The Cash Impact of Product Warranties

Essay

The Cash Impact of Product Warranties

Reliable Appliances, a leading manufacturer of washing machines and dryers, acquired a marginal competitor, Quality-Built, which had been losing money during the last several years. To help minimize losses, Quality-Built reduced its quality-control expenditures and began to purchase cheaper parts. Quality-Built knew that this would hurt business in the long run, but it was more focused on improving its current financial performance to increase the firm’s prospects for eventual sale. Reliable Appliances saw an acquisition of the competitor as a way of obtaining market share quickly at a time when Quality-Built’s market value was the lowest in 3 years. The sale was completed quickly at a very small premium to the current market price.

Quality-Built had been selling its appliances with a standard industry 3-year warranty. Claims for the types of appliances sold tended to increase gradually as the appliance aged. Quality-Built’s warranty claims’ history was in line with the industry experience and did not appear to be a cause for alarm. Not surprisingly, in view of Quality-Built’s cutback in quality-control practices and downgrading of purchased parts, warranty claims began to escalate sharply within 12 months of Reliable Appliances’s acquisition of Quality-Built. Over the next several years, Reliable Appliances paid out $15 million in warranty claims. The intangible damage may have been much higher because Reliable Appliances’s reputation had been damaged in the marketplace.
-How could Reliable have protected itself from the outstanding warranty claims in the definitive agreement of purchase and sale?