Moving 10-Year Parts Warranty In-House, Part 1

Moving 10-Year Parts Warranty In-House, Part 1

Tuesday, July 14, 2015

If you could create something that made you unique in your market area, was a huge benefit to your customer base, and substantially increased your profitability, would you be interested? What I am talking about is offering a 10-year labor and parts warranty to the sale of all major pieces of equipment you sell … and doing it "in-house." If it sounds too good to be true, it's not! What I am about to share will work for any company, in any trade, that sells and installs major pieces of equipment.

Becoming Self-Insured
There is a tremendous opportunity for individual contractors to take the 10-year parts and warranty program “in-house” for profit! However, several conditions must be met:

  • Pool – The pool of contributing customers must be large and growing.
  • Don’t Spend the Money – We will look at the potential profitability of the program shortly, but suffice it to say at this point that you CANNOT spend the warranty money when you receive it. It must be placed into a Current Liability Account and drawn out properly on an annual basis.
  • Curve – Another assumption is that repairs will occur based on the Normal Distribution Curve.
  • New Equipment - This program primarily applies to the sale and installation of new equipment.
  • Older Equipment – Although technically older equipment could be part of the program (if brought up to standard), it is not advisable.

The examples being used are for the HVAC industry since they are light years ahead of most of the other trades. With that said, keep in mind the "process" will work for any trade. The contractor will simply need to massage the numbers a bit to fit their equipment and the projected life span of the equipment in their trade.

As we approach this topic, there are a few other things you will want to keep in the back of your mind:

1. Warranty company failures - Multiple independent companies within the HVAC industry have offered warranty programs and, to date, all have gone out of business!

2. Check with your CPA - The approach of moving the warranty program in-house is the design of the author of this article in conjunction with his CPA. Your unique situation may be different (phasing out of business, preparing to sell the company, etc.). It is suggested you touch base with your own CPA prior to moving forward with this program to get their opinion from an accounting/liability standpoint.

Where Did the Idea of a 10-Year Parts and Labor Warranty (as opposed to 12 or perhaps 8 years) Come From?
The idea of a 10-year warranty did not just happen. HVAC manufacturers have done extensive wear testing on equipment and they “know” how many repairs to expect over the initial 10 years of the equipment’s life. They have also run the numbers. Like any business they have set pricing at $550 for the 10-year warranty based on their projected costs … and they have included a reasonable profit. I don’t know about you, but that tells me the warranty should be able to be handled in house, at a profit!

How to Price for Profit?
The formula is pretty simple. Pricing should be based on the actual cost of doing business with profit calculated at the very end. When it comes to the 10-year parts and labor warranty, the current industry providers have done their homework. Now let’s look at their costs verses yours.

  • Cost of Labor and Parts – The accelerated testing has told the companies what parts are most likely to fail and when. Those costs are the same for you as they are for the current provider. As a matter of fact, your costs may be less since they must factor in everyone’s hourly rate, and yours may be less – therefore increasing your profit – and you have profit already built into your rate!
  • Office Staff andMarketing – The national providers have to invest huge dollars in marketing the agreements to you. You, however, will not have those dollars and your current in-house staff should be able to handle the paperwork.
  • Overhead – We must assume a national warranty company is like any other company, they have overhead in the 25%-30% range. Your overhead will change little, if at all. Bottom line is more profit.
  • Profit – You can bet the national provides have built a healthy profit into their pricing. By eliminating the middle man the profit ends up in YOUR pocket, not theirs!

“Potential” Net Profit for You is Huge!
Again, using the HVAC number of $550 for a 10-year agreement, we will assume the normal overhead percentage to be in the 30% range with a projected 15% net profit. That means the actual “cost” of the labor and parts is only $302.50 ($550 x 55% = $302.50). If that assumption is true, the agreement should generate a 40% to 50% net profit. Also remember we are already making a profit on your labor rate, in addition to the profit generated by the warranty itself.

Standard Deviations
The basis of all statistics is what is known as the normal curve based on nine standard deviations. The below graph provides an example of a typical normal distribution curve. The best way to understand the curve is to assume 1000 identical light bulbs are installed in identical fixtures. The curve tells us that 4% will fail early, in the first year, with 7% failing in year two. Failure peaks in the 5th year and then has a similar failure rate on the other side of the curve.

We are going to assume our needed part failures for the 10-year warranty program will follow the normal curve, which is a pretty safe assumption. To be extra conservative, we will create a 9-year part and labor warranty program, since failure will actually occur as the nine standard deviations of our normal curve.

 Curve

Distribution of Expenses
You will remember the estimated actual cost of repairs for ten years (now nine) was $302.50. That means the “rough” breakdown of dollars spent on repairs should be very similar to the yearly dollars shown below.

Year Percentage Cost of Repair 
($302.50/9 years)
1 4.0 $12.10
     
2 7.0 $21.17
3 12.0  
    $36.30
4 17.0 $51.43
5 20.0 $60.50
6 17.0 $51.43
7 12.0 $36.30
8 7.0 $21.17
9 4.0 $12.10
  TOTAL: $302.50

 

Two Potential Ways to Offer the In-House Warranty Program
There are two potential ways to offer the customer your nine year parts and labor warranty program.

  • Sale of Equipment – When new equipment is sold, the $550 cost of the 10-year warranty is normally included in the price. The good news, if you are in the HVAC industry, is that you are already doing this so there isn’t any real “change” in the way you are doing business. The difference will come later as we discuss how to handle the dollars.
  • Premium Maintenance Agreement – If you were to decide not to include the cost of the warranty into the sale of the equipment there is another way it can be done. The idea is to incorporate the $550 into the annual maintenance agreement by spreading the cost over nine years at $61.11 per year. The $61.11 would simply be ADDED to your normal maintenance agreement program pricing. This will create a new premium maintenance agreement which will include all labor and materials. This will take all the worry away for the customer knowing EVERYTHING is covered. Of course this new premium maintenance agreement can only be offered on “newly” installed equipment….not existing equipment. Like the initial purchase of the equipment, the key to success is how you handle the money, which is part two of this topic.

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