April 5, 2018

Automotive OEM Warranty Report:

The car manufacturers used to spend a greater share of their sales revenue on warranty work than the truck manufacturers did. But because of persistent cost-cutting, that is no longer the case. Last year, car manufacturers cut their expense rates to below-average levels, while the truck manufacturers were slightly above their long-term average at the end of 2017.

Fifteen years ago, in response to federal regulations that required automotive manufacturers to analyze their warranty claims to spot patterns and trends, many OEMs began to implement new systems that actually began to reduce warranty costs. Others pretty much carried on as they were.

Now, fifteen years later, the results are easy to see. As we detailed in the March 8 newsletter, General Motors Co. GM accrued less than $300 per vehicle sold last year, and is setting aside only two percent of its revenue to finance future warranty costs. But some of the truck and heavy equipment manufacturers are setting aside closer to three percent of their revenue to pay warranty expenses.

To reach this conclusion, the first step was to gather warranty expense data from the financial reports of 24 U.S.-based manufacturers of cars, light trucks, motorcycles, and other small vehicles, and 26 U.S.-based manufacturers of heavy trucks, buses, recreational vehicles, and other large vehicles. And so, from each of their annual reports and quarterly statements published since 2003, we extracted details on the amounts of warranty claims paid, accruals made, and warranty reserves held.

For most of these 50 companies, we've now done this 60 times: 15 years times four quarters per year. And with three warranty metrics gathered per company per quarter, we have roughly 9,000 data points to examine.

We also gathered figures for the sales of vehicles covered by warranties, which means we had to subtract any amounts reported for finance revenue, insurance sales, investment income, service, licensing, and other sources of non-warranted revenue. That way, we could compare claims to sales, and accruals to sales, to calculate what percentage of product revenue was going towards paying warranty expenses. That produced 3,000 pairs of percentage rate calculations.

Paying Their Share of Claims

As can be seen in Figure 1, the amount of claims paid by the small vehicle manufacturers is vastly greater than the amount paid by the large vehicle manufacturers. But that's not only because their sales are also vastly greater. As we shall see, it's also partly due to the fact that for much of the past 15 years, the small vehicle manufacturers paid a greater share of their sales revenue in warranty claims.

In calendar 2017, small vehicle makers based in the U.S. paid just over $7.0 billion in warranty claims, which was down about $390 million from the 2016 total. Large vehicle makers spent $2.8 billion on claims, down around $90 million from 2016 levels. Together, the OEMs saw claims fall by $480 million, or 4.6%, but the percentage drop was slightly larger for the carmakers than for the truck manufacturers.

Figure 1
Automotive OEM Warranties
Claims Paid Worldwide by U.S.-based Manufacturers
(in US$ millions, 2003-2017)

Figure 1

A year ago, as we reported in our March 30, 2017 newsletter, the carmakers saw a $253 million rise in claims from 2015to 2016, while the truck makers were down by $21 million. But the biggest upwards change for both groups came in 2014, when GM was entangled with ignition key-related recalls and Navistar continued to have emissions-related warranty problems. Both of those warranty crises have now subsided, and so we're seeing sustained declines in claims costs as a result of that return to normalcy.

In fact, the biggest decline of all last year was GM's $581 million drop in claims payments. However, on a proportional basis, Harley-Davidson's $17 million drop in claims was just as big, when compared to 2016 totals. In the truck group, Navistar's claims costs fell by $56 million, and Caterpillar's fell by $49 million. Deere fell by $40 million; Paccar fell by $19 million; and AGCO Corp. fell by $5.6 million. There was plenty of good news in the claims departments of these automotive OEMs.

However, there were numerous increases as well. Ford Motor Company saw its claims total rise by $171 million. Tesla's claims were up by $43 million. And then on the large vehicle side, most of the RV manufacturers saw claims rise: Thor Industries saw claims rise by $56 million; Winnebago Industries saw claims rise $13 million; Spartan Motors was up $3.6 million; and Rev Group was up $2.8 million. But they were spared much of the pain because of increased sales.

Warranty Accruals

While warranty claims are the amounts companies actually pay to their customers and repair service providers, warranty accruals are the amounts they set aside to finance future payments. And while claims are paid on past sales, accruals are made on current sales. As such, they represent each company's best prediction of future trends in warranty expenses. Basically, they should remain proportional to sales unless the frequency of failures or the cost of repairs is expected to change.

