Optimal extended warranty strategy: uniform or nonuniform pricing?

• Author: Yanhong Sun,Husong Ding,Bin Zheng,Yiwen Bian
• Published date: 01 May 2021
• Date: 01 May 2021
• DOI: http://doi.org/10.1111/itor.12611

Intl. Trans. in Op. Res. 28 (2021) 1441–1464

DOI: 10.1111/itor.12611

INTERNATIONAL

TRANSACTIONS

IN OPERATIONAL

RESEARCH

Optimal extended warranty strategy: uniform

or nonuniform pricing?

Bin Zhenga, Yiwen Biana, Yanhong Suna,∗andHusongDing

b

aSHU-UTS SILC Business School, Shanghai University,Shanghai 201899, P.R. China

bSchool of Business, Nanjing University, Nanjing 210093, P.R. China

E-mail: B_Zhengin@163.com [Zheng]; ywbian@shu.edu.cn [Bian]; yahosun@shu.edu.cn [Sun];

hsding@foxmail.com [Ding]

Received 29 December 2017; receivedin revised form 25 July 2018; accepted 24 October 2018

Abstract

Manufacturers are increasingly selling extended warranties to achieve high profitability. An important ques-

tion is to sell the traditional or flexible extended warranty (TEW vs. FEW). TEW is sold at the time of product

sales with a uniform price, while FEW can be sold atthe time of product sales (the first point) or at the end of

base warranty (the second point) with nonuniform prices. When selling FEW, manufacturers need to decide

whether to preannounce the difference between the first-point and second-point warranty prices. To address

such challenging issues, we develop theoretical models regarding selling TEW or FEW and find that neither

of the two warranty services is always superior to the other. Particularly, FEW outperforms TEW when the

manufacturer’s cost efficiency of warranty is relatively high and/or the total warranty duration is relatively

short. Interestingly,when selling FEW, it is not always better off concealing the price difference information,

which is counterintuitive.

Keywords:traditional extended warranty; flexible extended warranty;uniform pricing; nonuniform pricing; preannounced

pricing

1. Introduction

Extended warranty is a typically optional service plan under which the providers promise to repair

or replace products for consumers. Unlike manufacturers’ base warranty, which is bundled with

the product, extended warranty provides consumers with additional coverage and is often sold

separately fromthe product (Li et al., 2012). With the decrease of profit margins on durableproducts

(e.g., home appliances, automobiles, and PCs), extended warranty, as a typical post-sales service,

greatly contributes to the manufacturers’ profitability. A recent survey shows that retailers’ margins

∗Corresponding author.

C

2018 The Authors.

International Transactionsin Operational Research C

2018 International Federation ofOperational Research Societies

Published by John Wiley & Sons Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main St, Malden, MA02148,

USA.

1442 B. Zheng et al. / Intl. Trans.in Op. Res. 28 (2021) 1441–1464

are usually between 60% and 70% from selling extended warranties (Hsiao et al., 2010). Besides,

extended warranty also helps to extend the useful life of products, and thus improve consumer

loyalty, brand image, and brand equity (Gallego et al., 2014). Not surprisingly, offering extended

warranty has been a critical marketing strategy in the durable consumer market.

Traditionalextended warranty (TEW) is generally sold at the time of product sales with a uniform

price. For example, Amazon requires that extended warranties must be purchased with hardware

products at the same time (Amazon, 2017). If a consumer does not buy the service at this time, he

will have no opportunity to buy it afterward. Similarly, as a typical extended warranty, all Apple’s

AppleCare+plans forMacs, iPads, and iPhones must be bought alongside a new device or within 60

days of product purchase (Clover, 2017). Notably, when the warranty selling price is relatively high,

those consumers with careful usage, low utilization, or high risk tolerance will have less motivation

to buy the extended warranty at the time of product sales (Gallego et al., 2015).

To better segment consumers, the providers have launched a type of flexible extended warranty

(FEW) (i.e., price-discriminationextended warranty) in recent years. This typical extended warranty

allows consumers to buy the warranty service at the time of product sales or at the end of base

warranty, or, indeed, at any other time with different prices (Warranty Week, 2007; Hartman and

Laksana, 2009). This type of FEW offers consumers with more choices and thus makes it more

attractive. Hence,in recent years, many firms in reality choose to providesuch extended warranty.For

example, consumers can buythe Samsung Premium Care for the devices during the standard limited

warranty period (Samsung, 2017). More recently, Lenovo has launched the “Lenovo Service” that

allows consumers to buy the extended warranty for the devices like laptop and desktop computers

during the base warranty period (Lenovo, 2018).

In addition to the segmentation of consumers,this typical FEW also facilitates consumer warranty

purchase decisions.In particular, consumers maydelay warranty purchase decisions to the expiration

of base warranty, in order to acquire more information about the product quality during the

base-warranty period and thus makes purchase decisions more reasonably. To defend against such

consumer behavior,many firms set a markup price for those consumers choosing to buy the warranty

service at the end of base warranty. Take HP forinstance, HP offers a two-year extended warranty at

RMB 799 bundled with the product sale of HP Elitebook 1040 G3, but sells it separately afterward

at RMB 999 (HP, 2017). This leads us to a challenging issue: how to set the warranty selling prices

at different points when offering FEW? If the difference between the warranty prices at different

points is greatly high, consumers who expect to purchase after the expiration of base warranty may

deter and even exit the market. If the price difference is too small, however, it will definitely not

differentiate the consumers.

To achieve more advantages during the game with consumers, many warranty providers (e.g.,

Samsung, JD, and SUNING) in reality choose not to preannounce the selling prices of extended

warranty sold at different time points until the exact sales time. In this context, consumers have

incomplete information about the future warranty selling prices at the time of purchasing the

product. However, we can also observe from Hpstore.cn that HP preannounces all the warranty

selling prices regarding the time of product sales or afterward(e.g., the end of base warranty). These

practices raise a further interesting question: is it necessary for the providers to preannounce the

full warranty selling price path when selling products?

Notably, the abovementioned evidence shows that, manufacturers have two choices to sell ex-

tended warranties in the market (TEW or FEW). As we know, offering any type of extended

C

2018 The Authors.

International Transactionsin Operational Research C

2018 International Federation ofOperational Research Societies