Tuesday, December 14, 2010

Negotiating product warranty

(Defects in material and workmanship).

The two factors drive a supplier's behavior regarding warranty for defects in material and workmanship. They are the potential financial exposure from the warranty and the potential of additional revenue generation. In reducing the potential financial exposure, Suppliers know that the shorter the warranty period, the lower the probability of claims against the warranty. The fewer claims, the smaller the supplier's warranty cost.

Warranty claims result from problems that usually occur in two distinct stages. The first stage of failures is what is referred to as "infant mortality", where the failure occurs early in the use of the product. This problem usually results from either defects in the material or the production process. To reduce the amount of infant mortality failures, companies would "burn in" the item by running it for some period. The more reliable the product proves to be, that period may be reduced or eliminated. Suppliers may also use pre-tested or "pre-conditioned" parts where the testing for infant mortality has already been performed.

The other stage of failures is those that will normally occur randomly during the life of the product. In understanding the potential warranty cost to a supplier, they will consider the average life or "reliability" of the product. Product reliability is usually expressed in a quantitative measure that is a statistical average of all projected failures. That statistical average or mean is called Mean Time Between Failures. For things like semiconductors and other electrical devices it may be expressed as “FIT” meaning Failures In Time in which one FIT equals one failure per billion hours where the rate is statistically projected by results of accellerated failure testing. The longer a product is used, or the more a product is used, the higher the potential incidence of failure. 

As warranty repairs, on-site calls and product returns may, under the terms of the warranty, be paid for by the Supplier, their goal is to reduce the period of the warranty which reduces their financial exposure to those costs.

A short warranty period also means that the supplier can sell you service or maintenance contracts sooner. The sooner they sell the service or maintenance contract the more money they stand to make. For example if one Supplier had a 12 month warranty and another had a 90 day warranty, you would need to add 75% of the annual service contract cost to the Supplier with the 90 day warranty to have equivalent warranty terms.

Warranties can be expressed in terms of time (days, months, years), or a function of usage (number of operating hours,  volume of production). For example a toolmaker may warrant their tool for a certain number of "hits" or times in which the tool is used. In addition to the actual term of the warranty there are other factors that affect the cost of warranty.
- Delivery terms may impact when the warranty starts
- The time required to inspect and accept an item may reduce the effective warranty period if warranty starts before then, such as with the shipment.
- What's covered by the warranty (does it include materials only or             labor
  and materials).
- Certain warranty language can have sufficient exclusions that the
  value of the warranty may be substantially diminished.
- Systems required to track and manage any warranty related claims
  can add to the cost.
- Requirements such as who pays for shipping of warranty returns can significantly add to the cost.
- As a buyer the quality and reliability impact the cost of the item.
  Low quality items mean more problems and greater inspection and acceptance costs.
- Low reliability items require more frequent replacement
- Reliability also impacts any strategies you may have for stocking of spare or replacement items.

In negotiating warranty provisions:
1) The period of the warranty should be long enough for the item to operate at full capacity under all required operating conditions. For example, if you replaced an air conditioning system in October, you would want at least a 9 month warranty so that it could be tested during the heat of July and August. If you purchase an item designed for a specific volume production, you would want the warranty to go past the
point at which you will achieve that volume. Many problems aren't seen until an item is functioning at its peak levels.

2) There should be a relationship between the warranty period and the reliability. Products that have high MTBF specifications should not have short warranties. If the vendor is pushing for a short warranty one of two things is happening: 1) they have a lack of confidence in the reliability of the product, or 2) they want to increase revenues by starting the service or maintenance agreement sooner.

3) In most companies maintenance, service contracts, spare parts and repairs are high profit margin, annuity businesses. The less self sufficient you are in supporting the item or the fewer alternatives you have for support, the more you need to protect yourself against the future cost of those items. The best time to negotiate them is when you have the greatest leverage that is before you purchase item.

4) How you use the item may be different from other customers, so you may need to tailor the warranty and follow on maintenance services to your specific needs. Items you may want to address are emergency contacts, response times, spare parts inventory required to be carried, problems escalation requirements, and preventative maintenance requirements. The more critical an item is to your operation, the tighter your requirements should be. Response times can be tailored to both performance and needs. For example, the greater the number of failures the faster the response you may require. If there are times at which you have significantly greater volumes, where the impact of being down is significantly greater,  you may require a faster response during those periods.

5). To do things right from the beginning may require some assistance from the supplier. With any major piece of equipment you would want
a complete set of operating manuals, recommended preventative maintenance requirements and schedules, training on the operation and maintenance of the equipment including replacement of high wear or consumable items and customer intended trouble shooting activities which can be performed. Items such as software applications require many of the same types of assistance.

