Lenovo reveals IBM warranty costs rising steadily

In detailing its agreement to acquire IBM’s personal computing division, China’s Lenovo Group 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 is to pay $1.25 billion in cash for IBM’s PC business. The deal also calls for IBM to take an 18.9 percent 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 31 December 2003 and the six months ended 30 June 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 approximately $452 million or 4.5 percent of net revenue in 2001, $430 million or 4.7 percent in 2002, $586 million or 6.1 percent in 2003 and for the first six months of 2004, the costs were $365 million or 7 percent.

“(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 does not discuss profitability or revenue of its warranty coverage. Representatives from Lenovo could not immediately be reached for comment.

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

“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. Then they can do it again just for desktop PCs. I think that’s what they’re saying here,” Arnum said in an e-mail response to questions. “While the overall warranty expense for IBM may be around 3 percent 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 percent.”

As a loose comparison, Dell, Gateway, and Apple Computer consistently maintained overall warranty claims rates below 3 percent, Arnum said. Hewlett-Packard has remained in a range of 3 percent to 4 percent, though it has a nonstandard warranty cost structure for its printers, he said.

The only large computer-related manufacturers with overall warranty claims rates over 5 percent of hardware revenue are Sun Microsystems, Lexmark International, and PalmOne. “In my experience, 5 percent has been the demarcation line for danger, anything above this level suggests a problem,” Arnum said.

Arnum warned that direct warranty cost comparisons between companies can be tricky because so much of what is and isn’t classified as a warranty expense is left up to each individual company to decide. Additionally, the overall company average may 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 have to be factored in.

According to Brian Gammage, principle analyst at Gartner, there has been no indication that IBM’s warranty costs are any worse that those of its competitors or that consumers are concerned IBM product quality. “It is completely the other way around. 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,” he said.

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

Lenovo needs to show people that they are a serious proposition and that quality will 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,” Gibb said. “SMEs (small and medium sized enterprises) 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.”

The full Lenovo release can be found online at: http://www.hkex.com.hk/listedco/listconews/sehk/20041208/LTN20041208081.pdf