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Brand equity, warranty costs, and firm value

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Abstract

Warranty management is frequently discussed in the context of businesses’ ongoing efforts to reduce costs. However, how marketing can contribute to warranty cost reduction is empirically unclear. This opacity led to the current study, which focused on how warranty claim costs and abnormal warranty accrual costs mediate the relationship between brand equity and firm value—as well as the contingencies for the mediation. The result shows that brand equity reduces warranty claim rate and abnormal warranty accrual rate through which it increases firm value. In addition, product innovativeness decreases the association between brand equity and warranty claims and between brand equity and abnormal warranty accruals. As such, the findings revealed the roles of brand equity and product innovation in warranty cost reduction and thus suggested the need for managers to build and leverage their marketing resources when attempting to control warranty costs.

Introduction

An issue of critical importance to manufacturers is effectively managing warranty costs associated with their products. Warranty expenses can easily run into billions of dollars annually for large businesses, thus adversely influencing the bottom line (Warranty Week, 2021). Warranty claim costs and warranty accrual costs determine total warranty expenses. Attending to warranty expenses—current and future—entails management’s focusing on specific warranty metrics.

Warranty claims are the warranty expenses a firm incurs when a consumer’s purchased item is repaired or replaced. Warranty claims and associated service costs typically range between 2% and 15% of net sales (Murthy, 2006). Warranty accruals are monies set aside when goods are first sold for fulfilling future claims, based on the firm’s projection of future warranty claim costs. Abnormal warranty accruals are the part of warranty accrual costs that cannot map to warranty claim costs; they reflect the accrual estimation error—a common problem in warranty management (Wang et al., 2017, Wu, 2012). Excessive or insufficient warranty accruals engender consequential costs for companies; firms maintaining billions of dollars of excessive, idle accruals incurred opportunity costs that could be converted into working capital without jeopardizing the ability to satisfy warranty claims (Spraker, 2007), whereas insufficient warranty accruals necessitate finding expensive emergency funds (Gurgur, 2011).

The preceding discussion suggests that an important issue facing firms is how they can manage their warranty costs—and thus improve financial performance—while offering competitive warranty coverage for customers. A prevalent challenge in warranty management pertains to the limited coordination of the actions and decisions of different functional groups in a business vis-à-vis managing warranty costs (BearingPoint, 2009). Disconnects between departments often impede the flow of usable information to support warranty reduction and forecasting. Understanding how a firm’s stakeholders, such as the marketing department, can contribute resources for achieving this objective is critical.

The foregoing apprehension is inadequate, though. Extant literature is largely limited to the impact of the degree of warranty coverage on consumers’ evaluation of product performance—such as quality perceptions (Jain et al., 2007)—and to the extent to which manufacturers have a tendency to offer warranty coverage based on consumers’ product quality perceptions (e.g., Balachander, 2001, Soberman, 2003). This constricted view has ignored whether certain marketing variables influence warranty management. For example, brand equity is central to many marketing efforts, as it can change consumers’ behavior (e.g., Slotegraaf and Pauwels, 2008) and employees’ commitment and behavior (e.g., Tavassoli et al., 2014), both of which could affect firm strategies and capabilities related to warranty cost management. Despite this possibility, the question of whether brand equity influences companies’ warranty costs has not been addressed.

Given the aforementioned omission in prior research, we propose that strong brand equity can help companies reduce warranty claim costs and abnormal warranty accrual costs and that these warranty cost factors mediate the relationship between brand equity and firm value. Brand equity could reduce warranty claim costs by motivating firms to undertake ongoing product quality improvement and actuating customers to assume augmented product maintenance efforts (which could decrease warranty claims) for their preferred brands. Brand equity might also lower abnormal warranty accrual costs by improving warranty cost predictions: a brand’s enhanced superior connection with customers might facilitate its managers’ accumulating market knowledge to estimate future warranty costs with increased precision. In addition to brand equity, innovativeness is another important quality signal to consumers and investors. If newer products have lower product reliability, innovativeness may be associated with higher warranty costs. Thus, for contingency effects, this study examines whether innovativeness weakens the negative association between brand equity and warranty cost factors, as well as the negative relationship between warranty cost factors and firm value.

This research makes three contributions to theory and practice. First, it calls attention to the financial impact of warranties, which has been underresearched in the marketing literature. Most warranty empiricism in prior work in marketing has focused on consumers’ reactions to warranty coverage (e.g., Kelley, 1988, Douglas et al., 1993). While warranty claims and warranty accruals contain important information about a firm’s current and future performance, their interplay with variables that fall under the marketing umbrella received little attention. Documenting the roles of warranty cost variables in a marketing context is a worthy endeavor.

