Manufacturer's warranties play an essential role in business cycles. They can be critical to a product's sales and marketing, building market share and customer goodwill, but also add significantly to product pricing and pose accounting and cost estimation challenges. Maintaining transactional level detail is critical for manufacturers to provide meaningful management reports and data for pricing analysis and liability estimation, as well as enhancement of quality control and dealer/distributor performance monitoring.
It Starts with Data
For more extensive warranty programs, a company can have thousands of warranty transactions every day. Working with such large volumes of data requires automated systems to collect and extract key points, perform workflow operations and statistical analysis, and provide summaries by meaningful groupings, such as business unit, location, or product type.
Companies track an array of transactional information. This information not only helps companies refine liability estimates, but it also enhances quality control and performance monitoring of service providers, dealers, and distributors, some of whose motivations may not align with the manufacturers. For example, tracking claims frequency by part and service provider may help a company identify high-frequency servicers and aid in future loss mitigation efforts.
Information tracked includes both product (exposure) information and claim (loss) information:
- Product information, which may include make, model, model year, component pairing, build location (including country), build date, and in-service date, is highly variable. For heavy equipment, machinery, and transportation products, this information is easily attainable by automating warranty registration. In contrast, a meager percentage of buyers of building and consumer products category complete registrations, which significantly limits the available datasets. Here, automation is especially beneficial to capture their information at or near the point of sale.
- Claim information provides a means for tracking warranty performance and may include time-in-service, labor code, part code, labor cost, part cost, transaction code, and repair location. This information is valuable both for tracking costs and for understanding the dynamics of cost emergence.
Adequate estimation of warranty costs is critical for durable goods manufacturers to maintain profitability. These typically rely on the following basic methods:
- Total losses by product type and in-service date. This method tracks products by the date a company places a product into service, which typically is the trigger date for coverage. This method develops losses using actuarial techniques to estimate the full cost by the end of the warranty period. This data grouping will not be reliable if different warranty terms (such as both three- and five-year terms) could apply to the same product.
- Total losses, by product type, in-service date, and warranty term. One of the basic tenets of warranty cost estimation is a consideration of the underlying warranty term. Grouping by term (for example, three-year terms in one group and five-year terms in another) directly addresses the cut-off point of warranty coverage.
- Cost per unit, by product type, in-service date, and warranty term. This procedure enhances the above methods by identifying specific per-unit warranty costs.
- Frequency and severity, by product type, in-service date, and warranty term. This data segmentation provides a complete picture of the components of warranty costs. This model generates information on how often products break (frequency) and how much each breakage costs (severity). For larger items, the analysis may identify trends in frequency and severity over the life of the warranty. For example, the frequency of auto warranty claims generally increases as the warranty ages, and the resulting claim severity also may increase.
Volatility Sources in Warranty Costs and Potential Solutions
Warranty costs aren't static - the introduction of new products, modification of existing products, regulatory changes, and coverage modifications all work to increase the variability and uncertainty of warranty costs. However, there are several ways to address such changes and work effectively in a dynamic environment.
- New products. The most common way to cost out new products is to look at similar products, perhaps in terms of usage, price, or both, and apply a cost equivalent to the existing product. Companies often provide a conservative cost estimate to new products or apply an implicit risk charge to reflect unproven technologies.
- Limitations in warranty coverage. While rare, companies may decide to shorten the warranty coverage time. In this case, estimation methods could utilize historical cost experience and cut off coverage for product failures that occur after a specified time before the end of the original warranty coverage. In estimating warranty liabilities, it is crucial to recognize that a reduction in the warranty period could lead to an acceleration of customers filing warranty claims, especially for big-ticket items. Service providers also may encourage customers to file claims before the new warranty expiration date, reducing the benefit of the reduction in warranty term.
- Expansion of warranty coverage. Changes created a high level of uncertainty when no manufacturer's warranty data existed to provide a clear indication of the increased costs related to the expanded coverage. However, various techniques can address this issue. Statistical models can leverage distributions applicable to existing warranty claim experience under the prior coverage to estimate future reporting and payout patterns under the revised coverage. Alternatively, manufacturers often have access to extended service contract data. Segmented correctly and adjusted for coverage terms, the ESC data may provide a reasonable indication of loss emergence after the original warranty expires; however, it can be challenging to align information such as coverage terms and contract length properly.
- Global presence. Manufacturers increasingly sell products globally. Associated warranties may vary from country to country based on regulation, custom, and customer behavior. Additionally, the same product may perform much differently from one climate to another. Therefore, contract and claims groupings and underlying warranty performance and costs may differ from market to market.
To see how automation facilitates warranty management cost containment, see Mize.