Flexible-duration extended warranties with dynamic reliability learning

Frequent technological innovations and price declines adversely affect sales of extended warranties (EWs) as product replacement upon failure becomes an increasingly attractive alternative. To increase sales and profitability, we propose offering flexible-duration EWs. These warranties can appeal to customers who are uncertain about how long they will keep the product as well as to customers who are uncertain about the product's reliability. Flexibility may be added to existing services in the form of monthly billing with month-by-month commitments or by making existing warranties easier to cancel with pro-rated refunds. This paper studies flexible warranties from perspectives of both customers and the provider under customers' reliability learning. We present a model of customers' optimal coverage decisions and show that customers' optimal coverage policy has a threshold structure under some mild conditions. We further show that flexible warranties can result in higher profits and higher attach rates in a homogeneous market as well as in a heterogeneous market with multiple segments differing in various dimensions.