Warranty FraudManagement

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Warranty FraudManagementReducing Fraud and OtherExcess Costs in Warrantyand Service Operations

Matti KurvinenIlkka Töyrylä

D. N. Prabhakar Murthy

Copyright © 2016 by Matti Kurvinen, Ilkka Toyryla, and D.N. Prabhakar Murthy.All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, ortransmitted in any form or by any means, electronic, mechanical, photocopying,recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the1976 United States Copyright Act, without either the prior written permission of thePublisher, or authorization through payment of the appropriate per-copy fee to theCopyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978)750–8400, fax (978) 646–8600, or on the Web at www.copyright.com. Requests to thePublisher for permission should be addressed to the Permissions Department, JohnWiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748–6011, fax (201)748–6008, or online at http://www.wiley.com/go/permissions.

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Wiley publishes in a variety of print and electronic formats and by print-on-demand.Some material included with standard print versions of this book may not be includedin e-books or in print-on-demand. If this book refers to media such as a CD or DVDthat is not included in the version you purchased, you may download this material athttp://booksupport.wiley.com. For more information about Wiley products, visitwww.wiley.com.

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ISBN 9781119223887 (Hardcover)ISBN 9781119239703 (ePDF)ISBN 9781119239741 (ePub)

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Printed in the United States of America

10 9 8 7 6 5 4 3 2 1

Dedicated to

Sirpa, Joni, Saila, and Niina, I love you all,and the memory of Marko, I miss you — MK

Susanna, Markus, and Sonja, for their understanding duringthe long hours it took to complete this book — IT

Jayashree for her support — DNPM

Contents

Foreword xiii

Preface xvii

Acknowledgments xxiii

About the Authors xxv

Chapter 1 Overview 1Warranties 3Warranty Servicing 4Warranty Costs 5Warranty Fraud 6Impact of Warranty Fraud 9Warranty Fraud Management 10Study of Warranty 10Goals of the Book 12Structure of the Book 12Note 14

Chapter 2 Products and Product Warranty 15Products 16Product Performance, Failure, and Reliability 19Product Maintenance 24Product Warranty 26Maintenance Service Contracts 36Insurances 37Notes 38

Chapter 3 Warranty Servicing 39Parties in the Warranty Service Network 40Warranty Service Process 46Outsourcing of Warranty Service 54Contracts 56Notes 62

Chapter 4 Warranty Costs 63Different Perspectives 65

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Factors Underlying Warranty Costs 68Warranty Cost Metrics 72Warranty Reserves and Accruals 77Warranty Cost Control 78Notes 79

Chapter 5 Warranty Management 81Evolution of Warranty Management 82Service Life-Cycle Perspective 84Product Life-Cycle Perspective 95Organizational Structure 100Warranty Management Systems 105Warranty Management Maturity Models 122Notes 124

Chapter 6 Warranty Fraud 125Fraud in General 126Actors and Victims of Warranty Fraud 128Classification of Warranty Fraud 129Fraud Patterns 130Consequences and Impacts of Warranty Fraud 135Customer Fraud 139Service Agent Fraud 147Sales Channel Fraud 162Warranty Administrator Fraud 166Warranty Provider Fraud 169Notes 175

Chapter 7 Warranty Control Framework 177Contracts 180Transaction Controls 181Analytics 183Service Network Management 187

Chapter 8 Customer Fraud Management 189Customer Contract 190Customer Entitlement 200Material Returns Control 207Analytics 208Notes 213

Chapter 9 Service Agent Fraud Management 215Service Agent Contract 216Entitlement and Repair Authorization Processes 237Claim Validation Process 239

C O N T E N T S xi

Analytics 248Material Returns Control 278Service Network Management 280Notes 291

Chapter 10 Fraud Management with Other Parties 293Sales Channel Fraud Management 294Warranty Administrator Fraud Management 299Warranty Provider Fraud Management 305

Chapter 11 Structures Influencing Warranty Fraud 307Effective Service Process 308Service Organization 315Notes 318

