Embed Size (px)
DESCRIPTION
Citation preview
20112011®
®
“Warranty Goodwill:What is it Worth?”
Michael Paczolt, FCAS, MAAA
Consulting ActuarygMilliman
About Milliman ®About Milliman
• Actuaries and other consultantsActuaries and other consultants
• Independent – Not broker or insurance • Independent Not broker or insurance carrier
• Over 2,100 Employees
• Offices in most major cities globally
3
Warranty Goodwill ®Warranty Goodwill
• VoluntaryVoluntary• Customer satisfaction• Brand reputation• Brand reputation• Sometimes viewed as an unnecessary
expenseexpense• Can be significant portion of warranty
spend (5 to 25%)spend (5 to 25%)
4
Franchise Value ®Franchise Value
• William H. Panning’s “Managing Interest William H. Panning s Managing Interest Rate Risk: ALM, Franchise Value, and Strategy”
• Value of prospective insurance renewalsp p
• Reason why Market-to-Book ratio exceeds Reason why Market to Book ratio exceeds 1.0
• Asset ignored by accounting5
Franchise Value – Dell ®Franchise Value Dell
• $26 Billion Market Cap
• $5 Billion Book ValueBook
Value, $5 Billion, 19%
• 5.2 Market-to-Book ratio
F t E i t
19%
• Future Earnings represent 81% of Firm Value
F hi Franchise Value,
$21 Billion, 81%
6
Goal ®Goal
• Maximize Firm Value (Book + Franchise)Maximize Firm Value (Book + Franchise)
• Current earnings are relatively fixed (Book • Current earnings are relatively fixed (Book value)
• What amount of warranty goodwill maximizes future earnings (Franchise maximizes future earnings (Franchise Value)?
7
Model Assumptions ®Model Assumptions
• Surplus is constantSurplus is constant
• Only warranty goodwill effects future • Only warranty goodwill effects future customer base
30 3Jan 1 June 30 Dec 31
Warranty Coverage Period Warranty Goodwill Period
25% 25%
8
25% Failure Rate
25% Failure Rate
Model Inputs ®Model Inputs
V i blVariablesCost to manufacture product $40In-warranty losses $10Discount rate 5%Discount rate 5%Surplus (used interchangeably with equity) $30,000Target return on surplus (or equity) 15%Fixed costs $60,000Fixed costs $60,000Variable expense 8%
9
Step 1: Product Price ®Step 1: Product Price
• Based on required Return on Equity (ROE)Based on required Return on Equity (ROE)
• ROE = Net Income / Surplus• ROE = Net Income / Surplus
10
Step 1: Product Price ®Step 1: Product Price
• Price is dependent on both:Price is dependent on both:• Number of customers• Amount of warranty goodwilly g
• Solve for price iterativelyp y
Warranty Goodwill (per product) $0 $1 $2 $3 $4Warranty Goodwill (per product) $0 $1 $2 $3 $4
Number of Customer (per year) 13,094 12,159 11,164 10,066 8,754
Price (per product) $55.36 $56.76 $58.25 $59.90 $61.87
11
Step 2: Current Economic (Book) Value ®Value
• Current Assets less Current LiabilitiesCurrent Assets less Current Liabilities
• Constant regardless of warranty goodwill • Constant regardless of warranty goodwill under ROE pricing assumption
Warranty Goodwill (per product) $0 $1 $2 $3 $4C t E i V l $32 857 $32 857 $32 857 $32 857 $32 857Current Economic Value $32,857 $32,857 $32,857 $32,857 $32,857
12
Step 3: Franchise Value ®Step 3: Franchise Value
• Future Assets less Future Liabilitiesutu e ssets ess utu e ab t es• Need an estimate of future customers
• Retention of Current Customers• Growth in New Customers• KEY INPUT!!!
• As Warranty Goodwill ↑ Retention ↑• As Warranty Goodwill ↑, Retention ↑• As Price ↑, Growth ↓
Warranty Goodwill (per Warranty Goodwill (per product) $0 $1 $2 $3 $4
Price (per product) $55.36 $56.76 $58.25 $59.90 $61.87Customer Retention 79.2% 85.6% 88.2% 90.1% 91.7%
Growth in new customers 20% 15% 12% 10% 8%
13
Growth in new customers 20% 15% 12% 10% 8%
Step 3: Franchise Value ®Step 3: Franchise Value
• Project future cash-flowsProject future cash flows
• Infinite geometric series• Infinite geometric series
14
Step 3: Franchise Value ®Step 3: Franchise Value
• Select maximum Market ValueSelect maximum Market Value
Warranty Goodwill (per product) $0 $1 $2 $3 $4 Price (per product) $55.36 $56.76 $58.25 $59.90 $61.87
Number of Customer (per year) 13,094 12,159 11,164 10,066 8,754
Franchise Value ($129 626) $247 371 $108 056 $85 054 ($19 390)Franchise Value ($129,626) $247,371 $108,056 $85,054 ($19,390)Current Economic Value $32,857 $32,857 $32,857 $32,857 $32,857
Market Value ($96,769) $280,228 $140,913 $117,911 $13,467
Market-to-book Ratio -2.95 8.53 4.29 3.59 0.41
15
Results ®Results20.00
15.00
10.00
oo
k R
ati
o
5.00
ark
et
to B
0.00
Ma
16-5.00
Warranty Goodwill per Product
Conclusions ®Conclusions
• Other factors affect Franchise ValueOther factors affect Franchise Value• Useful framework• Smart spending is key• Smart spending is key• Biggest challenge are demand & retention
curvescurves• Brand reputation is crucial
• Warranty goodwill should be used as tool to maximize firm valuetool to maximize firm value
17
Questions
18
Relevant Formulae ®Relevant Formulae
• Price per ProductPrice per Product
• Current Economic Value
• Franchise Value
• Franchise Value
19