In 2017, the large and small vehicle makers obviously differed in their outlooks. As can be seen in Figure 2 below, the carmakers cut their accruals by $768 million while the truck makers raised their accruals by $538 million. Overall, the drop was $230 million for all automotive OEMs, but the big news was the proportionally large increase by the large vehicle makers.

Caterpillar raised its accruals by $208 million last year. Deere was up by $201 million. Both also registered sales increases, but the accrual increases were proportionally much larger than the sales increases. It was the same story for the RV makers. At Thor, Winnebago and Spartan Motors, accruals rose faster than sales. In other words, these companies are expecting warranty costs to increase in the future for the products they sold in 2017.

Figure 2
Automotive OEM Warranties
Accruals Made Worldwide by U.S.-based Manufacturers
(in US$ millions, 2003-2017)

Figure 2

There were some accrual decreases too, but they came mostly on the car and small vehicle side. GM led the pack with a massive $733 million cut in accruals. Ford also cut its accruals, but by a proportionally much smaller amount of $66 million. Polaris Industries, which is getting over some massive recall trouble that began in 2016, cut its accruals in 2017 by $49 million -- a 25% reduction.

And then there were the companies that went against the trend. On the car side, Tesla saw accruals rise by $95 million (at a pace slightly faster than sales). And on the heavy equipment side, Terex reduced accruals by $22 million, while Astec Industries cut accruals by $2.2 million (while sales rose). In effect, Tesla is predicting its already high warranty costs will climb higher; Terex believes its warranty costs will fall faster than sales; and Astec believes its expenses will decline even if sales increased.

Warranty Expense Rates

As was mentioned, the RV makers in particular are seeing rapid increases in sales. So it's no surprise to see their warranty expenses rise as well. The most important thing to watch is whether expenses rise proportionally to sales. And as was also mentioned, several of the RV makers saw accruals rise faster than sales. This means they expect warranty costs per unit to rise, even as they sell more units. And that's not good. It's precisely the opposite outlook expressed by Astec and Terex.

In Figures 3 and 4, we're taking the claims and accrual totals from Figures 1 and 2 and dividing them by the corresponding totals for sales. This gives us a pair of ratios, representing claims as a percent of sales and accruals as a percent of sales. Figure 3 displays the claims and accrual rates for the small vehicle manufacturers, while Figure 4 displays the claims and accrual rates for the large vehicle manufacturers. Each chart includes 60 pairs of measurements, for the 60 quarters between 2003 and 2017.

Figure 3
U.S.-based Car & Small Vehicle Manufacturers
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2017)

Figure 3

As we detailed in last week's newsletter, the average claims rate for the small vehicle manufacturers has been 2.5% over the past 15 years, while the accrual rate average has been 2.3%. The standard deviation for the claims rate is 0.3% and is 0.5% for the accrual rate.

And as we detailed in the March 15 newsletter, Polaris made the top 10 with its massive accrual rate reduction, from 4.3% at the end of 2016 to 2.7% at the end of 2017. Tesla was the only other small vehicle maker to feature on any of the other top 10 lists, but it was not for any movements in its claims or accrual rates, which have remained fairly steady (as have Ford's and GM's, despite the big changes in their totals). Instead, it was for its increase in warranty reserves.

Proportional Changes

The name of the game is proportion. The claims and accrual totals change in proportion to their year-ago totals, so the big numbers look small for large companies such as GM. And then those changes in expense totals are measured in proportion to sales, where the big numbers hardly move the needle for large companies such as GM.

But for the smaller OEMs, the smaller changes can have more impact proportionally. For instance, railcar manufacturer Greenbrier Companies raised its accruals by $3.5 million. It doesn't sound like much compared to the half-billion-dollar changes at GM, but it caused the company's accrual rate to more than quintuple, from 0.08% to 0.43%. It also didn't help that sales fell slightly.

