Being Sold A Bill of Goods

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ATI has reduced the warranty on its video cards down to a year.

That’s bad enough, but then they went and peddled a steaming heap of, well, bull-byproduct onto a, well, naive author.

What did they say, and what was wrong with what they said?

Here’s the main chunks, oops, points:

90% of video card returns happen in the first sixty days: Please notice the word “returns” rather than a word like “breakage.” “Returns” include all those perfectly functioning cards people buy, then returned because they didn’t like them for one reason or another. That probably is a pretty substantial proportion of that “90%” figure.

Take them out of the picture, and the percentage of cards needing warranty service after year one increases quite a bit.

Return of OK Cards

Real 1 Year + Warranty Rate

20%

12.5%

30%

14.3%

40%

16.7%

50%

20%

60%

25%

So the percentage of ATI cards requiring service after a year is probably a good deal higher, maybe a whole lot higher than 10%.

Losing Money On Inventoried Cards

Per the article, ATI claims that a “large inventory of cards” have to be kept on hand for warranty work.

What’s large? A hundred? A thousand? A hundred thousand? If it’s a matter of a few hundred or thousands, that pretty minor for a company with a few billion in sales. If it’s hundreds of thousands, you have to wonder how goods the cards were to begin with.

Additionally, it’s not like ATI has a warehouse of brand new cards waiting to be shipped out as replacements. On the whole, they repair cards. No doubt they use some new cards as replacement, but at least a good chunk of that “inventory” are simply fixed or being-fixed cards.

ATI also claims that they lose money because their cards lose value. Well, first, cards in the “repair inventory” shouldn’t affect the balance sheet at all. Inventory on the balance sheet represents both finished cards you haven’t sold yet, plus cards you’re making. Cards being repaired are neither.

Look at it this way. If you send X video card worth $200 to ATI to be repaired, and they send you a fixed card back when it was worth $150, did ATI lose $50 on the deal. No! They had to pay for the repair, and that’s it. The person who lost out due to loss of value was you, not ATI.

Let’s assume it’s a matter of a replacement card instead. Do you think ATI fills a warehouse on the day of product introduction with all the video cards they think will be needed for the three-year warranty period? No, they’d be fired if they did.

A competent way to handle this is to divert whatever units are needed by the repair unit from the production line so long as the card is being produced. There shouldn’t be any stockpile of cards gathering dust while the card is being produced by the company in this day and age. As the price drifts download over time, so will the “cost” of any replacement cards.

The only time you’d need to build up a stockpile of parts would be when a card is being discontinued, but again, ATI ought to have a pretty good idea how many cards ought to go belly-up after making them for two years or so, and if they get it wrong, we’re talking about a fraction of a fraction of a fraction of cards. If they underestimate repairs, no one would complain if they got a better, more current card. If they overestimate and have to sell the excess cheaply, it’s not going to be much of a loss.

So this looks pretty bogus, too, since the only way it could be significantly true would be if ATI pursued pretty bad business practices.

Give The Other Guys A Chance!

ATI was offering a longer warranty program that most of the third-party video card makers were offering. How unfair! So ATI will lower its warranty to give the other guys a chance.

If you believe that, the tooth fairy is coming to your house tonight. Promise.

If ATI really wanted to stop competing against the third-parties, why are they making any cards themselves to begin with? Shouldn’t they just stop making them?

Unbelievably, the article says that by ATI reducing its warranties, buyers will end up with a longer warranty.

Let me see, I’m better off when the choice goes from three years vs. two to one year vs. two?

The article mentions that one third-party is offering a limited lifetime warranty, and another might. OK, let’s do the comparison again. How am I better off when the choice goes from three years vs. limited lifetime to one year vs. limited lifetime?

And of course, I never think about extending my warranty when a major competitor has a longer one than mine, only when they lower their warranty to BELOW mine.

What Is REALLY Happening

When a company tells you a story that makes no sense, they’re doing it for a reason. Often it’s a smoke screen for something else.

A perusal of the ATI financial statements the last few years shows that they indeed have an “inventory” problem. It just has nothing to do with warranties.

To oversimplify, let’s compare ATI’s revenues with their real inventories in 2004. (ATI uses a fiscal year beginning in October, so this means using their fiscal quarters starting 2Q 2004 to 1Q 2005 (again, that means finished, unsold goods plus work-in-progress).

Time Period

Revenues

Inventory

Inventory/Revenues

Jan-Mar 2004

$463

$229

49%

Apr-Jun 2004

$491

$253

51%

Jul-Sep 2004

$572

$255

45%

Oct-Dec 2004

$613

$292

48%

You can see that the ratio between inventories and revenues hovers in the 45-50%. (In 2003, the ratio is roughly the same, though a little lower).

Now let’s look at 2005:

Time Period

Revenues

Inventory

Inventory/Revenues

Jan-Mar 2005

$608

$367

60%

Apr-Jun 2005

$530

$456

86%

Big change, isn’t it?

Why the big change in inventory? Two possible reasons:

  • ATI didn’t sell as many cards as it expected to the last couple quarters.
  • ATI is having some difficulties with its new generation of cards.

    Read the financial statements and it looks to be both.

    Now it is true that if finished video cards have been stockpiling, and end up being sold for rather less than ATI wanted, there will be losses as a result, quite possibly very substantial ones.

    But this has nothing to do with warranties, and lowering the warranty period if anything will make that inventory problem worse, certainly not better.

    So why is ATI doing this? Well, a minor reason is simply to make a bit more revenue by charging people $50 or $75 for repairs.

    I suspect a rather bigger reason will be to muddy the waters a bit should ATI start showing some big losses due to this inventory problem. They can say in their conference call that they are taking serious steps to reduce inventory, and if asked what, talk about reducing “excess inventory” in the repair section, even though that’s not the problem, and whatever tiny effect it might have wouldn’t occur for another year.

    ATI will release last quarter’s earnings tomorrow. It will be interesting to see what happens.

    For now, though, two thumbs down on all the fertilizer. Lost a lot of respect for them, thought they were better than that.

    Ed

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