Brand Mix

Photo: TVWall2 by justshufflingin (Flickr)

Did you know that extended warranties are often more profitable for retailers than the products the warranties are for? According to Business Week, profit margins on warranties are as high as 60% so they account for a disproportionate amount of retailer profits. (For Circuit City, before it went out of business, warranties apparently accounted for all of its profits.)

So it's clear why retailers try and power sell warranties. But why do we consumers continue to buy them and why are we prepared to pay a price so disconnected from the actual cost? We've been told for years that these things are a waste of money but we just don't listen.

Some insights into this question come from a new paper in the Journal of Consumer Research. The authors--Tao Chen, Ajay Kalra and Baohong Sun took a look at purchase data from an electronic retailer and they've concluded that the decision to buy a warranty depends a lot on the shopper's mood. Turns out that people are more likely to buy warranties on fun products (like flat screen TVs) than for functional products (like computers). The authors think that people buy warranties for the fun products because they care about them more and would feel a greater sense of loss if they broke and weren't covered. That means that the price we're prepared to pay for a warranty reflects our expected pleasure from the product purchased rather than from a rational assessment of whether it's likely to break or not, thus providing retailers their profit opportunity.

Any chance that retailers can wean themselves off these over-priced warranties? No. But they could and should do better and not exploit their customers failings. One way forward would be to add more value to warranties. The best example I could find is AppleCare. Rather than just a basic warranty coverage, Apple adds outstanding service and support from its experts. That adds value and it's a big hit with customers.

Meanwhile, when it comes to extended warranties, I'm just going to say "no," however happy I am with what I buy.