Product Warranty Trends:

The horizontal axis measures claims as a percent of sales. The vertical axis measures the capacity of all manufacturers' warranty reserve funds, expressed as a multiple of the most recent month's total warranty claims. Therefore, if a manufacturer has $20 million in their reserve and in the most recent month it spent $1 million on warranty claims (equal to $3 million per quarter), then the company's warranty reserve has a capacity of 20 months.

The third and fourth quarters of 2003 show the highest claims rates and the lowest reserve capacities of the 11 quarters included in the chart. Meanwhile, the first and second quarters of 2004 show the highest reserve capacities and the lowest claims rates. In fact, one could expect over time that more and more dots will land very close to the diagonal line drawn from the upper left to the lower right corners. Therefore, the first and second quarters of 2003 may prove to be anomalies, with a combination of high reserve levels and high claims rates.

Top Warranty Providers

Finally, we're adding a new twist to an old chart. Several times in the past three years we've run a table of the top 50 warranty providers, and more recently we've included year-over-year comparisons. We're including that again below, but this time the change from one year to the next is expressed as a percentage of a percentage. In other words, if your claims rate goes from 2% to 4%, it's a 100% increase. If it goes from 5% to 4%, it's a 20% decrease.

On that basis, 16 manufacturers reduced their warranty claims rates during the first nine months of 2005 while 29 saw an increase and five remained unchanged. However, the reason they remained unchanged is a lack of data. Since Black & Decker, Eaton, General Electric, Motorola, and Textron report their warranty expenses only once a year, we're still using 2004 figures as placeholder estimates. Therefore, there is no change in the claims rates.

One advantage of waiting until the new year to provide aggregate totals for all manufacturers is the fact that almost all the data we're expecting has arrived. There is little missing, and therefore little need for guesswork. Among the top 50 warranty providers, only Terex Corp. has failed to file its quarterly financial reports with the U.S. Securities and Exchange Commission. They are therefore excluded from this tabulation, with Rockwell Collins taking their place. All the others, including Apple Computer, Cisco Systems, Lucent Technologies, Rockwell Collins, and Tyco International, which each end their fiscal years on or around September 30, have had enough time to finish their annual reports.

Source: Warranty Week from SEC data   

Most of the other manufacturers concluded their fiscal years on December 31, although Dell's fiscal year ends January 31 and Hewlett-Packard's ends on October 31. We expect that by early April 2006, we'll have enough data on hand to provide full-year comparisons for 2003, 2004, and 2005.

The good news arrives courtesy of the 12 companies which cut their claims rate, particularly the five who kept it below one percent: Tyco International, Boeing, Honeywell, Ingersoll-Rand, and Danaher. These five have reported $478 million in warranty claims so far in 2005, down from $567 million during the same span in 2004. However, we should also note that at Ingersoll-Rand claims actually rose, as measured in dollars. Fortunately, sales rose faster. Claims paid also rose at Paccar, Lennar, York International, and American Standard, but again, sales rose faster.

So far in 2005, there have been a few surprises, both in terms of what did and what didn't happen. For instance, note that despite all the dire headlines about mounting recalls and alleged product defects, the claims rates at Ford, Apple, and GM are up by only 6% to 8%. Ford went from 2.5% to 2.7%. Apple went from 1.5% to 1.6%. And GM went from 2.9% to 3.0%. Comparatively, that's not an enormous increase. We'd suggest that the sky is not falling.

Pacemaker Problems

Look further down the chart, however, and you'll see some enormous increases. Guidant Corp., which conducted a massive recall of its pacemakers last year, saw its claims rate more than triple. First it was driven into a merger with Johnson & Johnson, but was outbid by Boston Scientific. Now Johnson & Johnson has apparently sweetened its bid, despite the recalls. For the first nine months of 2005, Guidant paid out $50 million in claims, as compared to $12 million during the same period of 2004 and $6 million during the first nine months of 2003.

Incredibly, though, there were three others for whom the claims rate more than doubled: Applied Materials, Goodrich, and Medtronic (another pacemaker manufacturer). And there were three manufacturers for whom the claims rate surged over 5%: Novellus, Palm, and Beckman Coulter (Lexmark has always been above 5%). In fact, as is noted in the headlines to the right, Morgan Stanley recently nailed Novellus about its high-and-going-higher warranty claims rate, causing the stock price to drop 3% today alone.

On the good news side of the ledger, Sun Microsystems has once again crossed below a 5% claims rate, having cut both the dollars and the percent of revenue that it spends on warranty. HP has also cut its claims rate, primarily by keeping claims dollars level while sales grew. And Nortel Networks, which had a rough 2004, is once again back to what appears to be its baseline claims rate.

While it's still impossible to compare one manufacturer's claims rate to another's, after almost three years of financial disclosures it's becoming easier and easier to compare one manufacturer against itself. Once we know the baseline, and once we know what's normal, high, and low for a given product or a given industry, we can readily spot the anomalies. And while three or four years ago warranty was a thickly cloaked mystery, today it's becoming an actionable item for analysts and investors. That's a big change.