Design and pricing of usage-driven customized two-dimensional extended warranty menus

Abstract

In this article, we study the design and pricing of customized two-dimensional extended warranty menus from the provider’s perspective, where each consumer is presented with a tailored warranty menu based on her usage rate. We propose to design such usage-driven customized menus in two steps. First, for a fixed usage rate, we design the corresponding menu by seeking optimal prices for given warranty limits. Then, the menu for any other usage rate is designed by fixing the optimal prices and determining the associated warranty limits. We prove that under the multinomial logit choice framework, if the product failure probabilities for respective options in two customized menus are the same, then the menus will have identical expected profits and attach rates. A case study on commercial vehicles is presented to demonstrate the customization methodology. We find that customized menus can generate a higher profit and attach rate than a uniform menu without customization, indicating the benefit of customization. In addition, we extend the original model to incorporate ancillary preventive maintenance programs. Our analysis reveals that the optimal preventive maintenance policy for each option is independent of those for other options; moreover, bundling preventive maintenance programs can increase profit and attach rate.