Longer Warranties: Jacking up sales or costs?

• In 2000, the Big Three automakers’ annual warranty costs were around $6 billion, or averaged roughly $500 per unit in North America (1)
• 90% of automotive suppliers say they believe automakers are increasing their focus on analyzing these costs (2).

• But 69% of automotive suppliers say they don’t get enough information on warranty chargebacks and 50% say they aren’t sure who has responsibility for design (2).

An automaker’s success depends upon the performance of the entire value chain. Only changes in the supplier / automaker relationship that are mutually beneficial will result in profits that are sustainable in the long run. Excelling in the competitive automotive industry requires cooperation throughout the entire value chain. Suppliers report seeing an increase in automakers’ focus on warranty cost analysis and the resulting warranty chargeback(2). Many believe that OEMs are down-shifting design responsibility and financial risk. In fact, a major fear of suppliers is that warranty costs will be charged to the supplier without necessarily knowing the root cause. They believe that there may be a failure to differentiate between actual part defects and system related failures (2).

The warranty cost of $500 per car sold by the Big Three was quite high relative to the Japanese producers’ warranty cost, which may have been lower than $75 per unit (1). Clearly, warranty costs can hurt profits. Despite this fact, Chrysler upped its three-year, 36,000-mile power-train warranty coverage to transferable, seven-year, 70,000-mile coverage in July of 2002. Will this move hurt the company’s profits? Without significant improvements in operations throughout the supply chain, it may.

The intended effect of establishing the longer warranty was to boost the resale value of Chrysler’s vehicles and the related demand for new auto sales. It takes about five years for the high resale value message to permeate the market (3). Chrysler’s decision to lengthen the warranty was prudent if their $7.5 billion investment (3) in new power-train development drastically improves quality, which in 5 years results in a higher resale value, which in turn results in an increase in sales and related profitability (to the extent that it offsets added warranty cost).

Although it is probably too early for the marketplace to pass judgment on Chrysler’s decision, the changes the corporation has made in an attempt to shrink the gap on the competition have apparently resulted in some quality improvements. In September of 2002, Quality Magazine quoted Chrysler Group President and CEO Dieter Zetsche: “Our overall quality levels have improved substantially, while warranty costs have dropped 20% in the latest model year, and have been cut in half since 1996 (4).”

This may be counterintuitive, but it doesn’t necessarily take more time to build a quality product in the automotive industry. In fact, according to the Harbour Report, Harbour and Associate’s annual guide to automotive manufacturing performance in North America, improvements in quality (a decrease in the number of defects) go hand-in-hand with improvements in manufacturing performance (an increase in productivity) (5).

But at the time of the Harbour Report, Chrysler was the least efficient assembler in North America. The company averaged 30.8 assembly hours per vehicle. That seems like an eternity when compared with Nissan, the fastest assembler, which had an average of 17.9 assembly hours per vehicle (6). Does that mean that, overall, Chrysler produced vehicles of the lowest quality and Nissan the highest? Ron Harbour, President of Harbour and Associates, states “…companies that are truly working on quality are likely to be putting in manufacturing systems in which error-proofing and other quality procedures are implemented at every step of the production process. The result is fewer hours for repair and rework, which improves both productivity and quality results (5).” Assembly productivity may be one indication of the quality that is built into a vehicle, but it certainly isn’t the only one.

Furthermore, productivity may be a necessary condition for profitability, but alone it is insufficient. In fact, labor accounts for only 10 to 15 percent of the actual costs in a vehicle (7). Additionally, sales, which of course are very important to automakers, aren’t directly dependent upon productivity numbers. In other words, customers generally do not purchase a vehicle because they are happy with the number of assembly hours that went into it. But sales are closely related to the customer’s perception of value, and quality is a factor that is built into that perception. Remember, Mr. Harbour stated that companies are implementing error-proofing and quality procedures at “every step of the production process (5).” He did not say every step of the “assembly process.” An automaker’s focus should be on increasing the quality and productivity of the entire value chain.

Naturally, automotive manufacturers are looking to gain ground on their competitors. They aim to improve their value chains both in terms of productivity and quality. Mr. Harbour further notes that companies that improve upon their ability to design-for-manufacture will require fewer resources to produce higher quality products. In addition, better coordination of process engineering and product design reduces the need for in-line inspections (5). This will require cooperation on the part of automakers and their suppliers. The end result will increase warranty coverage that jacks-up sales more than it jacks-up costs.

References:

(1) Allen, R. (June, 2001). Lean: A Supplier’s Weapon Against Warranty Costs. Manufacturing Engineering.(2) Truett, R. (December, 2002). Survey Says Cooperation Is Key to Cutting Vehicle Warranty Cost. Automotive News.

(3) Greenberg, K. (December, 2002). Chrysler Gets Radical to Boost Image by Planning to Make Better Vehicles. Brandweek.

(4) Extended Warranties Signal Vehicle Quality. (September, 2002). Quality Magazine.

(5) Harbour, R. (July, 2002). The Big Story. Automotive Industies.

(6) Winter, D. (July, 2002). Efficiency Scoreboard. WARD’s AutoWorld.

(7) Slater, D. (February, 2002). Don’t be fooled by productivity. Automotive News