Simultaneous or Sequential? Retail Strategy of a Durable Product and an Extended Warranty

Extended warranties are highly profitable after-sales service contracts that consumers can buy with durable products. In practice, a consumer's purchase decision on an extended warranty can be either conditional on or joint with a product purchase, leading to a sequential or simultaneous consumer purchase pattern. This article considers a monopolistic firm offering a durable product and an accompanying extended warranty directly to end consumers, and develops a stylized model to examine the impact of consumer purchase pattern on the firm's optimal retail decisions and profitability. We find that the optimal warranty lengths are identical across consumer purchase patterns; the warranty should be sold at its marginal cost under the simultaneous pattern, whereas at a premium under the sequential one. Moreover, we show that either retail strategy can result in a higher expected profit depending on the consumers' price sensitivities, although the firm is generally better off inducing a simultaneous consideration of products and warranties. This is attained by setting a lower warranty price to attract more consumers to purchase the product-warranty combination, and charging a higher markup on the product to make more profit. In addition, we show that these findings are robust to an extension to the base model that incorporates the consumers' failure probability distortion behavior caused by the lack of precise product reliability information. The primary findings and insights provide key guidance to practitioners in managing product and extended warranty businesses.