EXPRESS: 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 a sizable number of durable goods customers purchase extended warranties that they rarely make claims against. This study offers a reference-dependent-preferences-based theoretical explanation of why consumers purchase extended warranties even if their purchased good is already covered by a base warranty. Consistent with our theory of reference-dependent preferences, we 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. Specifically, our theory model predicts that the loss aversion motivation for consumers with base warranties results in these consumers valuing extended warranties more favorably than their peers purchasing identical products without a base warranty. The authors validate the predictions from the theory model using observational data from the automobile industry and show how the reference-dependent-preferences-based effect varies with vehicle quality and with macroeconomic conditions. The analyses reveal autobuyers' 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 and what extended warranty should be marketed.