Chapter 12 Implementing a Warranty Control Framework 319Assessing The Current Situation 320Crafting an Improvement Plan 322Defining Policies and Rules 322Building the Capabilities 323Deploying the Change 325Business Case Considerations 327Implementation Challenges 328Achieving the Transformation 329

Chapter 13 Epilogue 331Opportunities to Improve Warranty Control 333New Research into Warranty Fraud 335

Appendix A Detailed Claim Data 337

Appendix B Agency Theory 343

Appendix C Game Theory 347

Glossary 351

Acronyms 355

References 357

Index 363

Foreword

As warranty management has seen a significant evolution over the last25 years—from a purely reactive/administrative task toward a strate-gic component within the product life cycle, and nowadays even moreas an essential part of how to manage the customer experience inthe customer/consumer purchase-to-repurchase cycle—it is surpris-ing how limited the available literature on warranty management andfraud avoidance is.

Matti Kurvinen, Ilkka Törylä, and D.N. Prabhakar Murthy havenow written an important book about this topic. They are addressingall major points of warranty (fraud)management and explainingmanyimportant topics and interdependencies. As it provides many practi-cable samples and a very pragmatic approach to many theories, thisbook is the perfect reading for everybody who has to deal with war-ranty management, either looking for new insights or as an excellentholistic overview for those who are new in the business.

The first few chapters focus on explaining the general area of war-ranty and associated terminology and influencing levers. In Chapter 2,there are essential insights about products and warranty concepts. Theauthors describe the correlation between product performance, fail-ures, and product reliability, followed by an explanation of the natureof warranty and different types and classification of warranties.

After a general description of the topic and clarification of core ter-minology, Chapter 3 describes the warranty servicing process, channelsand parties in a warranty service network, and associated contracts.As warranty cost is the most critical metric for most warranty own-ers, Chapter 4 concentrates on this topic. It describes critical factorsunderlying warranty costs, warranty cost metrics, and warranty costforecasting and management.

With Chapter 5 the authors are going beyond the core descriptionsand explanations. From my perspective, this chapter touches oneof the most important areas, which—unfortunately—is not reallymanaged well in most companies, as it requires true holistic businessunderstanding and associated mandate to influence entire processesand business models. This chapter looks at end-to-end warranty man-agement from a product life-cycle perspective, including critical key

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decisions to be made at different stages of product life cycle. As soon asthe preparation determinations are made during the product creationstage, the focus must change toward the service life-cycle perspectiveand how to manage the warranty process from bringing a productto market and to customers, to how to provide warranty service, tosubsequently managing the claims process and related invoicing andpayments within the service delivery ecosystem.

Chapter 6 goes into details of potential fraud variants with manyuseful samples and cases. It introduces the different forms of warrantyfraud and a structure looking at the actors, victims, motivations,and methods for fraud. Especially when looking at how to improvewarranty (fraud) management in your organization, there is a holisticperspective of what could go wrong. In addition, the chapter high-lights several aspects that are addressing the motivation and rootcause for fraud attempts, such as underpay by original equipmentmanufacturers or too-high investments in required infrastructure,tools, and certification.

Although all attempts are to a certain extent unethical, thereshould be a difference between intentionally driven (criminal),opportunistic, using gaps in the system (criminal), and unconscious(unaware and missing knowledge) motivation. The chapter provides adeeper insight into what root cause has been “created” by the warrantyprovider itself or brings weaknesses of service delivery ecosystemto the surface.

As soon as warranty owners understand motivation and appliedmethods of warranty fraud, they are reasonably prepared and canmake the first step toward initiatives on how to fight against it.Chapters 7 to 10 provide insights on how to manage or even avoidfraud, including many examples. The authors provide core under-standing for how to create a basic structure for a manufacturingcompany, how to manage warranty fraud and more specific methodsfor customer fraud avoidance, and opportunities for fraud detectionand management. Methods for fraud avoidance and management aregiven from many different perspectives and directed at all parties ofa holistic warranty service delivery ecosystem. Based on their ownexperience and expertise, the authors share practical ways to directfocus to start initiatives against warranty fraud.

