Warranty Length, Product Reliability, and Secondary Markets

Abstract

Problem definition: Inspired by variations in warranty length specifications in the U.S. automotive industry, we study how a durable good producer’s product warranty length choice relates to its product reliability. We introduce a producer’s secondary market interference (e.g., buyback of used products) as a possible driver for such variations observed in practice. Methodology/results: Using an analytical model of a monopolist finitely durable good producer, we first study the interaction between product reliability and the producer’s warranty length choice in the presence of secondary market interference. This analysis suggests that a durable good producer’s warranty length offering is U-shaped in its product reliability. That is, only producers with sufficiently low or high product reliability benefit from offering longer product warranties. Otherwise, a short warranty offering is preferred. We show that this result is driven by a producer’s strategic use of secondary market interference. We then test the predictions from these results in the automotive industry. An exploratory analysis of U.S. automotive industry data also suggests a U-shaped association between warranty offerings and product reliability, and points to the theoretically predicted dependency between producers’ secondary market interference and warranty length. Managerial implications: Producers with sufficiently high product reliability will benefit from longer warranties, as longer warranty coverage has marginal impact on their new product demand cannibalization by used products and warranty fulfillment costs. In contrast, producers with sufficiently low product reliability can use secondary market interference to jointly avoid the cannibalization from used products and high warranty fulfilment costs associated with long warranties for low reliability products. Producers with moderate product reliability, on the other hand, cannot leverage secondary market interference as effectively, and benefit more from shorter warranty offerings.