How do people value extended warranties ? evidence from two field surveys.

Abstract

Extended warranties are popular but expensive. This paper examines how consumers valuethese warranties, and asks whether economic considerations alone can account for their popularity. Results from two field surveys show that consumers greatly overestimate both thelikelihood and the cost of product breakdown. However, these biases alone do not explain their willingness to buy them. In fact, we find evidence of probability neglect, in whichwarranty purchase decision depends on the magnitude of the possible consequences of nothaving insurance and not on the probability of having to suffer these consequences. Theexpected emotional benefits ("peace of mind") from having a warranty was the best predictorof purchase decision and willingness to pay. We also found that people with higher numeracyand cognitive skills are less likely to overestimate the economic determinants of warrantyvalue, yet are still highly influenced by emotional considerations when deciding whether topurchase a warranty. We conclude by arguing that consumer welfare could be improved byincreasing the competitive intensity in the market for warranties.