Very often, warranty (fraud) management is established as a func-tional entity within the service organization, with limited access andmandate to improve or change relevant processes or business models.The sphere of influence of warranty (fraud) management owners

F O R E W O R D xv

is very small and realistically restricted to information gathering,analytics, and reporting. In order to drive significant changes, they aredependent on many other stakeholders and business owners outsideof their influence. Chapter 11 takes a holistic view of the customerservice process and service organization—what are the mechanisms,when and where to influence warranty management in generaland warranty fraud management in particular. By understandingthe end-to-end picture and the associated levers where to tacklewarranty fraud most effectively, this chapter gives excellent input fororganization design and associated governance principles.

Closely linked to organization design, processes, and governanceare the underlying capabilities for organizations, which are described inChapter 12. Here the authors lay out an initiative to improve warrantyfraud management capabilities. They describe the key considerationsfrom understanding the as-is situation through laying the foundationfor improved warranty control and developing critical capabilities andhow to implement these.

Finally, Chapter 13 gives an interesting outlook toward newapproaches and potential impact of new technologies.

Overall, I highly recommend you read the book if you are directlyor indirectly responsible for reducing warranty fraud and improvingthe warranty management process in your business. There are manyways that you can positively impact the bottom-line success of yourcompany by taking this topic seriously and approaching it in a holisticway. The shared expertise of the authors will help you avoid mistakesand improve the overall approach to warranty (fraud) management.

Maximilian KammererAltaussee, Austria, December 2015

After various leading after-sales service positions at Apple and beingthe Global After Sales Service Executive at NOKIA Mobile Phones at itsheight, Maximilian Kammerer is one of the thought leaders in the after-sales service industry. In addition, Maximilian has been lecturing severalyears at the ISS International Business School of Service Management inHamburg. Nowadays, as Partner at Barkawi Management Consultantsand Managing Partner at 1492: \\ The Collective Intelligence, Maximilianis developing new service strategies and designing the right organizationalcapabilities to execute these strategies. One focus area is how to avoid fraud,or at least to properly manage warranty cost without negatively affectingthe customer experience within the service delivery ecosystem.

Preface

A multinational manufacturer made an after-sales process assessmentto evaluate its performance and compare it with leading practicesacross comparable industries. The initial focus was on operationsin Europe. One of the findings was that the warranty costs acrosscountries within the company were not consistent, taking into accountthe general cost levels and sales volumes per country. A closer studyrevealed further inconsistencies and bigger anomalies, comparingdifferent service agents inside each country.

That triggered the need to initiate activities to understand whatwas going on and ways to detect problems (such as fraud) andreduce the amount of warranty costs, starting with a few pilotcountries. The results were almost instant. Many service agents had,over the years, learned to work around the seemingly loose controlsof the manufacturer, and significant levels of fraud were detected.The manufacturer decided to accelerate the work and widen the focusto other European countries, which yielded similar results.

After the successful European implementation, the regional ser-vice heads of themanufacturer were approached for targeting the sameimprovements at the global level. There was a high level of skepticism,as indicated by the statement of one of the senior managers: “Yes, theEuropean results were impressive, but Europe was crap. You are wel-come here, but you won’t find anything. We know our service agents,and our controls are watertight.”

After less than two weeks of analytics on the regional data inanother region, there was enough evidence of fraud (and high war-ranty costs) leading to the implementation of improvement programssimilar to that in Europe. This was then followed up with otherregions of the globe. During the implementation, many of the localcustomer service managers were shocked when they noticed the scaleof fraudulent activities done by their long-term partners. “I have beenplaying golf with this guy every Sunday for the past five years. I can’tbelieve he has been doing this to me,” said one customer servicemanager. Not to talk about the incidents, where the employees of thecompany were also part of the scheme, working in collusion with thelocal service agents.

