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Don't buy product warranties
If the expected utility calculations don't convince you, maybe this will:
Neither Circuit City nor Best Buy discloses how much of its bottom line comes from extended warranty sales. But analysts have estimated that at least 50 percent and in some lean years 100 percent of profits at the electronics retailers come from extended warranty sales.
Here is the full story. The paper (but not on-line) edition notes that a desktop computer has a 37% chance of needing a repair in the first three years; if you are going to buy one warranty, maybe that should be it. But you are still best advised to buy insurance only when a) the potential loss is very large, or b) your wife insists.
Gabaix and Laibson have a very good paper on myopia, consumer ignorance, and shrouding.
Posted by Tyler Cowen on October 4, 2006 at 07:48 AM in Economics | Permalink
Comments
To my mind, one of the best values out there is the laptop warranty. Desktop computers can have individual parts replaced fairly easy. Laptops are much less modular, and a busted screen or shorted out motherboard means the whole thing is useless.
Posted by: Brock at Oct 4, 2006 9:10:04 AM
My wife never insists on extended warrantees.
Posted by: Jennifer at Oct 4, 2006 9:31:25 AM
Dr. Cowen,
My mother insisted on one for the shreader she bought.
She took one look at all of my father's papers and knew she'd burn out at least one. She's in the fifth.
Posted by: Paul McMahon at Oct 4, 2006 9:41:34 AM
With great laptops available new for under $1000, and the constant improvements in what that money will buy, the warranty is only worthwhile if you break the thing in the first year. I know the Best Buy guys tell me laptop screens are easy to break, but in ten years of fairly hard laptop use, I've yet to break one.
Besides, again, the basic economics of the thing. Even without the article above, you know the computer stores are not losing money on these deals, else they would raise the warranty price. Ergo, unless they can somehow get a fantastic repair price you cannot, it's got to be a bad deal for you to buy the warranty. (Much like you can know that the expected return on a lotto ticket cannot be as much as you paid for it, without doing any fancy math, as long as you know the lotto commission isn't losing money.)
Not to mention I don't really trust those Best Buy guys to repair my machine....
Posted by: Sol at Oct 4, 2006 9:44:39 AM
I would never buy an Apple laptop without Applecare - repairs are too expensive without it, and you know you'll need at least one repair inside of those three years.
Posted by: Edward Vielmetti at Oct 4, 2006 9:45:35 AM
Anything pushed so heavily by salesmen on commission is something you don't want to buy! The comment about laptops is on target, but I would suggest another source for an extended warranty, gratis: your trusty American Express card. And for longer extensions of protection, I would bet that there are third-party insurers that would offer you a package at a fraction of the retailers' price.
Posted by: David Nishimura at Oct 4, 2006 9:47:49 AM
I'm a dedicated free-rider: I'll let the people who buy the warranty do the hard work of giving the store an incentive to make its products not need a warranty.
If the store is willing to sell a warranty, it means that the product must break rarely enough compared to its price and the price of the warranty that the warranty isn't itself a money-loser for the store. If that's the case, I don't want the warranty. I guess that's an adverse selection problem for the stores, but it's tasty savings for me -- I can free-ride off of everyone who does buy the warranty.
Posted by: Grant Gould at Oct 4, 2006 9:52:47 AM
You're not allowing for the reality that very few electronics products can be repaired cost effectively by the consumer after the fact, and thus lead to an endless new product parade with more adjustment costs than advantages. The extended warranty costs may well sometimes be worth the ability to have longer product upgrade cycles and lower research costs.
Regards, Don
Posted by: Don Lloyd at Oct 4, 2006 10:35:05 AM
I agree that warranties are best for laptops. Laptops are exposed to food, drink, bumps, drops, etc. I wouldn't buy a laptop without one.
Posted by: eriks at Oct 4, 2006 10:52:27 AM
My father gets a warranty on most of his expensive purchases. I always thought that it was a ridiculous waste of money. I look at it as, if you are careful with your possessions, a warranty is not neccesary. Until I broke my cell phone. A friend of mine had the same problem with her phone and got her's fixed for free because she purchased insurance. I did not. I was forced to pay $50 for the repairs because my phone was not insured.
Posted by: Christine at Oct 4, 2006 11:10:21 AM
Extended warranties may or may not be worthwhile (I assume most are not). But evidence that they are profitable does not imply that they are a ripoff. (Their quarterly statement indicates that that damn Google ripped me off again.)
I suspect that extended warranties are another form of price discrimination against the "probability theory challenged."
Posted by: MW at Oct 4, 2006 11:19:23 AM
Christine, don't you think you've saved more than $50 over the years by not buying warranties? My guess is your strategy is still coming out ahead.
Posted by: ed at Oct 4, 2006 11:37:00 AM
Most warranties on electronics aren't worth it, but laptops definitely are (my work Dell has had its screen replaced 3 times in less than a year, and is currently malfunctioning again). Desktops almost never are, unless the manufacturer uses proprietary parts instead of open standards. Dell, in particular, used this tactic (such as reversing the AGP slot on the motherboard so that graphics cards had to be purchased through their online store if you desired an upgrade) in previous years but has thankfully ceased, and at one time or another most PC manufacturers have indulged in this.
It can also be worthwhile to purchase plans on cutting edge technology because the long term failure rates simply aren't known. I purchased a high definition DLP television several years ago and took an extended warranty because it covered the replacement of the light bulb as well as any other problem. The cost? $400. The cost of a new bulb? About the same. I have one year left on my warranty, and the bulb should be at the end of its life based on usage hours.
