Cyber Monday Advice: Don’t Buy the Extended Warranty

 

For a change in pace from all the politics, I thought I’d offer a little consumer advice as we head into the Christmas shopping season. To wit, buying an extended warranty is almost always a bad idea.

To explain why, let me show you a graph of the typical life-cycle of a manufactured product. In engineering we call this a ‘bathtub curve’ because of its resemblance to the shape of a bathtub:Bathtub Curve

Allow me to explain. Any product goes through three phases of reliability in its lifespan. First is the “infant mortality” phase, denoted by the green box above. This is the time when products fail due to manufacturing errors, design errors, materials issues, etc.

The second phase is the normal life of the product; i.e, once the early failures have left the market, what remains tends to work properly for the rest of its design life, with very low overall failures. That’s the white section in the graph.

Finally — as a product reaches the end of its design life — it begins to wear out. Things start to fail because of normal wear and tear. That’s denoted by the blue area in the graph.

Now, a manufacturer’s warranty protects you from the infant mortality phase. If parts on your car or toaster fail here, it’s because something was built wrong, and the warranty covers you in that case. And protecting you from manufacturing flaws is precisely what a warranty should do.

An extended warranty applies to the “middle” phase, and is timed to end before normal wear and tear starts causing failures.

Manufacturers of products have the data that allows them to predict these phases. They know where the period of high reliability starts and ends. You, on the other hand, do not. Magazines like Consumer Reports or independent research like JD Power reports may give you good information about the early failure rates, but they aren’t going to be able to tell you when the thing you are buying will begin to wear out.

What this means is that the manufacturer in this case has an advantage over the consumer: a classic example of an information asymmetry. That allows them to offer a “warranty” at relatively high cost that protects you from product failure during the period the product is least likely to fail. And since you have no idea how likely that is but they do, they can use that information to price the extended warranty such that a healthy profit for them is baked in.

In a complex product like a car, there are many “bathtub curves.” Each sub-assembly may have different failure patterns. So, when you look at an automotive extended warranty, you’ll usually find that certain things aren’t covered, sometimes inexplicably. The engine may be covered, but not the alternator. The transmission may be covered, but not the torque converter. Why? Because the extended warranty is optimized to maximize profit for the auto dealer, and sometimes that means leaving things out that are likely going to be too expensive to fix because they are most likely to fail during the extended warranty period, or because their lifespan is too dependent on variables like driving habits or road conditions to be predicted with enough accuracy to work into the formula.

In fact, it can be worth looking at the extended warranty when considering the purchase of a car not because you want to buy the warranty, but because looking at the list of excluded items can tell you a lot about what the car company expects will fail first on the car. That can help inform your knowledge of the vehicle’s overall reliability.

Other Reasons to Avoid Extended Warranties

This advice about avoiding extended warranties doesn’t just apply to vehicles, but to all consumer products. I won’t go so far as to call them a scam, but they are usually a very high profit item for the seller, and therefore very poor value for the consumer. Here are some other reasons why:

  • You may forget about it. If you have a habit of buying extended warranties, how do you know that the product that just failed is covered by one? Do you remember which of your goods is covered by warranty and which are not? Do you have all the paperwork? Did you think to check for it before tossing the thing in the trash? The statistics show that many extended warranties are never claimed, even when they are valid. That’s pure profit for the seller.
  • You may replace the product before the warranty is out. A five year extended warranty on a laptop is useless if you tend to replace it after two or three years. Or, you may break the product in a way that invalidates the extended warranty anyway. Every car wrecked during its initial warranty period is a car that will never claim extended warranty coverage, coverage that might have cost thousands of dollars.
  • The warranty may be invalid. Some items have very specific conditions for a valid warranty claim. They may require you to have a copy of the contract and the invoice for the product. They may inspect the product and decide it wasn’t used correctly. The specific failure may not be covered by the warranty. There are many reason why an extended warranty may not be claimed.
  • The warranty isn’t transferable. Many extended warranties cannot be transferred. So, if you sell the item covered, that value is lost. And even if it is transferable, is the new owner going to know that? Is he or she going to care? Can you extract value from that warranty by charging a higher price? Almost certainly not.
  • The warranty costs you now, but has no value until the factory warranty runs out. Think about that one: if your car has a 5 year warranty, and you pay up front for a 5 year extended warranty, the car company gets the use of your money for five years before it has to worry about possibly paying it back. If you could have earned 5% per year on that money, the warranty cost you 28% more than the up-front price.

