Lenovo reveals IBM warranty costs rising steadily

Lenovo reveals IBM warranty costs rising steadily

In detailing its agreement to acquire IBM's personal computing division, China's Lenovo Group has revealed data about growing warranty costs for Big Blue's PC business, and in doing so raised questions about quality control issues.

On Wednesday in China, the companies announced that Lenovo would pay $US1.25 billion in cash for IBM's PC business. The deal also called for IBM to take an 18.9 per cent stake in Lenovo, which is China's largest personal computer maker.

According to the 38-page statement from Lenovo detailing the agreement, IBM faced increasing warranty expenses between January 2003 and June 2004 due to faulty components in some of its PCs.

"Recent financial performance of [IBM] has been adversely affected by exceptionally high warranty expenses for the financial year ended December 31, 2003, and the six months ended June 30, 2004, due to certain Personal Computer products with problem components produced and sold previously," Lenovo said in the statement.

The company did not specify which components were causing the problems, what the problems were or which PC products were effected. Lenovo also didn't say if the problem has been resolved.

Lenovo said warranty costs were about $US452 million or 4.5 per cent of net revenue in 2001, $US430 million or 4.7 per cent in 2002, $US586 million or 6.1 per cent in 2003 and for the first six months of 2004, the costs were $US365 million or 7 per cent. "[IBM] estimated the warranty costs based on historical warranty claim experience for eligible products under warranty," Lenovo said in the statement.

IBM declined to comment on the Lenovo statement and added that IBM did not discuss profitability or revenue of its warranty coverage. Representatives from Lenovo could not immediately be reached for comment.

In general, it was difficult to break down warranty expense costs in diversified companies, editor of Warranty Week, a newsletter for warranty management professionals, Eric Arnum, said.

"Lenovo, or IBM, for that matter, have all the internal numbers, so for instance they can start with just ThinkPad revenue, and with warranty expenses just for the ThinkPad line, and calculate their percentage for that line alone," he said. "Then they can do it again just for desktop PCs. I think that's what they're saying here.

"While the overall warranty expense for IBM may be about 3 per cent of hardware revenue, it's much higher for the PC line. One can safely infer that it therefore must be lower for servers, mainframes and other hardware, if the overall corporate average is close to 3 per cent."

As a loose comparison, Dell, Gateway and Apple consistently maintained overall warranty claims rates below 3 per cent, Arnum said. HP had remained in the range of 3 per cent to 4 per cent, although it had a nonstandard warranty cost structure for its printers, he said.

The only large computer-related manufacturers with overall warranty claims rates over 5 per cent of hardware revenue were Sun, Lexmark and PalmOne.

"In my experience, 5 per cent has been the demarcation line for danger, anything above this level suggests a problem," Arnum said.

He warned that direct warranty cost comparisons between companies could be tricky because so much of what was and wasn't classified as a warranty expense was left up to each individual company to decide.

The overall company average also might not reflect the true experience of just the PC line of business, for example warranties for Gateway's plasma TVs and for Apple's iPods had to be factored in.

Principle analyst at Gartner, Brian Gammage, said there had been no indication that IBM's warranty costs were any worse that those of its competitors or that consumers were concerned about IBM product quality.

"It is completely the other way around," he said. "Customers have indicted that quality has risen for IBM. Where quality has become more difficult for some other manufacturers in this highly competitive market, IBM has been able to keep themselves ahead of the rest on the quality issue."

IDC research analyst, Ian Gibb, said that quality would be a key issue for both Lenovo and IBM as they sought to reassure customers that PCs with the IBM brand - which Lenovo can use for the next five years - would still be a mark of quality.

Lenovo needed to show people that they were a serious proposition and that quality would not be sacrificed, Gibb said.

"I would assume that IBM is already in the process of talking individually to its large corporate customers to reassure them about the benefits of the new arrangement," he said. "Small and medium-sized enterprises [SMEs] will be a tougher challenge. IBM will need to pass the necessary information out to channels and let them reach out to SMEs. In that case, it becomes very much about channel education."

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