Flexible-Duration Extended Warranties with Dynamic Reliability Learning
Production and Operations Management, 23 (4) 645 - 659
32 Pages Posted: 24 Aug 2013 Last revised: 1 Oct 2014
Date Written: August 19, 2013
Frequent technological innovations and price declines adversely affect sales of extended warranties as product replacement upon failure becomes an increasingly attractive alternative. To increase sales and profitability, we propose offering flexible-duration extended warranties. These warranties can appeal to customers who are uncertain about how long they will keep the product as well as to customers who are uncertain about the product's reliability. Flexibility may be added to existing services in the form of monthly-billing with month-by-month commitments, or by making existing warranties easier to cancel with pro-rated refunds. This paper studies flexible warranties from perspectives of both customers and the provider under customers' reliability learning. We present a model of customers' optimal coverage decisions and show that customers' optimal coverage policy has a threshold structure under some mild conditions. We further show that flexible warranties can result in higher profits and higher attach rates in a homogeneous market as well as in a heterogeneous market with multiple segments differing in various dimensions.
Keywords: post-sales service, flexible warranty, reliability learning, threshold policy
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