There are other reasons to avoid extended warranties, but these are the big ones. In general, an extended warranty violates the principle that you should never pay for insurance when you have the finances to self-insure. Insurance is always a negative-expectation bet, with the insurance company selling you risk mitigation at a cost. It’s never a good deal, but may be necessary if you can’t bear the risk. In the case of most consumer goods, that’s not true for most people.

A Good Alternative Strategy

Here’s a good strategy for managing risk while saving money: set up a savings account called “product insurance.” Every time you are offered an extended warranty, refuse it and put an amount equivalent to the cost of the warranty into that savings account.

When a product you own fails outside of the normal warranty but within the extended warranty period, replace it with money from that fund. You’ll almost certainly find that the account grows in size over the years, and perhaps very substantially. Every dollar in that account is a dollar that did not go to line the pockets of the salesman and the company that sold you the product.

Happy shopping!

There are 57 comments.

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  1. PHCheese Inactive
    PHCheese
    @PHCheese

    Very good advice.

    • #1
  2. Judithann Campbell Member
    Judithann Campbell
    @

    Thank you, Dan. I was just buying a television earlier today, and the salesman was pushing hard for me to buy a warranty on it. I decided not to, but was unsure whether I had done the right thing or not. Now I feel better :)

    • #2
  3. Roberto Member
    Roberto
    @Roberto

    Dan Hanson:For a change in pace from all the politics, I thought I’d offer a little consumer advice as we head into the Christmas shopping season:

    Buying an extended warranty is almost always a bad idea.

    Indeed. Now let me propose a much more difficult question, in what circumstance (if any) is a extended warranty not a bad idea? Chew on that one.

    • #3
  4. RightAngles Member
    RightAngles
    @RightAngles

    Good advice.

    • #4
  5. Aaron Miller Member
    Aaron Miller
    @AaronMiller

    Thanks.

    On a related note, I was pleasantly surprised when Target ended their Target Ticket video streaming service that all content purchased for that service would be transferred to competitors like Vudu (Walmart) and CinemaNow (Best Buy). That increased my confidence in buying digital movies and TV generally, though it might not be guaranteed that other companies would do the same.

    • #5
  6. Chris B Member
    Chris B
    @ChrisB

    Roberto: Indeed. Now let me propose a much more difficult question, in what circumstance (if any) is a extended warranty not a bad idea? Chew on that one.

    Mission critical equipment, such as servers. I frequently advise my clients to purchase extended service plans for equipment that they intend to use beyond the end of the manufacturer’s warranty. If a server or switch has a component fail, being in warranty means they will have a replacement part next day (or even same day). Going through normal retail channels, the same replacement part may be back ordered or no longer generally available, and could easily take a week or more to acquire.

    They’re expensive, but they make sense when considered against the cost of extended downtime, or purchasing a dedicated spare.

    • #6
  7. Roberto Member
    Roberto
    @Roberto

    Chris B:

    Roberto: Indeed. Now let me propose a much more difficult question, in what circumstance (if any) is a extended warranty not a bad idea? Chew on that one.

    Mission critical equipment, such as servers…

    They’re expensive, but they make sense when considered against the cost of extended downtime, or purchasing a dedicated spare.

    Chris B for the win.

    • #7
  8. wilber forge Inactive
    wilber forge
    @wilberforge

    Well stated. When the rubber hits the road, who in your knowledge has been granted satisfaction for said purchase ?

    • #8
  9. Percival Thatcher
    Percival
    @Percival

    Most electronic equipment either fails in the first 96 hours or doesn’t fail until well out in its life cycle. Frequently companies selling such gear will report their product’s “burn-in” time – the amount of time they had the unit plugged in and functioning before they shipped it. This cuts down on the number of units that let the blue smoke out immediately after being deployed.

    • #9
  10. Manny Member
    Manny
    @Manny

    I never take.  I’m an engineer myself.  But I’ve never heard of the term “bathtub curve” though.  I like that.  I’ll have to remember it.

