Why Do Consumers Buy Extended Service Contracts?
Tao Chen (University of Maryland), Ajay Kalra (Rice University), and Baohong Sun (Carnegie Mellon University)
Journal of Consumer Research vol. 36, no. 4
In the late 1980s, large electronics stores began offering customers extended warranties to guard against possible mechanical failures. Warranties have since become ubiquitous at the checkout aisle, and extended service contracts have become a core product for retailers, generating about US$15 billion in revenue annually. According to Business Week, in 2003 warranties accounted for more than half of Best Buy’s profit and almost 100 percent of Circuit City’s. And yet most consumer advocates argue against buying these contracts, which can cost as much as 50 percent of the price of the product. By some analysts’ estimates, the contracts also deliver 18 times the margin that regular products do, which seems to imply that consumers often don’t end up using the warranties. The authors set out to understand why consumers choose to buy extended warranties, and how product characteristics, marketing of the warranties, the retail environment, and the consumers’ demographics affected their decisions to purchase them.
Analyzing data from a large retailer, the authors accessed the consumer purchase histories of extended service plans for more than 600 households over a yearlong period ending in October 2004, covering 1,676 purchases of consumer electronics and 553 warranty purchases. The authors found that consumers are more likely to purchase warranties for what they call “hedonistic” goods, such as video game consoles, rather than “utilitarian” items, such as printers — partly to justify the purchase and assuage their guilt. Customers are also more likely to purchase service contracts for products they buy at a discount, or when an unadvertised sale makes them feel good about the purchase. Consumers who have bought and used warranties previously are also more likely to buy them for other items.
The authors found, in contrast with previous research, that low-income consumers are more likely to purchase warranties because they are more sensitive to a product’s replacement costs. The authors warn that if warranties really do offer little actual value, lower-income consumers may be paying more than their wealthier counterparts.