Introduction
Warranty expense reduction is probably not part of your job description. But it should be. Here are the top three reasons why service and support executives should own warranty expense reduction. Remember, you are the customer advocate. And warranty failures always come at the worst time – just when your end user is coming to depend on your product. Bad timing! You have the data. Your service management system captures the cause and solution to all your customer’s problems and issues. Someone in your organization is, or should be, looking at the data and trying to squeeze out new insights. So, when you go to manufacturing or engineering with a problem, you are not grumbling, but are bringing actionable insights. You pay the price for warranty claims because they hit your budget and suck up your valuable resources. Don’t you get tired of going to the CEO and making the case for additional resources that do not produce revenue? Aren’t you secretly concerned that she will get tired of spending money on warranty solutions and one day say, “When are you going to solve these warranty problems? Should I start looking for someone else for your job that will address the warranty expense problem?” Now that I have your attention let’s look at how significant a problem warranty expense is and how these costs have been changing over the past few years.
Actual warranty expense data
Note: The figures in this section come from WarrantyWeek, the best source of curated warranty data available. Let’s start by looking at a chart showing all US Based Companies that Warranty Week has followed since 2003. The data shows both warranty claims and warranty accrual rates on this and the other charts. Here is what each term means: 1. Warranty claims are the amount of money actually spent to correct problems discovered while the equipment is still covered by the manufacturer’s warranty. The claims include all or some of these costs:
- Labor, including hourly pay plus all benefits
- Travel, including out-of-pocket expenses or a pro-rated share of fixed asset costs like depreciation, maintenance, fuel, etc.
- Cost to replace or repair defective parts, including shipping
- Cost of technical support, service management, call center resources, and other quantifiable overhead costs.
It should be noted that a 2017 report from the IBM Institute of Business Value titled “Powering warranty reinvention, How electronics companies leverage new technologies to improve warranty management” reported that “only one-third of warranty costs are spent on direct repair or defective goods replacement.” This will become important as we discuss the implications of warranty failures. 2. Warranty accrual rates are based on recent history and are the expected warranty cost expensed as a “covered” item is shipped. This is usually charged to Cost of Goods Sold. As a warranty claim is processed, the amount is deducted from the total warranty reserve on a serial number basis. At the end of each fiscal year, the warranty reserve is evaluated to decide if the company accrues too much, enough, or too little into the account. The accruals for future years will be adjusted annually to try and match accruals and expenses. Occasionally, the excess accrual is released and shows up as a profit.
All U.S.-based Companies
This chart shows that the Claims Rate was 1.8% in 2003 and 1.3% in 2017. The claim rate dropped steadily from 2003 until 2012 and then became pretty erratic. This could be because businesses were rapidly increasing production capacity to satisfy a high level of demand caused by the surging economy. This chart does not show that warrantied product sales in 2017 totaled $1.8 trillion and the total warranty claims paid was $24.7 billion. At this level, half a percentage point is $9 billion; this is real money!
Medical & Scientific Equipment
It turns out that these product areas have two distinct segments: laser and x-ray equipment and all others. Look at how they compare.
Read the complete article here. If we project a best-fit line to the claims rate for laser and x-ray equipment, it appears that the rate dropped from 2.8% in 2003 to 1.3% in 2017. Does this mean that product or service sales prices for this segment have been decreasing because of the lower warranty expense? If not, when will this drop start?
Semiconductor & PC Board Equipment
The data for this group includes not only the capital equipment used to produce semiconductors and printed circuit boards (PCB) but also the semiconductors and PCBs themselves. Since we are only talking about the capital equipment we service, let’s disregard the Chips and PCBs.
Read the article here. From the article, “Some of the capital equipment companies have made spectacular progress when it comes to reducing their warranty expense rates. For instance, Applied Materials and KLA-Tencor reduced their claims rate from 3.1% at the end of 2003 to only 1.2% at the end of 2016. Lam Research cut its claims rate from 2.3% to 1.7% over the same time period.” These declines represent significant company savings. For example, in 2017, Applied Materials product sales were $11.5 billion. If their claim rate had remained at 2003 levels, they would have expensed $35.6 million instead of $13.8 million. This was a saving of $21.8 million, which flowed directly to the bottom line. Only about 1/3 of warranty expenses are spent on direct repairs or replacement of defective items. The remaining expenses cover overhead, which no customer would consider as adding value. Unfortunately, this data does not indicate whether the cost reductions were made by making the products more reliable or by automating processes to eliminate indirect costs. If we look at the Scientific and Medical chart, we see a dramatic drop in warranty costs for laser and x-ray equipment without a corresponding drop in the “other” group. Since any rational businessperson would adapt best practices to all segments doing a similar task like warranty processing, it is reasonable to think that making products more reliable caused the declines.
What about the customer?
Generally, a warranty failure occurs during the first year of ownership, although some B2B products have a longer warranty. For example, solar systems offer a minimum a 10-year warranty. And few B2B capital equipment sales include a shorter warranty period. This is important because the first year usually leaves the strongest impression in the minds of the end users. So frequent or long-duration failures will tarnish the end users’ confidence in your products and when the time comes to buy a second piece of equipment, you may find that the customer purchased from your competition. Another thing that may occur is the end user tells her Purchasing bloodhound to demand the warranty be extended as compensation for the downtime and the hassle caused by having to juggle production schedules. And we all know that these professionals are very good at getting their way. In fact, they may demand a one-year, no-cost service contract to make things right. You may think this is unusual, but I have had it happen to me, and the negotiation was two (purchasing plus our salesperson) against one (me). You know how that turned out. In the previously mentioned IBM report, the authors included this chart, which shows the impact of three levels of warranty maturity on three business KPIs in the electronics industry:
Being a warranty management leader certainly appears to pay off.
What should you do?
At the start of this post, I suggested that a service leader should take a major role in reducing the frequency and duration of warranty failures. The IBM report included this table which lists key practices to achieve this objective and shows which business areas should be involved in the various key practices for warranty management. It shows the customer relationship and aftermarket area (fancy talk for service, support, and/or success) has the leading role.
I think it’s time for us to tackle the warranty failure problem head-on. And, if we tie it into failures observed during installation, we can eliminate many service calls, heroic acts of service recovery, and major efforts to overcome customers’ ill will. This will be a win for all of us. Reach out to me if you want to hear about my personal experience in this area – it is an interesting story!
About Middlesex Consulting
Middlesex Consulting is an experienced team of professionals with the primary goal of helping capital equipment companies create more value for their clients and stakeholders. Middlesex Consulting continues to provide superior solutions to meet the needs of its clients by focusing on our strengths in Services, Manufacturing, Customer Experience, and Engineering. If you want to learn more about how we can help your organization reduce warranty expenses, please contact us or check out some free articles and white papers here.