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How do people value extended warranties? Evidence from two field surveys

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Abstract

Extended warranties are popular but expensive. This paper examines how consumers value these warranties, and asks whether economic considerations alone can account for their popularity. Results from two field surveys show that consumers greatly overestimate both the likelihood and the cost of product breakdown. However, these biases alone do not explain their willingness to buy warranties. In fact, we find evidence of probability neglect, in which warranty purchase decision depends on the magnitude of the possible consequences of not having insurance and not on the probability of having to suffer these consequences. The expected emotional benefits from having a warranty was the best predictor of purchase decision and willingness to pay. We also found that people with higher cognitive skills are less likely to overestimate the economic determinants of warranty value, yet are still highly influenced by emotional considerations when deciding whether to purchase a warranty.

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Notes

  1. Insurance against small cost consumer durables is among the most profitable items sold by commercial electronics stores. In the US, 40–80% of the profit on electronics comes from the sale of these warranties (Consumer Reports 2005). It is often suggested that it is only by selling warranties that commercial electronics stores can stay in business (e.g., Berner 2004; Malester 2004).

  2. We have never seen a brochure advertising extended warranties that has not mentioned “peace of mind.” To investigate this, we conducted a Google search of all sites in the .com domain containing the terms “extended warranty” and “peace of mind” and obtained 115,000 hits—with almost all items in top pages being companies selling warranties. A corresponding search replacing “peace of mind” with “probability” yielded 12,200 hits—with almost all the top items containing anti-warranty consumer advice.

  3. Although there is no necessary relationship between fair price and personal willingness to pay, we expected fair price to be correlated with willingness to pay, and the results of both our studies support this view.

  4. The revealed distribution of subjective breakdown probability in year t+1 first order stochastically dominated that of subjective breakdown probability in year t.

  5. The median subjective actuarial value for a 3-year warranty was £21 although the objective actuarial value is approximately £7. The actual price of a 3-year warranty in Belgium, however, is about £40—eight times as high as its (objective) actuarial value.

  6. We thank the Editorial Board and an anonymous referee for pushing us to distinguish between the components of the numeracy scale. Only the two CRT items reliably predict the warranty value estimates or hypothetical purchase decisions, suggesting that a certain degree of higher-level thinking is called on to make these decisions optimally.

  7. Our finding that the average expected cost of repair, and not the expected probability of breakdown, significantly correlates with the average fair price estimate is consistent with studies elsewhere. Huber et al. (2001) found that when choosing a product, respondents were not particularly interested in precise probabilities if they were not directly supplied. Williamson et al. (2000) found that when deciding whether to buy an extended warranty and invited to ask for information, respondents mainly asked about the cost and the terms and conditions of the policies, again not about the probabilities of breakdown.

  8. Interestingly, CRT is not simply picking up the effect of schooling. When we include a dummy indicating whether the highest grade of schooling completed was (partial) higher education as an explanatory variable in all the regressions that we report in the paper, the coefficient of CRT barely changes (significance levels never change) and the schooling dummy variable is never statistically significant.

  9. Purchase intention cannot be directly inferred from fair price. To see why, imagine we asked people to state the ‘fair price’ for a wheelchair. We would expect prices in the order of £200 or more, but expect that only those who needed one would be willing to pay anything at all.

  10. In our study, of course, we could not emulate the effects of ‘hard sell’ from zealous salespeople.

  11. Domestic consumer market regulations in Belgium have traditionally worked to insulate consumers from product-related risks and thus evolved very differently from those in the UK and US (Trumbull 2006). Therefore, the implicit purchase rate of 22% may be on the high side. In Study 2, however, the implicit rate was even higher for the Belgian than London sample.

  12. This is a Belgian Public Institution for Social Security that disburses unemployment benefits. There are 34 such offices nationwide, including one in Antwerp.

  13. We split our sample into two groups based on individuals’ CRT test score and repeated the same analysis as in Table 7 for each group. The estimated OLS coefficients reveal the same insights as those reported in Table 7. We therefore conclude that CRT does not change the influence of emotional benefits on the warranty purchase decision.

  14. It is perhaps unnecessary to emphasize that Kahneman and Tversky (1979) took a more sophisticated view of matters. As they observe: “A comprehensive theory of insurance behaviour should consider, in addition to pure attitudes toward uncertainty and money, such factors as the value of security [what we would call peace of mind], social norms of prudence, the aversiveness of a large number of small payments spread over time, information and misinformation regarding probabilities and outcomes, and many others.” (p. 286)

  15. As further evidence that probability was not seen to be relevant to warranty pricing, those who gave breakdown probabilities of 0 typically gave positive values for warranty fair price and maximum willingness to pay.

  16. The standardized regression coefficient for EBI, when predicting both fair price and WTP, was greater than that for repair cost. This was true despite the fact that the repair cost was given in the same currency as the value estimate, and always appeared closer in the questionnaire, so any “common method variance” effect would favour repair cost.

  17. We recognise that while this solution is conceptually simple, it is not so easy to implement, and it places a constraint on the freedom of retailers to make their own marketing decisions. But there are precedents in which the use of what might be called local monopoly power has been curtailed by requiring monopolists to provide market access to their rivals (for an example of such procedures see O’Brien 2009). Likewise, the power of organizations such as lending institutions to set interest rates and gambling establishments to set odds are limited by legislation, to protect vulnerable consumers. Extended warranties have long been recognised as a good, like loans and slot machines, for which unprotected consumers are liable to make mistakes.

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Authors and Affiliations

  1. Department of Management, London School of Economics, 54 Lincoln’s Field Inn, London, WC2AE 3LJ, UK

    Marieke Huysentruyt

  2. SITE, Stockholm School of Economics, Sveavagen 65, SE-113 83, Stockholm, Sweden

    Marieke Huysentruyt

  3. Durham Business School, Durham University, 522 Mill Hill Lane, Durham, DH1 3LB, UK

    Daniel Read

  4. Yale School of Management, 135 Prospect Street, New Haven, CT, 06511-3729, USA

    Daniel Read

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  1. Marieke Huysentruyt
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Correspondence to Marieke Huysentruyt.

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Huysentruyt, M., Read, D. How do people value extended warranties? Evidence from two field surveys. J Risk Uncertain 40, 197–218 (2010). https://doi.org/10.1007/s11166-010-9094-9

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