Overview

Warranty costs, Returned merchandising Authorization (RMA) costs, mostly emerge due to Cost of Poor Quality (COPQ) of manufactured goods and services. Global quality initiatives help manufacturers to capture product and process defects sooner in the lifecycle, thereby eliminating the expensive costs associated with warranty returns and recalls.

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Over the last few years, Compliance and Quality initiatives have begun to play a critical role in managing warranty costs for large and mid-size manufacturers. Manufacturers are challenged to both enhance product quality and reduce warranty costs at the same time. American manufacturers reserve and spend well over $24 Billion annually on warranty reserves (Source: Warranty week). please click here.

Warranty costs, Returned Merchandising Authorization (RMA) costs, mostly emerge due to Cost of Poor Quality (COPQ) of manufactured goods and services. Global quality initiatives help manufacturers to capture product and process defects sooner in the lifecycle, thereby eliminating the expensive costs associated with warranty returns and recalls. Stronger quality initiatives can certainly help reduce warranty related costs as experienced by many of MetricStream customers. However, in the world of Sarbanes-Oxley, compliance pressures are creating further impetus for most American manufacturers to better manage their product quality. The Securities and Exchange Commission (SEC) has recently mandated under FASB, FIN 45 that manufacturers have to accurately reserve and account for Warranty reserves on the balance sheet. This further implies that compliance with the SEC would require manufacturers to fully understand product and process quality across their extended enterprise (suppliers, internal, customer) and make informed representations on their 10-K’s and other SEC filings about the associated warranty obligations.

Why does the SEC care about your compliance and quality initiatives? 
Well, Traditional wisdom says that quality initiatives are focused on the internal operations of the corporation and should not be of interest to the regulators.

However, in the world of Sarbanes-Oxley, with the arrival of the FASB (FIN 45) ruling, manufacturers have to be sound in their product and process quality initiatives; else one would run the risk of miscalculating or under-reserving warranty liabilities and costs on the balance sheet. Here is the verbatim regulatory requirement for managing product warranties for manufacturers.

FASB FIN 45 (14). For product warranties ... a guarantor is not required to disclose the maximum potential amount of future payments specified in paragraph 13(d) above. Instead, the guarantor is required to disclose for those product warranties the following information:

  1. The guarantor's accounting policy and methodology used in determining its liability for product warranties (including any liability [such as deferred revenue] associated with extended warranties).
  2. A tabular reconciliation of the charges in the guarantor's aggregate product warranty liability for the reporting period. That reconciliation should present the beginning balance of the aggregate product warranty liability, the aggregate reductions in that liability for payments made (in cash or in kind) under the warranty, the aggregate changes in the liability for accruals related to product warranties issued during the reporting period, the aggregate changes in the liability for accruals related to preexisting warranties (including adjustments related to changes in estimates), and the ending balance of the aggregate product warranty liability

Companies that sell industrial products need to continuously reduce their warranty costs by increasing product quality while doing an accurate job in reserving and managing their warranty liabilities on the balance sheet as per the SEC ruling. Good quality management initiatives create the foundation to both reduce your ongoing warranty claims, but also provide an effective framework for the financial office to report on expected warranty forecasts and liabilities.

The following best practices enable these companies to improve their own product quality, lower the associated warranty costs and enhance compliance with the SEC.

Best Practice #1: Linking RMA (Return Merchandise Authorizations) with Quality Management 
Most organizations do not link their RMA processes with the Quality initiatives today, yet the benefits of doing so can be significant

  • Closed loop feedback on product quality and customer complaints from the RMA processes leads to improved product quality.
  • Visibility into Quality issues for the RMA operation center is equally critical. Known quality problems can be proactively managed and warranty claims can be minimized.
  • RMA operation depots and repair centers can refurbish returned merchandise based on “root cause” analysis of product defects.
  • Analytic dashboards built on top of RMA and Quality data can help determine the optimal financial reserves for warranty and compliance.

World-class manufacturers are using all of the above approaches to increase quality, lower warranty and gain compliance to SEC FASB 45.

Best Practice #2: Cost recovery 
Supplier cost recovery can be an area of significant cost savings to reduce the warranty costs created through poor quality of products. The total COPQ is equal to the COPQ of OEM plus the inherited COPQ of suppliers. As a result, companies need to proactively work with their suppliers to improve their quality, so that they can reduce their own COPQ. Hence a cost-recovery system, where suppliers are charged back for providing poor quality of components, is an effective way to introduce business discipline and accountability into the supply chain. Warranty claims, reimbursement requests, payments can then be passed on to the defaulting suppliers based on the root cause of the problem.

Manufacturers can institute quality management systems to automate and aggregate supplier cost recovery processes and use it for charge-backs, not only would they be able to fully recover the costs of poor quality from their suppliers, they would be able to institute a discipline that forces the suppliers to quickly improve the quality of their products shipped.

Best Practice #3: Reporting Dashboards 
Forward thinking manufacturers are implementing reporting dashboards which not only aggregate real-time product quality data and RMA data but also offers direct visibility into the warranty costs. This visibility forms the basis of making warranty reserves both for internal operating use, and for the SEC filings. As regulators are increasingly looking under the hood, it is not advisable for CFO’s and financial office to report on warranty liabilities without direct visibility into the Quality scorecards of its products and processes. For example, if the quality scorecards have indeed deteriorated over the prior quarter, one may be more prudent to make a larger warranty reserve in your upcoming quarterly disclosure to the SEC.

By deploying these best practices, manufacturers can dramatically enhance product quality, reduce warranty costs and gain compliance with the SEC regulations. Such practices have been implemented by world-class manufacturers using enterprise quality management software. We invite you to take a look at MetricStream’s software suite and see how our solution can help you deploy such practices within your environment.

About MetricStream 
MetricStream enables its customers to improve supplier quality through its integrated and comprehensive quality management solution. Market leaders in industries as diverse as Automotive, High Technology, Consumer Goods, Manufacturing, Pharmaceutical and Food Services use the company's solution. Developed from the ground up, using web architecture, MetricStream provides an integrated set of modules to drive enterprise wide compliance and quality. The modules are as follows:

  • Audit Management
  • Inspection Management
  • Non-Conformance Management
  • CAPA
  • Change Control
  • Document Management
  • Training Management
  • Equipment Management
  • Cost Recovery
  • Supplier Scorecard
  • Analytics/dashboards
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