Public Release: 

Selling extended warranties via independent companies lowers price but hurts consumers: INFORMS

Institute for Operations Research and the Management Sciences

Retailers selling home appliances and electronics goods typically make 15-20 percent profit from these products but realize more than 200 percent profit from selling extended warranties for them. A new study that appears in the January issue of Marketing Science, a publication of the Institute for Operations Research and the Management Sciences (INFORMS), finds that even though selling warranties through independent firms will lower extended warranty prices, the consumers may actually be worse off.

The research, Risk Preferences and Demand Drivers of Extended Warranties, was conducted by Pranav Jindal, assistant professor of marketing at Pennsylvania State University's Smeal College of Business.

Combining conjoint analysis, one of the most widely used market research tools, with economic models, Jindal analyzed stated choices of more than 550 consumers drawn from an online panel, and addressed two key questions -- "Why do consumers buy extended warranties?" and "Why do consumers pay such a high premium for extended warranties?"

"Paying $500 for a new laptop is not the same as paying $500 for repairing or replacing a laptop you already own," Jindal said. "Consumers view paying for repairs as a loss. Consumers feel it hurts 3-4 times worse than paying the price of the product itself. This hurt drives consumers to buy extended warranties."

This behavior of consumers is called loss aversion.

Through an online survey, the author collected data on consumer choices for washing machines and extended warranties to show that loss aversion along with peace of mind are the key reasons why consumers buy extended warranties for their products.

"Consumers search for low product prices but do not search for low warranty prices," says Jindal. "So, they are locked in by retailers selling appliances and electronic goods. Conventional wisdom says that extended warranties should be sold through independent firms selling only warranties, which will make extended warranties cheaper and consumers better off. But according to this new research, obtaining extended warranties through independent firms may be cheaper but it does not make consumers happier."

This unexpected result is based on the finding that retailers discount the price of home appliances and electronic goods and in turn charge consumers a premium for extended warranties. If these retailers are not allowed to sell extended warranties, then prices of home appliances and electronic goods will go up, although extended warranties (now sold through independent retailers) will become cheaper. On average, however, consumers lose more from the increased product prices than they gain from lower extended warranty prices.

While the study focused on the role of losses, it acknowledged that other factors such as over-predicting failure rate, lack of information about repair and replacement policy, and financial constraints may also result in consumers purchasing extended warranties.

"Consumers may buy a warranty for a variety of reasons. Controlling for others, this study shows that consumers' perception of potential losses and peace of mind are important factors, and have important implications for how extended warranties should be sold," Jindal concluded. "Moving forward, it would be really interesting to get into the consumer's mind and understand when they think a product will fail and how much they believe it will cost them to repair or replace the product."

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About ISMS

The author of the study is a member of ISMS, the INFORMS Society for Marketing Science. ISMS is a group of scholars focused on describing, explaining, and predicting market phenomena at the interface of firms and consumers. This press release was prepared by the author with the assistance of Gerard J. Tellis, Vice President for External Affairs of ISMS.

About INFORMS

INFORMS is the leading international association for professionals in analytics and operations research (O.R.). INFORMS advances research, and develops and promotes best practices in analytics and O.R. through collaboration, knowledge sharing, and professional development. INFORMS helps business, government, and other organization professionals make better decisions to drive value to their organizations and society. Our certification program (CAP®), highly cited publications, educational meetings and conferences, continuing education, industry and process focused networking communities, competitions, and recognition provide professionals with the knowledge and connections they need to achieve ever greater value for their organizations. The INFORMS Society for Marketing Science (ISMS), a subdivision of INFORMS, is a leader in fostering the development, dissemination, and implementation of knowledge, basic and applied research, and science and technologies that improve the understanding and practice of marketing. Further information about INFORMS, analytics, and operations research is at http://www.informs.org or @informs and further information about the INFORMS Society for Marketing Science (ISMS) is at https://www.informs.org/Community/ISMS.

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