Motorcycle-maker Harley-Davidson (NYSE:HOG) recalled roughly 10 times as many motorcycles in 2014 as it did in 2013 -- and 2015 is on course to become another record year.
According to a tally conducted by The Wall Street Journal this week, Harley-Davidson has recalled 312,000 motorcycles so far this year. With two months left to go in the year, Harley is en route to its worst year for recalls, ever.
Or looked at another way -- its best year ever.
According to the Journal's research, Harley-Davidson had to recall an average of 94,000 bikes per year over the decade from 2003-2013. Last year's total of 210,000 recalls ran to more than twice that number, while this year's total could reach three to four times the average.
Harley senior vice president for manufacturing and suppliers Michelle Kumbier said she is "disappointed" at the number of recalls the company is experiencing, and called this not "acceptable." But in at least one respect all these recalls aren't just "acceptable." They're wonderful.
How big of a problem is this?
Viewed from one perspective, growing numbers of product recalls sounds like a big problem for Harley-Davidson. Recalls hurt perceptions of brand quality, while repairs performed to fix the problems that forced the recall subtract profits from Harley-Davidson's bottom line.
According to the company's most recent 10-K filing with the SEC, Harley announced 24 separate recalls over the past three years, and incurred total warranty costs of $30 million on those recalls. Mathematically, that works out to about $1.25 million in added cost for Harley-Davidson per recall. Looked at another way, though, the 230,000-odd motorcycles recalled in those 24 incidents cost Harley just $130 or so per bike to fix.
Weighed against the $16,699 starting price of a Harley-Davidson Fat Boy, though, that's less than 0.8% of the bike's price. Despite these costs, Harley-Davidson still averaged a 19.5% operating profit margin across those three years (according to data from S&P Capital IQ).
A nice problem to have
Could Harley-Davidson have earned more money without those recall costs? Sure. But they could also have earned less money.
A few years ago, when Harley-Davidson was in the headlines for similar recall-related reasons, I wrote a column expounding on the likely cost of the recall to Harley's bottom line. Alert Fool readers, however, quickly pointed out that in their experience, Harley-Davidson uses "recalls" as an opportunity to get Hog owners back in the showroom -- and attempt to upsell them to more expensive bikes, and high-margin merchandise.
In one particularly pithy comment on a recall for faulty bike "braces," Motley Fool CAPS member edhans predicted that "if any part of the brace is visible externally, HD will sell 'Screaming Eagle' braces to consumers for upgrades and turn this into a profit."
A separate comment from the Journal article supports this theory of Harley-Davidson turning recalls into "loss leaders." Quoting Pittsburgh-area Harley dealer George Gatto, the Journal observed that many of the defects Harley has been recalling bikes for lately "can be fixed quickly" while the customer waits. And while the customer waits, one imagines that he's going to be wandering the showroom. The Journal also cites a Harley owner noting that despite the recent spate of recalls, he remains a valuable customer because of "good service from his local dealership."
Translation: A recall isn't just a sales opportunity. It's an opportunity to show off the company's service prowess, and strengthen customer loyalty.
The upshot for investors
The Wall Street Journal is painting Harley-Davidson's surging recall numbers as if they're a real crisis for the company, but the truth is a bit more complicated than that..
Yes, recalls cost money. Yes, at first blush they threaten to tarnish a company's reputation. But with Harley-Davidson still controlling 47.5% of the motorcycle market in the U.S., and raking in profit margins 4 full percentage points better than rising rival Polaris, and nearly four times as high as what Honda earns, the company seems to be doing just fine, regardless of the recalls.