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Design of Extended Warranties in Supply Chains

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  • Li, Kunpeng

    (U of Illinois at Urbana-Champaign)

  • Chhajed, Dilip

    (U of Illinois at Urbana-Champaign)

  • Mallik, Suman

    (U of Illinois at Urbana-Champaign)

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    Abstract

    Consider a supply chain involving an independent retailer and an independent manufacturer. The manufacturer produces a single product and sells it exclusively through the retailer. Using this supply chain framework, we develop a game theoretic model to study two commonly observed practices of selling extended warranties: the manufacturer offers the extended warranty directly to the end consumer, and the retailer selling the product offers extended warranty. We show that, of the two decentralized systems, when the retailer offers an extended warranty, it is for a longer duration and generates more system profit. We compare and contrast the two decentralized models with a centralized system where a single party manufactures the product, sells to the consumer and offers the extended warranty. We identify the different causes of inefficiencies in each of the two decentralized models and propose coordination mechanisms that eliminate the inefficiencies. We also provide contracts to achieve both coordination and a Pareto improvement over a wholesale price contract.

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    File URL: http://www.business.illinois.edu/Working_Papers/papers/05-0128.pdf
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    Bibliographic Info

    Paper provided by University of Illinois at Urbana-Champaign, College of Business in its series Working Papers with number 05-0128.

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    Date of creation: Sep 2005
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    Handle: RePEc:ecl:illbus:05-0128

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    Web page: http://www.business.uiuc.edu/Working_Papers/Main.asp
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    1. Dybvig, Philip H & Lutz, Nancy A, 1993. "Warranties, Durability, and Maintenance: Two-Sided Moral Hazard in a Continuous-Time Model," Review of Economic Studies, Wiley Blackwell, vol. 60(3), pages 575-97, July.
    2. Morris A. Cohen & Seungjin Whang, 1997. "Competing in Product and Service: A Product Life-Cycle Model," Management Science, INFORMS, vol. 43(4), pages 535-545, April.
    3. Padmanabhan, V, 1995. "Usage Heterogeneity and Extended Warranties," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 4(1), pages 33-53, Spring.
    4. Nancy A. Lutz & V. Padmanabhan, 1995. "Why Do We Observe Minimal Warranties?," Marketing Science, INFORMS, vol. 14(4), pages 417-441.
    5. Russell Cooper & Thomas W. Ross, 1985. "Product Warranties and Double Moral Hazard," RAND Journal of Economics, The RAND Corporation, vol. 16(1), pages 103-113, Spring.
    6. Duncan P. Mann & Jennifer P. Wissink, 1988. "Money-Back Contracts with Double Moral Hazard," RAND Journal of Economics, The RAND Corporation, vol. 19(2), pages 285-292, Summer.
    7. Spence, A Michael, 1977. "Consumer Misperceptions, Product Failure and Producer Liability," Review of Economic Studies, Wiley Blackwell, vol. 44(3), pages 561-72, October.
    8. K. Sridhar Moorthy, 1988. "Product and Price Competition in a Duopoly," Marketing Science, INFORMS, vol. 7(2), pages 141-168.
    9. Heal, Geoffrey, 1977. "Guarantees and Risk-Sharing," Review of Economic Studies, Wiley Blackwell, vol. 44(3), pages 549-60, October.
    10. Emons, Winand, 1988. "Warranties, moral hazard, and the lemons problem," Journal of Economic Theory, Elsevier, vol. 46(1), pages 16-33, October.
    11. V. Padmanabhan & Ram C. Rao, 1993. "Warranty Policy and Extended Service Contracts: Theory and an Application to Automobiles," Marketing Science, INFORMS, vol. 12(3), pages 230-247.
    12. Ganesh Iyer, 1998. "Coordinating Channels Under Price and Nonprice Competition," Marketing Science, INFORMS, vol. 17(4), pages 338-355.
    13. Emons, Winand, 1989. "On the Limitation of Warranty Duration," Journal of Industrial Economics, Wiley Blackwell, vol. 37(3), pages 287-301, March.
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