Design of a trade-in and performance-based warranty considering time-varying covariates

Performance-based warranties are being adopted by more and more manufacturers in competitive markets because they satisfy both customers’ need for better product experience and manufacturers’ need for profit growth. Trade-in, as another after-sales service policy to increase profit, has also been promoted in the context of sustainable development. It not only stimulates market demand with a lower price of new-generation products, but also reduces the production and carbon emission costs through product recycling. Based on these benefits, this paper proposes a new policy that integrates a performance-based warranty policy and a trade-in service. To better characterize the time-varying operating environments in practice, first we adopt a nonlinear Wiener process model with dynamic covariates and derive the probability density function of the remaining useful life to forecast the warranty cost. By providing the trade-in option as the alternative to the extended warranty when the base warranty expires, the optimal pricing, warranty design, and trade-in rebate decisions can then be obtained by maximizing the manufacturer’s total profit. Finally, we conduct a Monte Carlo simulation and sensitivity analysis to demonstrate the superiority of the proposed policy. The result shows that the new policy creates another profit growth revenue for manufacturers compared to the existing service. The incorporation of the dynamic covariates also behaves better in terms of prediction accuracy. Managerial suggestions from the aspects of products, maintenance action and dynamic covariates are also provided to manufacturers to guide the policy design.