The Frontal Cortex

Product Warranties

Don’t ever buy them. Ever.

Each year, millions of people gladly pay an additional 10 to 50 percent of a product’s original price to extend a warranty. These snap purchases help fuel a booming, $15 billion-a-year business and feed a lucrative profit stream for retailers that sell the warranties and companies that underwrite them. Many consumers do so because they say the plans provide them with peace of mind.

The decision to buy an extended warranty defies the recommendations of economists, consumer advocates and product quality experts, who all warn that the plans rarely benefit consumers and are nearly always a waste of money.

“The things make no rational sense,” Harvard economist David Cutler said. “The implied probability that [a product] will break has to be substantially greater than the risk that you can’t afford to fix it or replace it. If you’re buying a $400 item, for the overwhelming number of consumers that level of spending is not a risk you need to insure under any circumstances.”

Now, I’m as guilty as the next consumer, and I just invested in an extended warranty for my iPOD. Why? Behavioral economics provides us with a nifty explanation, called mental accounting. Richard Thaler was the first economist to document this irrational phenomenon. When he asked people whether they would drive 20 minutes out of their way to save $5 on a $15 calculator, 68 percent of respondents said yes. However, when he asked the same people whether they would drive 20 minutes out of their way to save $5 on a $125 leather jacket, only 29 percent said they would. According to Thaler, this discrepancy demonstrates that our decision about whether or not drive 20 minutes depends less on the absolute amount of money involved ($5), than on the mental account in which the decision occurs. How does mental accounting relate to consumer warranties? Well, after just spending a few hundred dollars on a new HDTV, or washing machine, or iPOD, spending a few more dollars on an extended warranty doesn’t seem like a big deal. Because the warranty is only a small part of a much bigger purchase, we end up paying for a frivolous option that we would never purchase otherwise. Retail stores have learned to take advantage of this mental accounting heuristic, and it’s estimated that up to 50 percent of profits at the big electronic retailers (like Circuit City) come from extended warranty sales.

PS. Another possible explanation for the plethora of extended warranties is loss aversion. I know that when I saw my beautiful new nano iPOD, I cringed at the thought of it being broken, and was all too happy to spend $40 to avoid that outcome.

Comments

  1. #1 Orac
    October 4, 2006

    I can tell you why I bought an extended warranty on my recent purchase of an Intel Mac.

    Before this, I never purchased these warranties. Never. I knew they were a waste of money. However, my last computer (a dual processor G4) was the first outright lemon that I ever got from Apple in 16 years of buying Macs. It had its motherboard replaced twice in the first year, after which, realizing that I had a lemon, I sprung for the extended warranty. Sure enough, over the next three years it was in the shop twice more, once when its Superdrive died unexpectedly and then when it developed another motherboard glitch. I got many times more than what I paid for it out of my extended warranty.

    This time around, burned once, I decided to spring for the extended warranty for my new Mac, even though I know from my past track record that it’s pretty unlikely that this machine is a lemon too.

    On the other hand, I’ve never sprung for the extended warranty for any of the three iPods that I’ve ever purchased. They’re just not expensive enough of a device to be “worth” it to me (I’m fortunate enough to have an income that lets me rationalize it by simply saying that I’ll buy a new one if my old one dies after its warranty expires, something that’s never happened so far), and 90% or more of any defects will show up within the first year.

  2. #2 Kevin W. Parker
    October 4, 2006

    Even the article doesn’t say “never.” Okay it does say “hardly ever”, but for treadmills, plasma TVs, or laptops — assuming you can get a decent price on an extended warranty — it makes sense. It also points out that if you’re planning on running something into the ground — the specific example is a heavily used fax machine — it might be worthwhile.

  3. #3 Brock Henry
    October 4, 2006

    Perfectly illustrated by Homer Simpson. Moe determines that the crayon has been hammered far enough into Homer’s brain when Homer says “Extended warranty? How could I lose?”

    http://en.wikiquote.org/wiki/Homer_Simpson

  4. #4 proka
    October 5, 2006

    You also need to think about the period in which you’ll use that product. If you plan to use it for like two years, but the warranty is only for one year, it’s not such a bad thing to buy extended warranty.

  5. #5 bigTom
    October 5, 2006

    Or how badly you use it. My 16 year old son always buys the warranties, and things like cell phone insurance. With his combination of perfectionism, and the tough environments he puts these devices through, he frequently gets them replaced via the extended warranty.

  6. #6 Colleen Merreot
    November 20, 2007

    My husband and I purchased a Gateway computer from BEST BUY, along with an extended warranty. Not only will we never purchase an extended warranty again, we never shop at BEST BUY again. Our computer has crashed 4 times. Twice they replaced the hard drive and once they CLAIMED it was the software and once they said their diagnostic tests showed nothing. Amazingly the extended warranty reads that the hardware must crash FOUR times before they replace the unit. YOU MUST READ THE FINE PRINT! Oh, by the way, when they claimed it was the software, we needed to pay an additional $140 for the software diagnostic test to be performed, because this was not covered under the extended warranty. NOT ONLY WILL WE NEVER BUY ANOTHER EXTENDED WARRANTY, WE WILL NEVER PURCHASE ANOTHER ITEM FROM BEST BUY!!

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