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Designing and pricing menus of extended warranty contracts

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  • Joseph C. Hartman
  • Kamonkan Laksana

Abstract

Extended warranties provide “piece of mind” to a consumer in that product failures which occur after the base warranty expires are rectified at little or no cost. They also provide an additional source of revenue for manufacturers or third‐party providers, such as retailers or insurance providers, and help cultivate consumer loyalty. In this article, we analyze a number of extended warranty contracts which differ in design, including restrictions on deferrals and renewals. With the use of dynamic programming, we compute the optimal strategy for a consumer with perfect information and determine the optimal pricing policy for the provider given the consumer's risk characterization. We also provide insight into when different contracts should be issued. Finally, we illustrate how profits can be dramatically increased by offering menus of warranty contracts, as opposed to stand alone contracts, with the use of integer programming. Surprisingly, risk‐taking consumers provide the greatest benefit to offering menus. These insights can help a company develop a comprehensive warranty planning strategy for given products or product lines. © 2009 Wiley Periodicals, Inc. Naval Research Logistics 2009

Suggested Citation

  • Joseph C. Hartman & Kamonkan Laksana, 2009. "Designing and pricing menus of extended warranty contracts," Naval Research Logistics (NRL), John Wiley & Sons, vol. 56(3), pages 199-214, April.
    • Handle: RePEc:wly:navres:v:56:y:2009:i:3:p:199-214
    DOI: 10.1002/nav.20333
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    References listed on IDEAS

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    Cited by:

    1. Tong Peng & Liu Chunling, 2020. "Designing differential service strategy for two-dimensional warranty based on warranty claim data under consumer-side modularisation," Journal of Risk and Reliability, , vol. 234(3), pages 550-561, June.
    2. Wang, Yukun & Liu, Zixian & Liu, Yiliu, 2015. "Optimal preventive maintenance strategy for repairable items under two-dimensional warranty," Reliability Engineering and System Safety, Elsevier, vol. 142(C), pages 326-333.
    3. Wang, Xiaolin & Zhao, Xiujie & Liu, Bin, 2020. "Design and pricing of extended warranty menus based on the multinomial logit choice model," European Journal of Operational Research, Elsevier, vol. 287(1), pages 237-250.
    4. Dai, Anshu & Yang, Xi & Yang, Duo & Li, Ting & Wang, Xin & He, Shuguang, 2025. "Optimizing extended warranty options with preventive maintenance service under multinomial logit model," European Journal of Operational Research, Elsevier, vol. 321(2), pages 600-613.
    5. Lianmin Zhang & Lei Guan & Daniel Zhuoyu Long & Houcai Shen & Huajun Tang, 2023. "Who is better off by selling extended warranties in the supply chain: the manufacturer, the retailer, or both?," Annals of Operations Research, Springer, vol. 328(2), pages 1557-1583, September.
    6. Rui Zheng & Chun Su & Yuqiao Zheng, 2020. "Two-stage flexible warranty decision-making considering downtime loss," Journal of Risk and Reliability, , vol. 234(3), pages 527-535, June.
    7. Huang, Yeu-Shiang & Fang, Chih-Chiang & Lu, Chang-Ming & (Bill) Tseng, Tzu-Liang, 2022. "Optimal Warranty Policy for Consumer Electronics with Dependent Competing Failure Processes," Reliability Engineering and System Safety, Elsevier, vol. 222(C).
    8. Afsahi, Mohsen & Shafiee, Mahmood, 2020. "A stochastic simulation-optimization model for base-warranty and extended-warranty decision-making of under- and out-of-warranty products," Reliability Engineering and System Safety, Elsevier, vol. 197(C).
    9. Behzad Hezarkhani & Mahesh Nagarajan & Chunyang Tong, 2022. "Toward servitization: Optimal design of uptime‐guarantee maintenance contracts," Production and Operations Management, Production and Operations Management Society, vol. 31(10), pages 3806-3822, October.
    10. Mengqi Liu & Yueli Zhao & Rui Huang & Sandun Perera, 2023. "Vertical value-added cost information sharing in a supply chain," Annals of Operations Research, Springer, vol. 329(1), pages 781-814, October.
    11. Bian, Yiwen & Xie, Jiazheng & Archibald, Thomas W. & Sun, Yanhong, 2019. "Optimal extended warranty strategy: Offering trade-in service or not?," European Journal of Operational Research, Elsevier, vol. 278(1), pages 240-254.
    12. Yanrong Li & Lai Wei & Wei Jiang, 2021. "A Two-stage Pricing Strategy Considering Learning Effects and Word-of-Mouth," Papers 2110.11581, arXiv.org.
    13. Guillermo Gallego & Ruxian Wang & Ming Hu & Julie Ward & Jose Luis Beltran, 2015. "No Claim? Your Gain: Design of Residual Value Extended Warranties Under Risk Aversion and Strategic Claim Behavior," Manufacturing & Service Operations Management, INFORMS, vol. 17(1), pages 87-100, February.

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