6) When you consider a warranty you also have to consider how much the item costs and what it will cost to enforce the warranty? In some instances it may be worth negotiating a discount for no warranty.  In other situations it may make sense to have a system where you get a credit for a failure but don't have to return it, or can consolidate returns
to reduce shipping costs.

7) Warranties sometimes need to be looked at not by what is included, but what has been deliberately excluded. Does it include parts only where the greater expense will be labor? Does it provide free labor, when there is minimal labor content?

8) Another portion of warranty discussions, mostly from an OEM perspective, is "no problem found charges". The concept behind a no problem found charge is material returned for repair under warranty should be failed material. If the material isn't defective, the argument goes that you haven't done your job at screening the material and hence
you should pay for the supplier incremental costs to receive and re-test the material. The easiest way to may this go away is to offer to accept the no problem found charge if the supplier accepts all your costs every time they ship any bad material.

9) If the item has a long useful life, in addition to all other requirements you may want to include an "end of life" purchase option, where if the supplier elects not to make the product or parts any longer, they provide you with an option to make a one time "end of life" purchase of critical materials you feel are needed to continue to use and maintain the equipment.

10) The channel you buy from has a major impact on your ability to negotiate warranty provisions. While certain distributors or re-sellers may perform warranty services, a distributor or re-seller cannot bind the OEM. Without the OEM's express consent, any changes to the warranty or unique warranty terms you negotiate would have to be provided from the resources of the distributor or re-seller. Most distributors or re-sellers support is usually limited and focuses on "tier 1" support where they have the capability to fix common problems and the OEM is available to support the more complex "tier 2" problems.

11. Service warranties normally address the standard to which the service is being provided (e.g. Conform to the specification; Good. work person like manner; comply to certain professional standards). It will also address the responsibility of the supplier to correct any problems or errors (e.g. full conformance, substantial conformance, conformance to material requirements). It will also address the timing
for the correction (e.g. within X hours or days, immediately, within pre-defined response times).

12. Software warranties normally address the standard to which the software is being provided (e.g. Conform to the specification). It will also address the responsibility of the supplier to correct any problems or errors (e.g. It may have different tiers of importance with different requirements for each and also address providing an initial "work around"  and a later revision to correct the item and may also address the degree to which each will be performed (full conformance, substantial conformance, conformance to material requirements). It will also address the timing for the correction (e.g. within X hours or days, immediately, within pre-defined response times and with pre-agreed escalation processes).

13. One of the important things to consider when negotiating warranty is how you will be able to track and manage the warranty period. For single purchases it may be easily tied to the delivery date. You may allow the it to be tracked from the supplier's shipping date as long as the in-transit and inspection and acceptance time is added to the warranty period. For higher volume purchases a simpler method or tracking may be required such as date coding the items.

14. As with other terms, what you negotiate for warranty provisions needs to drive the right behavior on the part of both parties. For example the period to do warranty repairs may be set at one time (assuming that there will be minimal problems) and have a much shorter, more aggressive requirement in the event there are substantial numbers of warranty problems. While I don't think a buyer should ever pay to return an item
for warranty repairs, if you do agree to pay it should be based upon a small number of returns, and if the number is exceeded the Supplier should pay.

The whole issue of warranty is who should bear the costs in the event of a problem with the product. The attitude you should have is that the party who has the greatest ability to manage against that risk is the one who should bear the majority of the costs associated with the problem. The supplier is the one who has the greatest ability to manage the product's quality by its design, materials used, processes, inspections, etc. When there are quality problems that result in warranty claims, they should bear the biggest financial burden.

Should the length and extent of a supplier warranty impact what’s required for Supplier quality management? The answer is easy. Under a traditional warranty scenario, the warranty responsibility is to repair or replace athe defective product and that may cover only a small portion of the costs. That commitment may be further reduced by exclusions to the warranty:
·      The definitions of what is warranted. Not all problems may be covered. For example: Contract Manufacturers may warrant their workmanship, but may exclude any warranties on the materials you specify.
·      How long a period the warranty runs and what starts it. E.g. 12 months from shipment.
·      Specific exclusions such as environment use with other products, misuse, Damage from electrical surges, static discharge.
·      The supplier’s responsibilities in the event of a covered failure. E.g. Repair, replace, credit.
·      The supplier’s responsibilities for consequential damaged that accrue. E.g. Do they pay for the cost re-work, repair or replace or do they just give you the part?

The key is who bears the cost? In a traditional warranty situation here’s how it would break out depending on the phase. 

