Profit Maximizing Warranty Period with Sales Expressed by a Demand Function

Abstract

AbstractThe problem of determining the optimal warranty period, assumed to coincide with the manufacturer's lower specification limit for the lifetime of the product, is addressed. It is assumed that the quantity sold depends via a Cobb–Douglas‐type demand function on the sale price and on the warranty period, and that both the cost incurred for a non‐conforming item and the sale price increase with the warranty period. A general solution is derived using Response Modeling Methodology (RMM) and a new approximation for the standard normal cumulative distribution function. The general solution is compared with the exact optimal solutions derived under various distributional scenarios. Relative to the exact optimal solutions, RMM‐based solutions are accurate to at least the first three significant digits. Some exact results are derived for the uniform and the exponential distributions. Copyright © 2006 John Wiley & Sons, Ltd.