Design of customized two-dimensional extended warranties considering use rate and heterogeneity

Abstract

Extended warranties have become a rich source of profits for manufacturers. In the current marketplace, two-dimensional extended warranties are often sold to all customers with a fixed coverage region and the same price. However, customers are heterogeneous, as they have different use rates and failure history, which significantly affects the cost of the extended warranty. In this study, we first propose a customized extended warranty strategy that takes into account the use rate of the customer. Under the strategy, we develop a warranty cost model to compute the expected repair cost and the expected profit of the manufacturer, based on which the optimal price for the customized extended warranty can be determined. Building upon this model, we further propose a policy that makes use of both the customer’s use rate and the product’s failure history. We conduct a comprehensive numerical study to compare the two proposed policies with the prevailing fixed-region strategy. The results reveal that the customized policies are better than the prevailing policy in terms of fairness, flexibility, and profitability.