Extended warranties are often more profitable to the retailer than the product it covers.
They generally amount to “unnecessary and overpriced insurance” since most products don’t break within the period covered, and repairs tend to cost no more than the warranty itself.
So, why do so many consumers buy extended warranties?
Answer: Peace of mind is a benefit … especially for folks of limited means who are buying “hedonic” products.
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Shoppers tend to agonize over the relative merits of different models of electronic goods such as digital cameras or plasma televisions.
But when they get to the till, many spend freely on something they barely think about at all: an extended warranty, which is often more profitable to the retailer than the device it covers.
Shoppers typically pay 10-50% of the cost of a product to insure it beyond the term covered by the manufacturer’s guarantee. The terms of these deals vary (and there is often a great deal of fine print).
Yet products rarely break within the period covered, and repairs tend to cost no more than the warranty itself.
That makes warranties amazingly profitable: they generate some $15 billion annually for American retailers, according to Warranty Week, a trade journal.
So why, asks a paper published in the December 2009 issue of the Journal of Consumer Research, do so many consumers still buy extended warranties?
The researchers concluded that the decision to buy a warranty had a great deal to do with a shopper’s mood.
If a customer is about to buy something fun (i.e., an iPod rather than a landline phone), he will be more inclined to pay for extra insurance because consumers value “hedonic” items over utilitarian ones.
The study also found that poorer consumers are more likely to buy “potentially unnecessary and overpriced insurance”, because they are more worried about the expense of replacing a product if it breaks.
The popularity of warranties should logically depend on the likelihood of a product’s failure … but the emotional tranquility that comes with buying a new warranty is a benefit to buyers, even if “rationally, it doesn’t make sense”.
The Economist. London: Nov 21, 2009. Vol. 393, Iss. 8658; pg. 66
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An Angle: Extended warranties for laptops often cover the battery. If your battery should wear out – say, right before the extended warranty is about to expire – you might be able to get a “free” replacement battery – that has a FMV about equal to the price you paid for the extended warranty.
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