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WHAT HAS CHANGED DURING THE PAST TWENTY YEARS?

The first two authors have seen a number of similar cases and diverseways that fraud occurred in the servicing of warranties and mainte-nance service contracts as part of their consulting activities. The imag-ination and ruthlessness of some of these companies/individuals increating fraud has been very impressive—sadly, their behavior can onlybe described as unethical and antisocial. The surprising thing is, wehave seen and heardmany similar stories whenworking and discussingwith our clients. The strategic importance of warranty managementand the general maturity of the warranty profession in the industryhave improved during the past 20 years. In the same way, the develop-ment of technology (mobility, cloud, analytics, social media, industrialInternet) has enabled new and more effective information system sup-port for warranty management. Still, one hears and reads about peopleor companies (often accidentally) getting caught for cheating leadingglobal brands. In the client discussions, the two most common state-ments are still (i) we believe there might be something wrong, but wedon’t know who, where, and what is the scale of the problem, and(ii) this is not a problem with us. Depending on the source, the esti-mates of warranty fraud are between 3 and 15 percent of the warrantycosts. At the low end of the range, this translates to several billion USdollars globally.

WHY IS IT SO DIFFICULT?

Why is it so difficult for companies to recognize or do something aboutit? Why do we see the same gaps in control and same tricks applied wesaw 15 years ago? In our opinion there are three fundamental reasons:

1. Lack of awareness of the problem

2. The sensitivity of the issue

3. Lack of skills

Lack of Awareness

If you don’t have the right tools, processes, and skills to manage war-ranty fraud, you typically won’t detect it. In many cases, the first twoauthors have seen companies having these in place at the high level,but the small flaws in the details have a critical impact. When you

P R E F A C E xix

don’t detect fraud, you think it is not a problem, or if you believe it isa problem, you don’t have a picture of the magnitude of the problem.

A magazine article explaining that this is an industrywide issuewon’t necessarily convince companies that it is their issue as well.

This leads to the vicious circle—not believing it is an issue leads tonot investing in the capabilities, which leads to the issue staying underthe radar. Although huge amounts of money are lost, it stays as a partof the total warranty expenditure and “the mandatory cost of doingbusiness.”

Sensitivity of the Issue

“We don’t want to talk about warranty fraud, since the term fraudimplies intent, which is an overly harsh statement,” said one clientexecutive. Although the methods discussed in this book are also effec-tive in detecting and avoiding incidents resulting from sloppy proce-dures or unintentional mistakes, the main focus is on warranty fraudwith criminal intent.

It is a challenging topic because people want to believe the best inothers. Someone’s word is generally respected, so accusing the otherparty of fraud or even asking for further evidence to clarify unclearissues is very difficult for most people.

Also, as the matter is so sensitive, companies are not willing todiscuss it in public, so people can’t hear and learn from the experi-ences of others. For this same reason, we have chosen to keep everycase example anonymous (in many cases, that has also been a spe-cific request from the people interviewed) unless the case exampleoriginates from a publicly available source.

Lack of Skills

Typically, most of warranty management training happens by par-ticipating in conferences, seminars, workshops, and learning onthe job. All three authors have lectured at various conferences andconducted several workshops around the world. One of our inter-viewees (responsible for a global warranty management team in aglobal industrial equipment manufacturer) was quite frustrated aboutthe lack of a solid training curriculum for a warranty managementprofessional. “I am not looking for a one-day intro on a warrantymanagement topic, but something more comprehensive—something

xx P R E F A C E

like the PMI (Project Management Institute) certificate on warrantymanagement. If I could have that, I would instantly sign-up my wholeteam.”

