Quantifying the Economic Value of Warranties in the U.S. Server Market

Abstract

We quantify the economic value of hardware base warranties in the U.S. server market to manufacturers, channel intermediaries, and customers. We further decompose the value of a warranty into its insurance value and its price discrimination value, which are the two main rationales for warranty provision in the server market. We use structural modeling and counterfactual experiments to accomplish the empirical task. We derive our demand model from utility maximization, which accounts for a customer's risk aversion behavior and heterogeneity. We obtain our pricing model from the profit maximization behavior of manufacturers and downstream firms in indirect channels, accounting for the institutional realities in the server market. Our empirical analysis uses quarterly data from 1999 to 2004 on server wholesale prices, retail prices, and sales for direct and indirect channels in the U.S. market. We find that manufacturers and downstream firms benefit from warranty provision and from sorting across heterogeneous customers by offering a menu of warranties. Customers also benefit from manufacturer warranty provision as well as from the menu of warranties offered. The insurance value of warranties increases and the price discrimination value of warranties decreases with warranty duration.