    • #10
  11. Herbert Inactive
    Herbert
    @Herbert

    I won’t argue that it makes financial sense, and this is contrary to your advice. But, I’ve been pleased with square trade on my apple products. It covers damage from water and drops(I am prone to do this). It is also refundable (prorated) and transferable. Probably the biggest advantage to me is that they will reimburse you for an out of warranty exchange at Apple retail store. So if I drop the iPad, crack the screen, I can go get a replacement immediately at an Apple Store and be reimbursed from square trade for the fee I paid Apple (minus deductible). They have never given me any hassles with this.

    http://www.squaretrade.com

    • #11
  12. Belt Member
    Belt
    @Belt

    Exactly – One exception would be for mission critical devices, like a server, for instance.  But otherwise it’s almost never worth the money to get an extended warranty.

    • #12
  13. Percival Thatcher
    Percival
    @Percival

    When it’s lab equipment, the vendors never mention “extended warranties” to the lab rats because vendors do not enjoy being laughed at. Every once in a while, they’ll slide one by a business manager, though.

    • #13
  14. Ball Diamond Ball Inactive
    Ball Diamond Ball
    @BallDiamondBall

    As with business equipment such as servers, the use case for an extended warranty is pretty slim.  Warranties for business servers have had the math done for both sides, so competitive deals can be found.  If you purchase through a third party, the extended warranty can be more flexible, as the service there is part of the value proposition keeping the third party in business.  One shortcoming can be monolithic vendors who de-prioritize third-party warranty work.  Make sure that your third-party warrantor is prepared to get one a plane immediately.  They should also warrant that they have ready spares or access to them within a time limit.

    For consumer goods, the one one type of extended warranty I find objectively worthwhile is a “drop and break” inclusive one for things like laptops.  The risk of drop and break is constant, and is likely not covered even during the honeymoon.

    Finally, like business servers, if you would rather export the risk for a fee, such as for a vehicle that you rely upon for business, or you simply have a low risk tolerance for other reasons, that can make it worthwhile.  On the other hand, at that point you may be looking at AAA (“triple A”, the car rescue guys) as a better option.  That’s like a third-party warranty on situations, rather than equipment, which is usually the real hazard anyway.

    But yeah, usually, never get the extended warranty.

    • #14
  15. Locke On Member
    Locke On
    @LockeOn

    15 years ago I was an advisor to an investor in a company which served the extended warranty trade (as a web front end).  The rule of thumb at the time was that the expected payout on repairs was 50% of the customer’s cost for the warranty.  Assuming it’s still similar, there’s lots of room for sales commissions and other spiffs in there!

    What I’ve done every since for major purchases, particularly in a negotiating situation:  Ask for the price of the extended warranty about the middle of the discussion.  Write it down.  This has two purposes:

    1.  Take 50% of that number and add it to the offered price.  That’s your estimated cost of ownership (excluding energy and supplies) to the end of the extended warranty period.  Use that number if you are comparison shopping.
    2. Extended warranties almost always carry a higher commission than other sales – see above.  Mentioning it early may increase the salesman’s hopes for the back-end sale, and you get a better offered price on the item you want to buy in that hope.  Then turn down the extended warranty.  All’s fair in war and negotiation.
    • #15
  16. Metalheaddoc Member
    Metalheaddoc
    @Metalheaddoc

    Herbert:I won’t argue that it makes financial sense, and this is contrary to your advice.But, I’ve been pleased with square trade on my apple products.It covers damage from water and drops(I am prone to do this). It is also refundable (prorated) and transferable. Probably the biggest advantage to me is that they will reimburse you for an out of warranty exchange at Apple retail store. So if I drop the iPad, crack the screen, I can go get a replacement immediately at an Apple Store and be reimbursed from square trade for the fee I paid Apple (minus deductible). They have never given me any hassles with this.

    http://www.squaretrade.com

    I also had a good experience on a Square Trade warranty on a blender I got from Amazon. It died after the manufacturer warranty ran out. I made a claim with Square Trade which was very smooth and easy. No “send it in to inspect” shenanigans. They simply gave me an Amazon gift card for the original price plus 7 bucks to cover shipping. Very satisfactory experience.