NEED FOR A BOOK ON WARRANTY FRAUD

There is vast literature on warranty management topics, but verylittle on warranty fraud management. The first two authors had beenthinking about writing a book on warranty fraud since April 2014.In October 2014, they contacted the third author (as he had writtenfour books and edited one on various aspects of warranty) to explorethe possibility of writing a book jointly. The motivation for this wasto combine the deep understanding of warranty management andwarranty fraud of the first two authors with the broader perspec-tive of warranty of the third. In addition, it brought two differentperspectives—theoretical and practical—together. This is important,as theory and practice are two sides of the same coin.

During that time, we also teamed up with Bill Roberts from SASInstitute and Maximilian Kammerer from Barkawi ManagementConsultants and 1492:\\ The Collective Intelligence.

FOCUS OF THE BOOK

The focus of the book is to assist manufacturers and other extendedwarranty (maintenance service contract) providers to effectively man-age warranty fraud through detection and avoidance.

As mentioned earlier, the topic is sensitive and will stay sensitive.Our objective is to demonstrate the ways of dealing with this topicwithout offending honest business partners (which should be themajority) while still being fact based and determined to identifydishonest partners and initiate actions to improve.

Our focus is to provide practical ways to control warranty fraudthrough effective detection and avoidance methods. The book aims todevelop the skills of warranty professionals working in this area. Morespecifically, it addresses the following issues:

◾ What is the topology of the most common fraud scenarios, whoare the actors, what are their motivations, and who are thevictims?

P R E F A C E xxi

◾ What are the methods to tackle the known and also theunknown scenarios?

◾ What are the building blocks required for structured warrantyfraud management?

◾ How can organizations get started, and how can you implementa warranty fraud reduction initiative?

We hope that this bookwill increase awareness of the topic.We alsohope that the practical examples and methods described will help war-ranty professionals to analyze their data and processes from the fraudperspective, thus finding concrete evidence and facts of the situationin their own company and using that to increase the awareness, wherenecessary.

TARGET AUDIENCE

This book is primarily intended for after-sales professionals in generaland warranty management practitioners in particular. Due to thescale and impact of the problem, it could be of interest to finance andcontrol professionals as well. As a secondary target group, we see theacademic community and hope that this book will serve as a bridge toreduce the gap between academia and industry and for the blendingof theory with practice. The book can also be used as a referencebook for graduate-level programs in various areas such as operationsresearch, operations management, supply chain management, andafter-sales services.

Acknowledgments

Many people and companies have contributed in this effort. We thankMaximilian Kammerer for his insight and comments across the book,and his contributions to Chapter 11 and the Foreword, and Bill Robertsfor his insight on advanced warranty analytics and for establishing con-tact with John Wiley & Sons. We would also like to thank Eric Arnumfrom Warranty Week for his insights on warranty costs and fraud, KimVestman from Wärtsilä Corporation and Marko Niinistö from PhilipsHealthCare for their insight and experiences shared, Mark Nagelvoortfrom PCMI on updates on warranty management software capabilities,and Marko Ylä-Autio for his advice on warranty cost management. Wethank Springer Verlag for granting the permission to use material inAppendices B and C. We also want to thank the many people whomthe first two authors interviewedwho have chosen to stay anonymous.

Espoo, Finland: Matti KurvinenKlaukkala, Finland: Ilkka Töyrylä

Brisbane, Australia: D. N. Prabhakar Murthy

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About the Authors

Matti Kurvinen (Espoo, Finland) is a management consultantfocusing on service strategy and operations, warranty management,installed base management, and product/component traceability askey enablers of new industrial Internet-based service offerings. Priorto starting his own consulting company, he had a 23-year career withAccenture, where he has held various leadership positions (leadingthe Finnish Management Consulting practice 2009–2014, Global Leadof the Accenture Warranty Management offering 2006–2014) andworked as the responsible project director or content expert in severalsupply chain and warranty cost reduction initiatives across clients inindustrial equipment, automotive and electronics, and hi-tech indus-tries. He holds an M.Sc. (Industrial Engineering and Management)degree from Aalto University/Helsinki University of Technology.Matti Kurvinen can be reached through LinkedIn at fi.linkedin.com/in/kurvinen.

