The Warranty Psychology: Don’t Worry, Be Happy
MANY people would not think of making a major purchase without doing research to find the best model and the lowest price. But at the checkout counter, all of that preparation often breaks down.
There, shoppers are asked to buy a product that few have investigated: the extended warranty. New research suggests that the appeal of such warranties depends not only the inability of most people to assess risk, but also on the emotional state of the buyer. The happier you are, it turns out, the more risk-averse you become, so the more likely you are to buy the protection.
You’ve undoubtedly heard the reasons for buying one:
Your product could break. You are clumsy. Or your kids are. The plan is convenient and will save you time. You’ve already saved $200 from what the product cost two months ago. It’s cheaper than a dinner out.
I overheard them all at a Best Buy in a single Sunday afternoon.
You probably can guess why the salespeople try so hard. Extended warranties are highly profitable. They tend to cost about 20 percent of the purchase price, and they can run even higher.
For instance, a four-year warranty on the Nikon D3000 camera at Best Buy is $150, or more than 27 percent of the $550 price. The warranty on a Hewlett-Packard N270 netbook is $130, or just short of a third of the computer’s $400 price.
Such profit margins are high enough that companies having nothing to do with selling the original products have jumped into the market, offering warranties for about half as much. SquareTrade, which offers warranties for products bought in stores or online, will sell you a three-year warranty on that Nikon for $75. The netbook can be protected for $60.
“It’s not a bad service,” Steven Abernethy, SquareTrade’s chief executive, says of store warranties in general. “It’s just overpriced.”
Most consumer advocates, however, suggest that you skip warranties altogether. Consumer Reports, for instance, says they are bad investments because most electronics will not need a repair, but if one is needed the average bill is about the cost of the warranty. The magazine also concluded that extended warranties for cars weren’t worth the outlay.
We may try to do a calculation as the sales representative is giving the spiel: The service contract is appealing if it is less than the replacement price of the product minus some factor based on the estimated probability of its failure.
Few of us know what that failure rate is. But it is lower than you might think.
Consumer Reports surveys its readers about product reliability. It calculates failure rates over three to four years. The overall rate was 3 percent for 10 brands of televisions and 10 percent for cameras; it was higher for major appliances like refrigerators and washing machines.
The highest rate was for laptops, as much as 43 percent, but that includes accidents and keyboard spills (which often aren’t covered by basic extended warranties). The magazine says it doesn’t publish comparable data for autos, preferring its own measure of reliability. The range is wide. It says the Volkswagen Touareg is 27 times more likely to have a problem than the Honda Insight, the most reliable car on its most recent list. SquareTrade, which writes a warranty up to 90 days after a purchase, says its service gives people a little more time to be analytical.
Even then, Mr. Abernethy says, “no one will be able to tell you the exact failure rate, especially on new items.” His business studied the failure rates of game consoles and found that 2.7 percent of Nintendo Wii machines failed over three years. The rate was higher for the Sony PlayStation and the Microsoft Xbox 360.
SquareTrade sells a $30 three-year warranty for that $200 Wii. To a perfectly rational person, that insurance is worth exactly 2.7 percent of $200, or $5.40. But it can be worth more to someone who fears financial loss of the product or the inconvenience of repairs..
(Rebecca F. Goldin, an associate professor of mathematics at George Mason University, said that one way to strip away the emotion is to imagine that you’re a wholesaler. Would you really spend $300,000 to protect 10,000 Wiis?)
SO why do some people buy warranties anyway?
Three business school professors — Ajay Kalra at Rice University, Baohong Sun at Carnegie Mellon and Tao Chen at the University of Maryland, College Park — think they know why. You are in too good of a mood as you buy the object of your desire.
In a study published in the latest issue of the Journal of Consumer Research, the three professors looked at the customers of a major retailer who bought extended warranties. They found that people were more likely to buy warranties on products that brought them pleasure — what they call hedonic purchases — than on ones that are merely useful. “Consumers tend to overestimate the odds when they really like a product,” Mr. Kalra said.
(That may help to explain why washing machines, which typically have a far higher failure rate than television sets, carry extended warranties that are about 8 percent of the product’s price.)
They also found that people were more likely to buy an extended warranty if they received a discount on the product, especially an unexpected one. The windfall makes people feel good. And a positive mood makes people more risk-averse because they are afraid of losing that good feeling, which makes potential losses look greater.
The lesson is simple: Stay grouchy while shopping.
This article was originally found at the New York Times: http://www.nytimes.com/2009/11/08/business/08every.html?scp=1&sq=The%20Warranty%20Psychology&st=cse
