Business Process Services White Paper Optimizing Extended Warranty Processes by Embracing Analytics
About the Author Dr. Anuj Prakash Anuj Prakash is a part of the TCS Analytics and Insights Practice, working in the areas of flexible manufacturing system, computer integrated manufacturing, supply chain management, operation management, and optimization. He has a research background and holds a Ph.D. from IIT Delhi in the supply chain area. His research involves Genetic Algorithm, Simulated Annealing Artificial immune system, and application of fuzzy systems to flexible system problems. Prakash has also published and presented several papers in international journals and conferences.
Abstract In a competitive market driven by growing customer expectations, manufacturers are creating new revenue streams and strengthening customer loyalty by providing extended warranties. This also enables them to improve market share and reputation. However, warranties are a definite cost component for manufacturers and require a well-planned strategy to ensure cost savings that reflect positively in the bottom line. In this paper, we recommend the adoption of Weibull analysis to address the key challenges of extended warranty packages: period, pricing, inventory management, and coverage. We also present the findings of a study conducted to understand the intricacies of extended warranty in the small car segment, and use numerical data to illustrate this analysis.
Contents Extended Warranty for Better Outcomes 5 Analytics to Overcome Extended Warranty Challenges Determining the period and price of warranty 5 Identifying components for warranty 5 Forecasting inventory requirements 6 A Numerical Approach to Managing Challenges 6 Predicting parts failure time 7 Determining pricing 8 Calculating inventory replenishment requirements 8 Greater Customer Value through Extended Warranty Strategies 9
Extended Warranty for Better Outcomes Offering extended warranty contracts has been on the rise over the last two decades owing to the superior customer satisfaction and profit margins they generate. Typically, manufacturers sell products at base warranty period, after which, the customer pays for fixing any failure. By extending the basic warranty, manufacturers offer an enhanced period of assurance, during which they repair or replace defective products or parts that fail to perform their expected function. In a market marked by long repurchase cycles, manufacturers stand to create business differentiation by providing extended warranties on their products. Warranty and maintenance service, especially for repairable products such as automobiles, are critical factors in new product marketing and sales operations. With increasing types and complexity of products entering the market, customers struggle to make purchasing decisions. Effective extended warranty policies can influence the purchase of a product by reducing perceived risk and assuring consistent quality and reliability. They can thus create a win-win situation by providing additional streams of revenue for manufacturers, and improving customer engagement and satisfaction. Analytics to Overcome Extended Warranty Challenges Manufacturers need to thoroughly evaluate the challenges and issues in offering extended warranty to create a comprehensive warranty policy that works in their favor. Here are a few key aspects that need careful consideration: Determining the period and price of warranty One of the main challenges in offering extended warranty is deciding the period of extended warranty and the proposed price to the customer, as various components follow different life cycle patterns. Although providing extended warranty can result in increased sales, it also leads to higher costs for manufacturers. Therefore, the warranty policy and repair options should be carefully considered so that manufacturers can balance the benefits and costs effectively. In addition, the warranty cost is not the same across the entire product lifecycle and has to be determined separately for each period over its extended life cycle. This complicated process requires the use of predictive analytics. Identifying components for warranty The decision to provide extended warranty on separate product components instead of the complete product is crucial as various components follow different lifecycle patterns. Even manufacturers who offer the most comprehensive extended warranties exclude items that wear and fail to function over time. To decide the relevant set of components to be covered, association rules need to be considered. These rules 5
help identify components, which are related to one assembly. For example, if the warranty applies to the engine of an automobile, it should be applicable for all the parts associated with engine assembly. Forecasting inventory requirements Visibility into spare part inventory requirements is another area that is highly correlated to extended warranty and has great impact on customer service. Without sufficient inventory, customer service is impacted and could result in service delays. By adopting analytics, manufacturers can overcome these key challenges and realize greater value from extended warranties. Advanced analytical tools and systems enable manufacturers to extract and harness large volumes of warranty transactional data. Findings from a wide range of analyses performed on this data can be used to identify performance issues before they snowball into full-fledged problems. Analytics tools with efficient reporting