Optimal extended warranty strategy: Offering trade-in service or not?

• Published in: European journal of operational research Vol. 278; no. 1; pp. 240 - 254
• Main Authors: Bian, Yiwen, Xie, Jiazheng, Archibald, Thomas W., Sun, Yanhong
• Format: Journal Article
• Language: English
• Published: Elsevier B.V 01.10.2019
• Subjects: Extended warranty; Supply chain management; Trade-in price; Trade-in service; Warranty selling price; Warranty selling price; Supply chain management; Trade-in price; Extended warranty; Trade-in service
• ISSN: 0377-2217; 1872-6860
• DOI: 10.1016/j.ejor.2019.04.015

•An extended warranty with trade-ins for the same or upgraded product is emerging.•Whether to sell the traditional extended warranty or the one with trade-in service?•The optimal warranty strategy and associated pricing strategies are examined.•Some important findings and insights regarding extended warranties are obtained. Retailers and manufacturers are increasingly selling extended warranties to obtain high profitability. In addition to the traditional extended warranty (EWR), that offers a free repair and replacement service, a new extended warranty (EWT) comes to the market, under which an additional trade-in service is provided during the warranty coverage. The service provider faces three important decisions: (1) Whether to offer EWR or EWT? (2) How to set the optimal selling prices of EWR and EWT? (3) When choosing to sell EWT, how to determine the optimal trade-in price? To address such challenging issues, we first develop two theoretical models regarding EWR and EWT for a retailer, and further consider the cases where a manufacturer sells the extended warranties and the upgraded product has different failure probabilities. The results show that EWT should never be offered at a higher price than EWR, and when the handling cost for used products is relatively low, EWT will outperform EWR. While the optimal EWR and EWT selling prices increase with the product failure probability, the optimal trade-in price decreases with it. Interestingly, the optimal trade-in discount is not always increasing or decreasing with the failure probability. Moreover, an earlier trade-in time is usually better for the service provider. Compared with the retailer, the manufacturer will always set a lower warranty selling price, but neither of them will always offer a lower trade-in price or discount. We also find that the upgraded product's failure probability will affect the retailer's optimal warranty strategy and profit.