Ilkka Töyrylä (Espoo, Finland) is a management consultantwith over 20 years of experience fromNokia, Accenture, andMidagon.Service operations, outsourcing, warranty management and traceabil-ity are among his key areas of expertise. He has managed and/or beena subject matter expert in various warranty cost reduction projects.At Accenture, he was one of the key global subject matter experts inwarranty management and fraud reduction. He is a coinventor in theUS patent on Warranty Management System and Method issued toAccenture in 2011. The patent includes proven methods to identifyfraud in warranty repair data. For the last seven years, Ilkka Töyrylähas been a visiting lecturer at Aalto University, Helsinki, on warrantychain management and fraud reduction. He holds Dr.Sc. (IndustrialManagement) from Aalto University/Helsinki University of Technol-ogy and M.Sc. (Economics) from Helsinki School of Economics. Hisdoctoral thesis on traceability studied utilization of serial number data,warranty management being one of the application areas. He can bereached through LinkedIn at fi.linkedin.com/in/ilkkatoyryla.

D. N. Prabhakar Murthy is an Emeritus Professor in the Schoolof Mechanical and Mining Engineering at The University of Queens-land. He has held visiting appointments at 15 universities in the

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United States, Europe, and Asia and has carried out joint researchwith several research groups around the world. He has researchedvarious aspects of reliability, maintenance, warranties, and servicecontracts over the last 40 years. He has authored or co-authored25 book chapters, 170 journal papers, and 150 conference papers,and co-authored 10, and co-edited 3, books. He has given severalkeynote lectures at various international conferences and given over200 research seminars at several universities around the world. He hasserved on the advisory boards for 30 international conferences onreliability and technology management, on the editorial boards for12 journals, and reviewed papers for over 30 international journals.He has consulted for several businesses in Australia, Europe, and theUnited States on various topics onwarranty and reliability. He obtainedB.E. and M.E. degrees from Jabalpur University and the IndianInstitute of Science and M.S. & Ph.D. degrees from Harvard University.

C H A P T E R 1Overview

1

Warranty costs are a significant burden for manufacturing compa-nies. Traditionally, companies have seen warranty costs drivenprimarily by product quality and secondarily by repair network

efficiency. However, there is another factor to be taken into account:As with many other fields of life, if there is a lot of money involvedand an opportunity to get a part of that through fraudulent behavior,there will always be a small number of people or companies trying totake advantage of that. In our own client experience and in the news,we have seen the whole spectrum of warranty fraud, starting from abit of sloppy procedures and occasional overcharging and ending withorganized criminal activities in companies whose main business logicincludes generating revenues through warranty fraud in addition todoing some real repair service activities.

Various parties can be involved with conducting warranty fraud:customers, sales channel, extended warranty or insurance pol-icy brokers, service agents, warranty administrators, and even themanufacturer or warranty provider themselves.

The fraud done by the service network varies from opportunisticsmall-scale overbilling to fraud done by organized crime in industrialscale. Sources estimate that 3 to 15 percent of warranty billing is fraud-ulent (Arnum, 2015, AGMA and CompTIA, 2013, AGMA and PWC,2009). Consequently, the overall amount of warranty fraud can beestimated to be at least US$1 billion in the United States alone.

During the past 20 years, we have seen a lot of investment inwarranty control with improved validation and analytics capabilities—with some companies. However, it looks like the overall picture hasn’tchanged that much. Although some companies recognize the prob-lem and have taken prompt actions, many company representativeswe talked with either have said they think it is a problem but they don’treally know for sure or think that this is not an issue in their companies.And every now and then we read about well-known companies (e.g.,Apple, Cisco, HP, IBM, Jaguar, Nissan, Nortel, and Nokia) engaging inlawsuits against companies or individuals for warranty fraud.

The devil is often in the details—at the higher levels, everythingseems to be in place: validation rules, claim process, statistical dataanalysis, consumer entitlement—you name it. However, when you dig

2