capabilities enable manufacturers to manage cost concerns and forecast the necessary warranty reserves. The findings from these analyses can also help draft an appealing warranty policy that can be used as a strategic marketing and promotional tool. All of this, in turn, helps increase the sales rate and promote the quality of products. Manufacturers can cushion the increased costs they incur from a longer extended warranty period by ensuring better quality of products and monitoring performance of service providers. A Numerical Approach to Managing Challenges We conducted a comprehensive study to understand the best way to manage the challenges in offering extended warranty in the small car segment. The study covered data for only one small car model across all geographies, over the last 10 years of engine assembly. The main objective of the study was to understand the intricacies of offering extended warranty that would help make smart decisions on the warranty period and the associated cost for each. The scope of the study was limited in these ways: The repair data at the component level for only one type of model was considered. The repair data included vehicle model and its sold date. To identify the number of repairs or replacements, an identification number was provided for each vehicle. The types of failure and repairs or replacements along with the region were also taken into consideration. The purpose was to identify the probability of failure of one specific part type due to external factors in a particular region. For a deeper analysis, the labor charges, cost of the replaced parts, and cost of other supported materials were also factored in. 6
The study was based on these key business assumptions: If any part type is replaced, it is considered as a new part and its warranty is calculated accordingly. All the vehicles are in continuous use after being sold. If the failure of any part type is due to external conditions such as collision, the failure will be considered as normal failure. Key findings of the study are presented below. Predicting parts failure time Weibull Analysis has been used to predict part failure time, which is one of the parameters in deciding the extended warranty period. Figure 1 shows the results of the repair data analysis estimating the part failure time in days along with a snapshot of the data assessment, including errors and other parameters. Figure 1: Estimate of part failure time based on repair data analysis Figure 2 clearly depicts that after 100 days about 20 percent parts will fail, or need repair or replacement. The lifecycle ranges from the sales date to 300 days. 7
Weibull probability plot for life 80 Percent 60 40 20 0 Determining pricing 0 100 200 300 Life-cycle of parts in days Figure 2: Graphical representation of the results of repair data analysis Figure 3 shows the range of pricing for extended warranty, based on the warranty period and the cost incurred by the manufacturer. It shows that the price will increase as the time period increases. Figure 3: Pricing for extended warranty (period wise) The price is calculated on the basis of the inventory holding cost, the labor cost for repairs, cost of the repairing material, and cost of the replaced part. The graph also indicates that the change in price is not linear, that is, the change in price is not same as the change in period. Calculating inventory replenishment requirements The study provides insights on how manufacturers can improve the efficiency of support logistics for warranty management through efficient stocking of replacement parts. The results of the inventory analysis are depicted in Figure 4. The bar graph reflects that the inventory level changes according to the time period, implying a variation in the repair claims. Manufacturers can thus stock optimal inventory to efficiently fulfill repair claims based on the time period. 8
Figure 4: Inventory level of spare parts (period wise) The bell curve in the graph shows that while initially less inventory is required to meet repair claims, more inventory is needed from days 200-1700, and the requirement dips again after this period. The graph shows that most of the parts fail between days 200-1700. After this period, the lifecycle of the part is complete and it cannot and should not be used further. Therefore, after 1700 days, there is a lower requirement for inventory of spare parts. Based on these findings, manufacturers can make the necessary plans for storage and transportation of spare parts inventory. Greater Customer Value through Extended Warranty Strategies As extended warranties continue to play a significant role in the manufacturing business cycle, organizations are increasingly adopting integrated solutions and tools for effective warranty management. These next generation technologies enable organizations to streamline warranty management processes, meet their warranty obligations efficiently and effectively, and realize superior outcomes. Manufacturers can realize and provide greater value by leveraging data, technology and advanced analytics to implement profitable extended warranty plans. The study outlined in this paper can be broadened to include optimization techniques to find the optimal price for each period, and arrive at improved extended warranty strategies. By embracing a strategic and scientific approach, manufacturers can confidently market extended warranty products as an attractive, value added service feature. 9
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