    • #16
  17. skipsul Inactive
    skipsul
    @skipsul

    Roberto:a much more difficult question, in what circumstance (if any) is a extended warranty not a bad idea? Chew on that one.

    When you have kids, or a propensity for being hard on you products.  I’ve had a few pay off well in this regard.  My favorite was on a TV:

    In 2007 I purchased a Sony 50″ rear projection HDTV from Circuit City.  I also got the 5 year warranty.  A little of a year in, after the factory warranty expired, a fan went out.  Warranty fixed it.  A year after that, that fan’s opposite number on the other side of the set failed.  Again fixed.  Then Circuit City imploded and died, but the warranty program was guaranteed through the bankruptcy settlement.  Well, then a signal processing board failed through overheating (you guessed it, the unit’s 3rd remaining original fan).  Again, the warranty was supposed to cover it.

    Yet since Circuit City had gone, the company that took over the warranty program had less competent technicians.  The tech got what he thought was the right assembly (essentially the entire guts) in, only to find he put in the one from a succeeding model.  3 week later he got the right one in, but broke the sound board header (so he thought).  At this point the warranty company just sent me a new TV – a Mitsubishi this time.  They would not take the old set, so I fixed it.  It still works.

    • #17
  18. skipsul Inactive
    skipsul
    @skipsul

    Also, I got a warranty extension when I bought my SUV.  It had 50k miles on it, with a little factory warranty left, but was used.  I noticed some damage during the test drive, and got the dealer to fix it, but I took the warranty out as the nature of the damage (badly out of alignment rear end), suggested someone had curbed it.  That warranty not only fixed the rear end problems that came up later (and were what I predicted), but also fixed the vehicle’s entertainment system when it too failed.

    • #18
  19. skipsul Inactive
    skipsul
    @skipsul

    As a manufacturer of electronics myself, I do want to echo the sentiments above – electronics either fail rapidly, or not at all – it’s the mechanical components you have to watch.  Most of the returns to my company are the victims either of abuse (non warrantable), mis-application (non-warrantable), or else they work just fine.  Biggest culprits tend to be things like relays (which are mechanical), or vulnerabilities we missed in the design process (product works at 99% of customers, but that last 1% find a new way to break it).

    • #19
  20. Tedley Member
    Tedley
    @Tedley

    Clark Howard regularly made this point on his radio program in the 90s, as well as his book “Get Clark Smart, The Ultimate Guide for the Savvy Consumer,” published in 2000.  Thanks to him, I’ve always shied away from them.

    That said, I’ve been given extended warranties on expensive appliances by some stores for free, as an incentive to shop there.  Having the extended warranties turned out to be a good thing.  We had problems with two flat screen televisions well after the normal warranty ran out, and the most recent failure occurred just before the extended warranty ran out.  They were purchased when flat screens were very pricey, so I wouldn’t consider paying for one now.

    • #20
  21. MJBubba Inactive
    MJBubba
    @MJBubba

    We bought a new oven for a kitchen remodel in our home two years ago.   I was not interested in the extended warranty.   I was concerned, however, about the risks of a power surge.

    We had an interesting incident a little over ten years before.   We had been out on a Saturday afternoon when a bad thunderstorm moved through, with lots of lightning.   When we arrived home, Snooks said “what’s that smell?!”    It took a minute to find the source.   It was the microwave.   Evidently we had a power surge that fried its electronic brain in a way that caused the oven to turn on.   It cooked itself to death.   The heat had become so intense that it melted the glass platen cooking surface.   Fortunately, it was a well-made (1980s Litton) microwave, and it was in a stout wooden cabinet that was over the well-insulated oven cabinet.   No other damage, though it came close to burning our house down.

    So I asked for a surge protector for the new oven, but the appliance dealer had never heard of one.   I asked if the oven had a built-in surge protector, but nobody in the store knew, and since none was mentioned in the product literature, we concluded that it did not.

    continued:

    • #21
  22. MJBubba Inactive
    MJBubba
    @MJBubba

    Continued from comment #21:

    I asked what I was supposed to do to protect against a surge ?

    The store staff said “buy the extended warranty!”

    I asked if the extended warranty would cover my house if it burns down because a power surge triggered the oven to turn itself on and stay on indefinitely.

