Optimal Pricing Strategy for a Flexible Extended Warranty Policy

Abstract

Extended Warranty (EW) can only be purchased at the time of product sale or at the end of basic warranty in many practical situations. This paper proposes a flexible EW policy that allows customers to determine the start time and duration of EW coverage. The objective is to derive the optimal EW price for any arbitrarily selected coverage by maximizing the manufacturer’s profit. A variety of uncertainties such as start time, duration, unbalanced knowledge about product reliability, the risk attitude of customers, and the loyalty to the manufacturer are considered to develop the manufacturer’s profit model. The optimal EW price is proved to be proportional to the expected failure times over the EW period and the proportional coefficient is independent of the EW start time and duration. A practical example is developed to illustrate the applicability of the proposed model and sensitivity analysis is conducted to investigate the effects of various parameters on the coefficient.