Second, this research will enhance knowledge in the brand literature by providing new evidence about brand assets’ financial value from a cost-saving perspective. Marketing practitioners recognize the importance of strong brands, and scholars have suggested that brand equity can significantly strengthen profitability and shareholder value (Joshi and Hanssens, 2004, Rao et al., 2004). Brand value, however, has yet to be sufficiently taken into account in accounting systems and has not been associated with cost management. The empirical examination of the relationship between brand equity and warranty costs will help managers understand the financial accountability of intangible marketing assets.

Third, from the aspect of expense management, most prior work in marketing that has centered on expenditures has focused on advertising and R&D expenses (see, for an exception that examined warranty claims payments, Kurt et al., 2021). Different from advertising and R&D costs that are often expensed as they are incurred, the accounting rules require warranty costs to be accrued in advance in balance sheets for every sale generated. Warranty claims (realized costs) reflect the current product performance, while abnormal warranty accruals (the unexplained part of planned costs) reflect the quality of a firm’s warranty cost prediction. Examining both realized and planned costs can foster an increased understanding of the relationship between marketing variables and these two main dimensions of warranty expenses.

Section snippets

Overview of warranty expenses

According to the US GAAP’s accrual accounting rules, warranty expense should occur when revenue is recognized for all sales contract obligations to a customer. Specifically, at the time when sales revenue is recognized, warranty accruals should be added (credited) to the warranty reserve account and also be recorded (debited) in the warranty expense account. When actual warranty claims are received, the manufacturer then debits the warranty reserve account and credits the inventory account for

Literature review

There are two theories especially apt for studying warranties: signaling theory and incentive theory (e.g., Emons, 1989, Chu and Chintagunta, 2011).

The signaling theory of warranty suggests that, because warranty costs are related to product reliability systematically and are expensive to the firm, companies can use strong warranties to signal product quality to consumers under information asymmetry—thereby enhancing consumer preferences (Balachander, 2001, Grossman, 1981, Lutz, 1989, Spence,

Brand equity and warranty claims

A warranty claim is the warranty cost spent to correct current product problems discovered. Prior research has suggested that, relative to weaker brands, stronger brands are more likely to have higher product quality (e.g., Aaker, 1992) from which they experience reduced warranty claim costs. The association between brand equity and warranty claim costs can have additional ramifications. Specifically, we expect that brand equity influences warranty claims through its association with a higher

Data

The hypotheses were tested using data from multiple sources. First, warranty expense data was obtained for the years 2003–2017 from Warranty Week (http://www.warrantyweek.com). Financial Interpretation No._FIN_45, which took effect in 2003, mandated the disclosure of warranty information. Thus, all of the sample firms (publicly traded firms) that provided warranties were required to disclose warranty information. Warranty Week offers collections of US manufacturers’ product warranty expense

Variables

Firm value (Tobins_Q) has been used extensively in the literature to measure firm value as influenced by firm strategies, such as branding (Rao et al., 2004). Tobin’s Q was computed as the ratio of the firm’s market value of assets to the book value of the firm’s total assets (Perfect and Wiles, 1994). Grewal, Chandrashekaran, and Citrin (2010) noted that, as a performance metric of firm value, Tobin’s Q has advantages over other measures in that it reflects a firm’s stock of tangible and

Model

This research had three main objectives: (1) to study the mediating roles of warranty claims and abnormal warranty accruals with respect to brand equity and firm value (H1-2), and (2) to investigate the moderating effects of product innovativeness on the relationship between brand equity and warranty claims/abnormal warranty accruals) (H3), and (3) to examine the moderating effect of product innovativeness on the relationship between warranty claims/abnormal warranty accruals and firm value (H4

Results

We first present the relevant descriptive statistics. The average firm value was approximately 1.67 in the sample, which is in line with previously reported averages (e.g., Groening et al., 2016, Malshe and Agarwal, 2015). The sample firms’ average warranty claim rate was 1.9%, and the warranty accrual rate was 1.8%; these are close to the percentages reported previously (e.g., Warranty Week, 2019). The average brand equity value was 61.9, with a standard deviation of 6.1, similar to previously

Robustness tests and additional analysis

Several additional analyses were conducted to enhance understanding of the results.

Discussion

This research appeals to enhanced thinking and practice about the roles of marketing variables in warranty cost management. The evidence suggests that brands can create firm value through contributing to warranty cost management activities and that product innovativeness weakens the effect of brand equity on warranty costs. The findings have important implications for both theory and practice.

Limitations and future research

This study has certain limitations that yield avenues for further research. This research focused on large publicly traded companies due to the limitation in data availability. Future scholars can include small- to mid-sized companies in the sample to compare the strengths of the relationships in different types of organizations.

In addition, other marketing-controlled resources and market characteristics than those examined here should be incorporated into the analysis in a similar context.

Conclusion

This research offers new insights for firms in need of effective warranty cost management. The findings show that brand equity is associated with lower warranty claim costs and abnormal warranty accrual costs—through which it influences firm value. Product innovativeness weakens the negative association between brand value and warranty costs. Progressive organizations should develop their brand assets and leverage the effect of marketing variables in the process of warranty cost management.

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