A Reference-Dependent-Preferences-Based Model of Extended Warranty Purchase Decisions

Abstract

Durable goods often come bundled with limited-time and sometimes generous factory/base warranties. Yet, for many durable goods, customers purchase extended warranties against which they rarely make claims. This study offers a reference-dependent-preferences-based theoretical explanation for why consumers purchase extended warranties even if their purchased good is already covered by a base warranty. The authors show that consumers treat base warranties as a reference point, thereby creating a qualitative difference in the valuation of an extended warranty on the purchased product. The proposed theory model is validated using observational data from the automobile industry and shows how the reference-dependent-preferences-based effect varies with vehicle quality and macroeconomic conditions. The analyses reveal auto buyers’ elevated loss-aversion motivations and higher price sensitivity during weaker macroeconomic conditions than during more robust macroeconomic conditions. Finally, the authors use the empirical model to identify opportunities for auto dealers to engage in targeted price promotions as a function of prevailing macroeconomic conditions. These findings have important implications for marketing managers, as they provide valuable guidance on when an extended warranty should be promoted, to whom it should be promoted, and which extended warranty should be marketed.