This post on the concept of extended warranties from late last year on the blog Economists Do It With Models includes this quote from the book Nudge: Improving Decisions About Health, Wealth, and Happiness, by Richard Thaler and Cass Sunstein:
…the extended warranty is a product that simply should not exist. If Humans realized that they we paying twenty dollars for two dollars’ worth of insurance, they would not buy the insurance. But if they do not realize this, markets cannot and will not unravel the situation. Competition will not drive the price down, in part because it takes the salesperson a while to persuade someone to pay twenty dollars for two dollars’ worth of insurance, and in part because it is difficult for third parties to enter this market efficiently. You might think that firms could educate people not to buy the warranty, and indeed they might. But why should firms do that? If you are buying something that you shouldn’t, how do I make any money persuading you not to buy it?
The blog Thought Gadgets expands on this:
Shouldn’t exist? Well, yes. Most markets have enough competition that a $2 product priced for $20 won’t stay alive for long; but a few don’t. In the case of warranties, strange services offered only after you’ve purchased something else in the dark of an electronics store with little competitive information to guide you, the absence of knowledge allows margins to float to the sky. In this case, the friction that blocks comparative value data from competitors creates a sticking point of artificially high margins for the one company pitching the warranty.
We don’t mean to disparage the warranty industry; rather, simply to warn that price gouging of any kind always comes home to roost. Thaler calls this the point when consumers enter a “rip-off” stage of awareness…
Jeez, I have to admit, sometimes I do get the extended warranty. But I always experience an irritating cognitive dissonance when I do, because here I have just plunked down a good chunk of change for some fancy piece of electronics, and immediately the person who has just convinced or at least encouraged me to buy it is in my face telling me that there is a good chance that in the near future it may not work as it’s advertised on TV, in the newspaper, on the box, and as they themselves have just assured me it would.
Man, I need a drink, even if it’s just hot cocoa. See ya next week.
Posted on February 26, 2010 at 5:40 pm
http://economybeat.org/consumers/extended-warranties/
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Categorised under : consumers , economics
Tagged with : retail , warranties
