Usage Heterogeneity and Extended Warranties

Abstract

The role of product warranty in segmentation of consumer durable product markets is highlighted. I demonstrate that consumer moral hazard and heterogeneity in product usage create variation in the valuation of product warranties by the different segments in the market. In this context, the firm, by offering a self‐selecting menu of base warranty and extended warranties, satisfies the warranty demands of the various segments of the population. The consumer choice behavior prediction of the theory with regard to extended warranty is empirically validated with data from a survey of new car buyers.