Failure at Incoming. –
Buyer bears inventory costs, and management of replacement costs.
            Supplier pays for repair or replacement and some/all of the shipping.

Failure In-WIP
Buyer pays for inventory costs, re-work costs, and management of the replacement.
            Supplier pays for repair or replacement and some/all of the shipping.

Failure at the End Customer site
Buyer pays for inventory cost, service call, and management of the replacement.
            Supplier pays for repair or replacement and some/all of the shipping.

Epidemic failures
Buyer pays for inventory costs, service call costs, management of replacement costs, and deals with customer impact.
            Supplier pays for repair or replacement and some/all of the shipping and, depending upon what’s negotiated, the Supplier may reimburse Buyer for its costs, but that usually occurs only after an initial threshhold of failures has been exceeded.

Whether you rely upon their plan and warranties, or verify and pro-actively manage their quality gets down to whether you trust the Supplier and believe what they say. If you don’t, you need to independently verify that they are in fact managing the business in a sound, controlled manner that will produce high quality products. Since Buyers bear a large percentage of the total quality cost in the relationship, the concept of verifying their program and doing on-going management is something that needs to be done to manage the potential cost exposure.

The general rule with quality is that the sooner in the process you are able to catch the problem, the lower the cost impact. Once a product reaches the customer, the cost of quality problems grows exponentially so something which may only cost $1.00 to correct at the Supplier, may cost multiple hundreds of dollars to correct at the customer site.

The only risk warranties traditionally protect against is the cost of purchasing a new or repaired item. Warranties of component suppliers may not cover your costs of re-work at a Manufacturer. The real costs of quality to a Buyer is in the extra inventories they must carry, the customer shipments missed, the field repair costs, and customer satisfaction issues.

Mean time between failures
Product cost (warranty period received is LESS than that offered)
Delivery terms (Start of warranty
Product inventory
Systems (Both Buyer and Seller)
Spare parts inventory
Item cost
No problem found charges
Cost of handling
Warranty administration cost
Inspection and acceptance
Life cycle cost/ profit
Locations for returns
Competitiveness of service charge
Product inventory strategy
Reliability problems

What's covered by warranty


General thoughts on negotiating warranty terms:

  1. There should be a relationship between the warranty period and the supplier’s published reliability or Mean Time Between Failures (MTBF) data. Use the Suppliers published reliability data do achieve a longer warranty period.

  1. How much does the item cost? What will it cost to enforce the warranty? You always need to consider whether it is worth having no warranty or a system where you get a credit for failures but don't have to return it.

  1. For equipment it’s important to understand what is included in the warranty and what is its respective value? Does it include only parts where the real expense will be labor?

  1. Is the response time adequate? Have you considered requiring that the greater number of failures the faster the required response time?

  1. If the Supplier wants charge you a "no problem found" or no defect found charge for situations when good material was returned to them, have you countered by offering to accept those charges if the Supplier will accept all your costs for every time they ship you bad material? (This usually ends the discussion on no problem found charges.)

  1. If the vendor is pushing for a short warranty does that show a lack of confidence in the reliability of the product? Is the push for a short warranty tied to other goals such as the sooner the warranty expires, the sooner they can sell you a maintenance agreement.

  1. Once you buy you have lost leverage for later negotiations of service or maintenance agreements unless there are competent third party service providers who will insure that competition exists. Even then, you may still be at a competitive disadvantage as they may still need to purchase replacement parts from the original supplier.

  1. What is included in or excluded from the warranty and what is its respective value ? For example, does it include only parts where the real expense will be labor or does it include only labor where there is minimal labor content ?

  1. There are other things that affect warranty and the warranty you get affects a number of other factors
Delivery terms (if delivery is linked to the start of the warranty
Systems required tp manage warranty obligations (Both Buyer and Seller)
Item cost (where warranty redemption may not be economically feasible
Cost of handling
Additional Inspection, test and acceptance costs for repaired or replaced item
Locations for returns

Product Cost for products that use the item if the warranty period received is less than the warranty period offered to customer/
Product and Spate Parts nventory levels
Life cycle cost/ profit
Competitiveness of maintenance / service charges and profit of service business

  1. Maintenance and Service revenues are extremely important to many companies. They are frequently higher margin businesses within the company and considered “annuities business” which provide on-going revenues without, in many cases, a substantial sales effort. You may not be buying just the product, you may be buying the product and a potential long term revenue steam for the Suppler. In negotiating you must consider the total cost of ownership which includes price, the cost of on-going service, maintenance, support, parts, etc.

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