Posted by: CMC79 at Oct 4, 2006 11:58:06 AM
Insurance like gambling provides no value added the way Google can, they don't combine inputs to create something, their input is having more capital than you. So as a result it's almost always a loosing bet, but can sometimes be a good one if the results of a loss are larger than one could comfortably absorb. A good example would is fire insurance, the odds of your home burning down are much lower than your premium price vs the cost of rebuilding your home. But the loss of your home would result in a large enough impact to your finances that the risk is not worth taking by most people (ie it's worth paying to access a larger pool of capital). The loss of even a laptop generally isn't large enough to have more than a several month impact on the budgets of most buyers of extended warantees. These are short enough contracts that there's far less room for underwriting losses to access the float, too.
The very fact that Best Buy pushes them so hard indicates how profitable they are relative to the item sold. Big buyers of PCs of all kinds found it quite cost effective to just over order their systems with hot spares for the evenutal breakage and loss.
Posted by: nelsonal at Oct 4, 2006 12:26:51 PM
Every extended warranty I've ever bought for a laptop has more than paid for itself over the years. But then again, I'm a total klutz, an a heavy user / frequent traveler so I'm a lot harder on laptops than most people.
Posted by: Jacqueline at Oct 4, 2006 12:30:17 PM
No, it's still not worth it for laptops, unless you believe that the manufactuer's accountants are incompetent. (Adverse selection scenarios like Jacqueline's are the exception, as they are for any other product). I've owned several laptops, and my experience is that they either fail early due to manufacturing defects--when they are covered under the standard warranty--or after many years due to wear, when they would no longer be covered under the extended warranty.
Something else to consider: if you buy a $1500 laptop with an extended warranty and it dies after 2 years, the warranty hasn't saved you $1500, it's saved you the replacement cost of the now 2 year old laptop, which is substantially less.
Posted by: Brian at Oct 4, 2006 12:45:44 PM
I think the article raises the most important factor in the decision on purchasing extended warranties. How long do you plan on keeping the product? Many electronic products have become so cheap to buy, ie. telephones, printers, and household appliances, it is cheaper to buy a new one than getting the item repaired. The two products I would buy an extended warranty for is an automobile (36,000 miles comes a lot quicker than 3 years) and a computer (even though computers are outdated prior to the 3 yr warranty runs out, many people can’t simply buy a new computer every year). I don’t mind paying an extra $150 for more years of warranty on my computer, just in case I mess something up or $500 for up to 100,000 miles of warranty on my car. I’m going to be keeping both items past the end of the warranty period, so in my opinion, the initial cost is worth the lost opportunity.
Posted by: Marcus Burrell at Oct 4, 2006 12:46:19 PM
1) Warranties are highly profitable for stores. This means that in the long run warranties are bad for customers.
2) The only time (excepting rule "3") you ought to buy warranties or other insurance is when you can't afford to replace it on your own.
3) If you know that you are the type of person to royally abuse a product, warranties may be for you. :o
Posted by: happyjuggler0 at Oct 4, 2006 1:03:27 PM
Why don't stores make having any warrany at all optional?
Why don't manufacturers drop quality dramatically, assuming that everyone either buys the extended warranty, or doesn't mind buying a new one every year?
Posted by: DK at Oct 4, 2006 1:11:13 PM
Surprised you were taken in by the sloppy thinking here. Let's run some (simplified) numbers:
Best Buy sells a TV to a customer for $100. They had to purchased the TV from Sony for $75.
They also sell the customer a warranty for $35. They pay an insurance carrier $10 to underwrite the risk.
So the "profit on the TV" is $100 - $75 = $25
The "profit on the warranty" $35 - $10 = $25.
So "50% of Best Buy's profits come from warranties." But the $75 cost of the TV is a joint cost of the revenue associated with the TV and the revenue associated with the warranty. And there is no definitive way to allocate those costs - its a pure judgment call.
Posted by: sd at Oct 4, 2006 1:14:22 PM
"Something else to consider: if you buy a $1500 laptop with an extended warranty and it dies after 2 years, the warranty hasn't saved you $1500, it's saved you the replacement cost of the now 2 year old laptop, which is substantially less."
However, often when they replace the laptop under warranty, since they don't make the older model that you own any more they send you a newer model. My brother got a brand new laptop that way when his old one was irrepairable and still under warranty.
Posted by: Jacqueline at Oct 4, 2006 1:20:06 PM
I think that you all might be underestimating how much cheaper a large store (or warranty company) can get computers repaired than an individual person. The larger the pool of customers they draw from, the more stable their scheduling is, the more parts they can keep on hand, the more specialized their technicians can be, etc, etc.
Not saying that all extended warranties are a good deal, but just because the store makes money off of them doesn't make them ipso facto bad deals.
Posted by: Jake at Oct 4, 2006 1:45:09 PM
I cannot say conclusively that buying a warranty on a product is a good or bad idea. All I know is that a warranty, in most cases, gives peace of mind to the consumer. With a somewhat worry free outlook, it might just be worth the extra money for the warranty.
Posted by: AH at Oct 4, 2006 2:27:09 PM
The only thing we buy the extended warranty on are cars - we buy new and drive them at least 10 years, so upgrading to a seven year warranty is long enough to hit the first round of "big replacements" (tranny rebuilds, etc).
I know how to fix computers, so I just fix my own if it's out of the standard warranty.
This gets into a "personal finance" issue: if you have an emergency fund, you typically don't need this sort of insurance for small items like cellphones.
Posted by: Foobarista at Oct 4, 2006 2:34:29 PM
Thank you, Tyler Cowen, for being so intellectually honest and constantly challenging, rather than confirming, libertarian biases. I really could learn about intellectual honesty from you. I really need to get over my irrational hated of libertarians. I'm working on that as we speak.
Posted by: What Mike Huben Would Say If He Didn't Suck at Oct 4, 2006 3:19:28 PM
