claims Rates, 2003 to 2006
(in % of Product Sales)

Building Material Warranty Claims Rates

Notice that the builders of new homes suffer relatively low claims rates compared to the makers of HVAC systems and appliances. We think this reflects their ability to force more of their warranty costs back upon their suppliers and contractors, in a way that OEMs in the computer and automobile industries can only dream about. While homebuilders are generally below 1%, vehicle makers are closer to 2.5% and computer makers are closer to 3.5%.

Notice also that we haven't graphed a trend line for power generation equipment vendors. This is because it's a relatively small industry dominated by GE's turbine business. Moreover, two years ago, GE changed the way it segments its revenue, making it less possible to compare apples to apples. In 2003 and 2004, warranty costs were around 4% of a $17 billion "energy" business. Now, they're around 1% of a much more diverse $60 billion "infrastructure" business. The amount spent upon warranty hasn't changed much, but the claims rates have fallen artificially, and are therefore misleading.

High Level Snapshot

Taken together, we hope these eight graphs provide a good high level snapshot of the product warranty spending patterns of American manufacturers. Oh, we should have added: all these figures represent worldwide spending by US-based warranty providers. They do not include US warranty spending by foreign-based manufacturers, a list that now includes Lucent Technologies as well as DaimlerChrysler and the many other well-known brand names of Europe and Asia.

One suggestion we've taken under advisement is to try to figure out a number for worldwide product warranty spending by all manufacturers, no matter what their nationality. Another subscriber has asked for a more detailed look at the recent warranty experiences of semiconductor manufacturers. Both are on the way in the next few weeks, along with some other seasonal spotlights. Readers with additional ideas should contact the editor at earnum@warrantyweek.com by email.

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