Elsewhere on the large vehicle side, the changes at Winnebago, Navistar, and Caterpillar were large enough to earn them a spot on a top 10 list in the March 15 newsletter. But Deere, Thor, AGCO, and Paccar also saw proportionally large declines in their claims rates, while also Deere saw a proportionally large increase in its accrual rate (and Hyster-Yale, AGCO, and Terex saw proportionally large declines in their accrual rates). They just weren't proportionally large enough to make it onto a top 10 list.

In both Figures 3 and 4, the recent history has seen the claims and accrual rates for both groups remain within a narrow range for several years. In other words, expenses have remained more or less proportional to sales for the groups as a whole. Individual companies may change dramatically, but the industry as a whole has been fairly steady since 2014.

However, also note that the average rates for the truck group have usually been lower than those for the car group. In fact, out of the 60 pairs of measurements in Figure 4, the percentage rates for the truck makers have been below those of the carmakers two-thirds of the time. However, in the past three years, the percentage rate pairs for the truck makers have been lower only 25% of the time. And the percentage rates for the truck accrual rates only have been higher in all of the past 12 quarters.

Figure 4
U.S.-based Truck & Large Vehicle Manufacturers
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2017)

Figure 4

In other words, the trend has changed. Large vehicle manufacturers used to enjoy lower claims and accrual rates than the small vehicle manufacturers. In fact, that was the case in all 24 quarters from 2003 to 2008. From 2009 to 2014, they frequently traded places (with both groups seeing claims rate spikes in the recessionary year of 2009 and GM's recalls causing an accrual rate spike in 2014). But from 2015 to 2017, the carmakers have taken the lead, with their accrual rate hitting a new low of only 1.65% in the summer of 2017. So now, at least within these groups, cars have lower warranty expense rates than trucks or buses.

Part of the reason is the way the car manufacturers have worked diligently to reduce their warranty costs, while the truck group has remained about the same. For the truck group, the average claims and accrual rates have both been 2.1%, while the standard deviation, which measures the amount of variation in the data, has been 0.3% for claims but only 0.2% for accruals. At the end of 2017, both their expense rates were actually a bit above average (claims at 2.2% and accruals at 2.4%).

Warranty Reserves

Finally, we want to take a look at the balance in the warranty reserve funds of these 50 automotive OEMs at the end of each of the past 15 calendar years. In Figure 5, once again we have divided them into large and small vehicle makers, and once again the small vehicle makers dominate.

That's primarily because carmakers such as GM and Ford must keep multiple billions of dollars in their reserve accounts to pay claims on warranties that last multiple years in most cases. However, GM reduced its warranty reserve fund balance by an astonishing $1.37 billion by the end of 2017, compared to its year-ending 2016 balance. That's one of the major reasons that the carmakers collectively cut their reserves by $903 billion.

In fact, the only other small vehicle maker to cut its warranty reserves in 2017 was forklift manufacturer Hyster-Yale. All the other top sellers raised their balances: Ford by $336 million; Tesla by $135 million; Harley-Davidson by $15 million; and Polaris by $4.6 million.

Figure 5
Automotive OEM Warranties
Reserves Held Worldwide by U.S.-based Manufacturers
(in US$ millions, 2003-2017)

Figure 5

On the large vehicle side, the trend was similar. Navistar and Terex were the only major warranty providers to cut their warranty reserves. All of the others raised their balances, some by large amounts (e.g. Deere by $242 million; Caterpillar by $161 million; and AGCO by $60 million). Overall as a group, the large vehicle makers raised their warranty reserve balances by $348 million.

And still, when we combine both groups, both large and small vehicle OEMs reduced their reserves by $555 million. It sounds like a lot, but as can be seen in Figure 5, the amount of reserves is so huge that half a billion dollars barely registers as a change. In fact, the overall industry balance has remained close to a range of $19 to $20 billion for four years in a row. the last large jump came in 2014, and again, that was primarily linked to the problems of GM and Navistar. In the years since, as their problems have subsided, others have taken their turn in the crosshairs.

Supplier Recovery

Next week, we will take a look at the other side of the automotive industry: the suppliers. And we will also divide them into two groups: the powertrain component manufacturers and other suppliers. In a subsequent newsletter, we will take a look at the difference between the OEMs and the suppliers, examining not only the large gap between their warranty expense rates, but also how the gap has widened and narrowed over the years, as the supplier recovery efforts of the OEMs have waxed and waned.

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