Whenever we buy something, we take a gamble. What if it breaks? The bigger the purchase, the bigger the risk. A warranty aims to solve this problem by de-risking the investment and allowing a customer to get comfortable with purchasing a new or used asset. Warranties play a special role in asset finance for lower-income customers in developing economies, for whom a $1,000 purchase might be the equivalent of a higher-income customer buying a car.
A warranty is not only important to a customer. The distributor selling the product needs assurance that the supplier will pay reasonable warranty costs if the product doesn’t perform as per specifications. Without this, the distributor could be holding all the costs when a product breaks and the customer comes calling.
Despite the obvious importance of warranties, there are many signs that they are being treated as an afterthought in emerging markets, with adverse financial implications for both the suppliers and distributors who provide asset finance. A failure to address these issues could prevent companies from reaching scale and make critical investments too risky to be accessible for the world’s poorest people.
Why are warranties so core to successful asset finance?
A warranty is a supplier’s promise to cover the cost of repairing an asset should it break or malfunction within a certain amount of time. The average cost of fulfilling that promise is priced into the product. When an asset finance company purchases products from its suppliers, part of what it buys are the warranties on those products. End-customers who buy those products are then able to access the warrantied service.
Warranties play a vital role in helping asset finance companies attract clients, ensure loan repayment and keep costs low. When customers have confidence that a product will consistently function as advertised and do so for a long period of time, they are more likely to buy it on credit.
On the other hand, if a product breaks before the end of a loan term, will a customer (who does not yet own the product) keep paying down the loan on a dysfunctional asset? Unlikely. Even more unlikely in that scenario is any kind of referral, which is the lowest-cost means of acquiring new customers.
In short, warranties help asset financing companies boost sales, reduce credit risk and build a solid reputation, especially when lending to low-income customers who are wary of buying low-quality assets on credit.
Warranties can break down barriers to asset finance for low-income customers
The length and strength of warranties offered by suppliers can either encourage or discourage asset finance companies from lending to low-income customers.
This is because longer-term warranties are an important precondition to the longer-term loans that make life-changing assets more affordable. It would be highly risky for a supplier to extend its loan terms beyond a product’s warranty period. If the product started to have issues after the expiration of its warranty, the asset finance company would have to cover maintenance costs or risk the customer being unwilling to repay, in which case the customer would also lose their equity in an asset.
As a wider array of asset financing becomes more viable to low-income customers, longer-term warranties have the potential to drive much of the innovation and growth. Despite these benefits, companies in leading asset finance industries such as pay-as-you-go (PAYGo) solar — where claims are regularly made that a product will last five years or more — are offering relatively short warranties. Generally, warranties are not more than two years for a solar home system or are as short as one year for expensive accessories like solar TVs.
Without appropriate warranties, finance companies face a dilemma: either limit loan tenors to the warranty term and keep prices unaffordable for most people or extend loans beyond the warranty and take on more credit risk. For assets that are purpose-made to be financed such as PAYGo solar units or smartphones, it may be time to rethink whether the current warranty arrangement creates the best finance outcomes or if a more equitable sharing of risks and costs between suppliers and asset finance companies could help both to grow faster and more sustainably.
Providers of warranties have a massive say in the growth of asset finance
Currently, most of the risk in asset finance sits with the company that originated the loan, as opposed to the product supplier. Suppliers are paid long before an end-customer receives the product, whereas asset financing companies must make their money back over months or years. Whether this happens depends on customer’s ability and willingness to repay, which is itself significantly influenced by product performance.
When products break, replacement parts from the supplier can take months to arrive. In the meantime, the company that sold the product is left to deal with an irate customer, shoulder the cost of replacing the product and resolve repayment issues using their own working capital.
“We do not just sell a product,” said Hugh Whalan, CEO of PAYGo solar company PEG Africa. “We have to also provide financing to make this work, and we therefore make a commitment to our customers to fix their product during the loan term. If the product breaks, they stop paying. So our business model doesn't work without a strong warranty. It’s at the core of what PEG does.”
If asset finance companies are to reach scale quickly in emerging markets, they will need suppliers to support them. Suppliers should be incentivized to care about this: the better asset finance companies are at financing products and getting repaid, the more products they will buy.
Suppliers could prefinance expected repair costs through escrow accounts that finance companies draw on the moment a product is retrieved from the field. Suppliers could sell options for extended warranties or automatically extend warranties if defects for a particular product exceed agreed-upon thresholds. Neutral parties could collect data to understand the risk that defects pose and therefore how warranties should be priced in the market. And although it’s not a warranty issue per se, suppliers could extend longer payment terms to asset finance companies for products that are built to be financed.
Low-income households need access to more income-generating and life-changing assets. But finance for those investments will remain unaffordable and risky if suppliers do not offer better warranties. Many companies talk about how their products can change the world. It is time to back up that talk.