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Splurge Protection: Service Contracts Studied

Extended warranty thumbnail When it comes to buying extended service contracts, consumers are more likely to ante up for the HDTV than the vacuum cleaner.

According to research co-authored by Baohong Sun, Carnegie Bosch Professor of Marketing, it’s the luxuries in life we are looking to protect, rather than the practical.

“People feel guilty, so they don’t want the products to fail,” explains Sun, whose findings — co-authored by Tao Chen and Ajay Kalra — appears in the latest issue of the Journal of Consumer Research.

Long considered a waste of money by many consumer advocates, warranties — or extended service contracts (ESCs) in retail parlance — remain big business for stores that offer them on certain items. What the research team examined was which items were most likely to trigger the decision to purchase the service contracts.

According to Sun, when consumers consider buying the contract, they look for cues about a product’s reliability. Those cues include the price of the product and the length of the manufacturer’s warranty, which is included in the original sale.

“The higher the product price, it signals the higher the quality of the product,” she notes.

Retail environment also affects the probability that customers will buy the service contracts — which is significant because it’s within the retailer’s control.

“Even though retailers don’t have a lot of flexibility to price the product, they do have the authority to determine whether they can offer a promotion,” says Sun.

People who buy during a promotion are more likely to also opt for service contracts because they feel as though they’ve saved money on the initial purchase price, so they have enough left over to ensure the product’s function in the future. They’re also usually happy about scoring what they perceive to be a deal, which translates into a mood conducive to further spending.

“Whenever people feel happy, they’re willing to [spend money] make sure the happiness continues,” says Sun.

The characteristics of the consumer also play a role. For example, low-income people were, surprisingly, more likely to spend extra on service contracts, because they can’t afford to replace the product if it breaks down.

That pattern runs contrary to other insurance buying patterns, says Sun. Low-income people typically carry less automobile insurance, for instance.

Retailers can take advantage of the research by pushing service contracts during promotions — particularly surprise, unadvertised deals that heighten the good feeling that nudges people to buy more — and focusing their sales efforts on the hedonistic products that people are more likely to want to protect, says Sun.

In the future, the researchers hope to study how the pricing of an extended service contract affects purchase, says Sun. Because the contracts are offered by the store that sold the product and not the product manufacturer, there is fluctuation in that price, she notes. People are less likely to buy service contracts for products they replace frequently, such as DVD players, which are often bypassed by new generations of technology.

“This gives a hint to the retailer that whenever they price the ESC, it should be related to the life span of the product itself,” says Sun. “That’s a decision made by the manufacturer, not the retailer, but they should keep track of how often the product is changed by the manufacturer. If it is very frequent, the price (of the ESC) should be lower, not higher.”

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