Rafi Mohammed

Why Consumer Reports is Wrong About Extended Warranties

Posted on March 23th, 2012 (0 Comments)

Reprinted from the Harvard Business Review website.

It's long been a mantra of consumer advocates: Extended warranties are a sucker's bet. "We have long advised that extended warranties are a poor deal for almost every product," writes Consumer Reports, which has analyzed data and concluded that products such as cars usually don't require expensive repairs until after extended warranty coverage ends.

I have a different take: Consumer Reports is making a blanket judgment that does not account for the entire value — which extends far beyond an actuarial analysis — of extended warranties to consumers.

This difference of opinion impacts many businesses. Managers and salespeople of electronics, consumer appliances, and automobiles are heavily incentivized to sell extended warranties. For some people on the sales side of these transactions, this can create a moral quandary: Aren't they being asked to hard-sell a product that, according to the experts, most people don't need? In fact, customers can benefit from these purchases, and it's not only poorly-informed people who are duped into buying them. In fact, I often buy extended warranties myself.

First let's concede that Consumer Reports' basic point is correct. Every insurance product is "rigged" in favor of the issuer.. Since it is a given that the "house" is actuarially favored to win on every insurance transaction, there has to be more for consumers to evaluate beyond a "what's the chance that it'll break" financial calculation.

That's where the real value of extended warranties comes in. There are several "peace of mind" benefits associated with extended warranties. First, they allow consumers to avoid the anxiety and financial loss of an unexpectedly high repair bill. Second, if a product breaks, consumers do not have to invest time to search for a company to undertake the repairs. It's also comforting to know that if a product is not repairable, it will be replaced. Finally, extended warranties mitigate the concern of being "ripped off" on the repair, because service companies have an incentive to fix the problem efficiently. Bottom line: There's value in being able to sleep well at night.

Many extended warranties also include additional tangible benefits. Given my training as an economist, I'm thrifty. When I bought my current Dell laptop, I agonized over whether to buy an extended warranty whose cost was equal to one-third the purchase price of the PC. For me, the factor that made the difference was that the warranty included on-site repair; I made the purchase. In this case, the actuaries got it wrong: Not long after my purchase, my laptop stopped working. Given the central role that my computer plays in my life, I freaked out. One call to Dell had a friendly representative walking me through a set of diagnostics. "Yes," she concluded, "we have to come out to fix your laptop." In less than 24 hours, a technician was in my office and repaired the laptop within 30 minutes. The whole repair process could not have been more convenient, efficient, and stress free.

For consumers, there's no slam dunk "right answer" regarding whether to buy an extended warranty. Since you are guaranteed to come up short on the actuarial calculation, your decision hinges on risk tolerance as well as the value you place on warranty features.

And for businesses that make big money selling extended warranties, there's no reason to feel bad about the practice, despite what skeptical consumer advocates say. In fact, as companies try to devise new revenue streams, it's often useful to think about variations on extended warranties — such as the trip cancellation insurance that's become a big revenue driver in the travel business. What risks do your customers take when purchasing from you? Is there a way you can help them minimize that risk, and charge them for doing so? And remember, offering an insurance option better serves customers; those who value mitigating risk willingly pay you more for peace of mind.

It's also important to realize that simply offering this peace of mind — whether or not consumers choose to purchase it — can create real differentiation for a business. Example: Since Dell is the only company I know that provides next day repair insurance, for instance, it's the only brand of computers that I purchase.

So what do you think? Is Consumers Reports too focused on actuarial results instead of total customer value? Can your company offer various types of insurance in a manner that benefits both its bottom line and customers?

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