Extended product warranties are usually offered by retailers and sometimes by manufacturers to lengthen the coverage provided by the manufacturer's basic warranty. They are also sometimes referred to as Extended service contracts (ESCs) or Extended service plans. .(Chen, Karla &Sun 2001)
The importance of warranties can be explained from the economic studies that focus on the purpose of these legal contracts. Warranties may serve as signals of quality (Spence 1977), as insurance against variations in product performance (Heal 1977) or as incentive devices (Cooper-Ross 1985, 1988a, 1988b and Priest 1981).
Warranty is a legal obligation of the manufacturer or dealer who is liable to the consumers in case of failure of that product. It gives peace of mind to the consumer as well as confidence that the product would work well.(Anisur and Chattopadhyay 2004)
Magnusson-Moss warranty Act (1975) states that duration of lifetime warranty is a source of confusion because of difficulties in understanding life measures of coverage. In spite of complicacies in defining life, lifetime warranty has received a huge popularity in the product market as it guarantees a long reliable function of products.
Some of the issues related to warranties are discussed in details in Blischke and Murthy (Blischke and Murthy 1996), and Singpurwalla (Singpurwalla 1993).
A paper by AnisurRahman & Chattopadhyay (2004) explained the concept of lifetime warranty policies and looked into the complexities of modeling warranty costs associated with lifetime warranty policies. The paper also analyzed the potential of these policies if they could be applied in industries.
Some papers have examined the purchase of extended service contracts, which are essentially insurance products, for electronic products in a retail setting.While the impact of consumer characteristics (income, gender, and prior usage) on these insurance products purchase is also considered.(Chen, Karla &Sun 2001)
Literature on insurance identified determinants of purchase as being the probability of loss, the extent of loss, the insurance premium charged and buyer's risk aversion (Mossin1968; Schlesinger 1999).
Chen, Karla &Sun's (2001) study was the first attempt to examine consumers'purchase of extended service contract in a retail environment using field data.
Padmanabhanand Rao (1993) examined manufacturer warranty policies in a market characterized by the moral hazard problem and consumers with heterogeneous risk aversion.
Others investigated manufacturer strategies for extended service plans in the presence of competition from third-party insurers.Lutz and Padmanabhan (1995) proposed that manufacturers should not offer extended warranties in this context because firstly they will have to consider the increased expected costs of both the basic warranty and the extended warranty and if consumers buy the extended warranty from the third-party insurers, they likely will reduce their maintenance effort in the product during the warranty period.
Day and Fox (1985) did a qualitative study and concluded that while general attitudes towards extended warranties are negative, consumers are more favorably inclined to extended warranties that provide insurance against catastrophic loss or those that provided regular maintenance.
Grossman (1998) studied the information role that warranties play and the additional information they provide about quality of the products. Whereas a paper by Balanchander (2001) explained that a longer warranty may be offered by a product with lower quality .They showed that in a market where a new product competes with an existing product ,signalling behavior leads to an outcome where the less reliable product may carry the longer warranty
However, Spence (1977) argued that a high-quality product might provide a longer warranty to signal its quality to uninformed buyers .
A paper by Welling (1989) explains that firms compete on the basis of price offered and refund policies and they base their prices on the quality of the products. consumers with high income levels tend to pay higher price for high quality products if the product risk is not insurable, with higher refunds if the product fails to meet expectations.
Consumers consider warranty as signals of product quality because they know that offering warranties are expensive for firms. Longer warranties increase consumers' utility and increases the likelihood of product being chosen. Choi ( 2006)
If all insurers in a competitive insurance market are well informed of consumer risk types there is an increase in efficiency of market. however if the entrant does not know about the risk types there is less efficiency in the market. Strauss & Hollins (2007)
Boulding and Kirmani (1993) the warranty can, in effect, serve as a telling signal of the qualities of products carried by both firms, high bond credibility firm one which incurs a high cost if the signal is false, and low bond credibility firm, the one incurring low costs as a result of false signal.
Warranty and product quality can be thought of as consistent with the use of warranty as a basis of judging quality of a product when consumer moral hazard is present. High quality can be signaled by a low quality. Lutz(1989)
Appliance warranties can be considered to provide a market signal of appliance reliability. However, the cost to consumers of obtaining enough information to interpret the signal causes the dispersion of warranty provisions to be limited. The more complicated the laws surrounding warranties, the greater the cost to consumers of warranty information. Gerner & Bryant (2006)
Consumer product warranties are prevalent in many markets. Consumer durables as well as some necessities and services are frequently sold in combination with kind of warranty. Emmons(1989)
Warranties serve as marketing device to extract consumer surplus if a product is offered with a variety of warranty contracts. However warranty contracts cannot be use as a device to maintain producer surplus because as service warranties may require a larger network of dealers which might be expensive to setup, in that case it serves as a barrier to entry of producers. Emmons(1989)
When products are sold with warranties, a linkage is created between buyer and seller. Because the seller's future profitability is dependent upon the behavior of future consumers, warranties also imply a linkage between different cohorts of consumers. Bigelow, Cooper, & Ross(1993)