    “Of course not.”

    After checking out other ovens and not finding any difference, I bought the one Snooks wanted.   I did not buy the extended warranty.

    I have another home project coming up.   As part of the next project, I am planning to have a whole-house surge protector installed.

    • #22
  23. Misthiocracy Member
    Misthiocracy
    @Misthiocracy

    I used to buy the conventional wisdom that one should never buy the extended warranty, but I have recently identified a couple of instances where I make exceptions:

    a) I only buy the extended warranty when purchasing a refurbished item, such as my most recent computer purchase. Glad I did it too, as the computer required a new power supply just after the 30-day standard warranty had expired.

    b) My boss, who has five young children, always buys the extended warranty because his electronics have a nasty tendency of being mysteriously dropped and/or gummed up by that perennial culprit in such households – the dreaded “Nobody”. He’s been known to go through as many as three iPads before the AppleCare runs out.

    family_circus_notme21

    Of course, one must consider how much the extended warranty costs. For a refurbished computer I have to ask myself, “instead of an extended warranty, could I simply apply the extra money to the purchase of a new computer instead?”

    (Then again, the reason I went with refurbished rather than new was because it was the only way to get Windows 7 rather than Windows 8.)

    • #23
  24. Man With the Axe Inactive
    Man With the Axe
    @ManWiththeAxe

    There is a glaring omission in the analysis of extended warranties so far. Most of what has been said is true, but it fails to consider the difference, the substantial difference, between the cost to the manufacturer to repair or replace and the cost to the consumer to do the same.

    I’ll make up some numbers for the sake of illustration.

    • Automobile: I pay $3,000 for an extended 10 year bumper-t0-bumper warranty (really, 7 extra years) . The cost of repairs during those 7 years to the average purchaser is $5,000.  I have the average experience and I save a bunch. The dealer does the repairs at a cost to him of $2,000. He makes a nice profit, and he got his $3,000 up front.
    • HD TV: I buy the extended warranty on a $2,000 TV for $200. I believe that the expected cost that I am avoiding (10% chance of serious problems requiring replacement plus 30% chance of minor problems requiring in-home repair) is $400. The company can replace the set at a cost to it of $800, and can do the repairs at a cost to it about 1/3 what it will charge me. It’s expected payout is $120.

    The warranty is not a bad deal for you simply because it is a good deal for the seller. You face different prices than they do for taking on the risk.

    • #24
  25. Nick Stuart Inactive
    Nick Stuart
    @NickStuart

    I wish you could convince my wife of this.

    • #25
  26. Man With the Axe Inactive
    Man With the Axe
    @ManWiththeAxe

    Nick Stuart:I wish you could convince my wife of this.

    I don’t know if your comment is directed at me or at Dan Hanson.

    I feel like a guy at a bar who sees a pretty girl winking at me, but then I discover that there is a younger, handsomer man standing just behind me.

    • #26
  27. Man With the Axe Inactive
    Man With the Axe
    @ManWiththeAxe

    To elaborate on #24, given that the cost of taking on the risk to the seller is likely to be much lower than the cost to the buyer of assuming that same risk, a contract for the seller to take the risk creates a surplus for the parties to share. There should be a price for any warranty where the parties split the surplus, and both benefit. 

    It is possible that some warranties are priced so high that the seller will gain all the surplus and then some. The seller thinks he can get away with this because of the buyer’s ignorance. But the buyer also has knowledge that the seller doesn’t, namely, how rough the buyer is on the item. Someone who knows that he uses his dishwasher really hard, or is likely to drop his iPhone into the toilet, or leaves his TV on practically 24 hours a day, may find the warranty to be more valuable to him than the average buyer.

    • #27
  28. skipsul Inactive
    skipsul
    @skipsul

    Man With the Axe:To elaborate on #24, given that the cost of taking on the risk to the seller is likely to be much lower than the cost to the buyer of assuming that same risk, a contract for the seller to take the risk creates a surplus for the parties to share. There should be a price for any warranty where the parties split the surplus, and both benefit.

    It is possible that some warranties are priced so high that the seller will gain all the surplus and then some. The seller thinks he can get away with this because of the buyer’s ignorance. But the buyer also has knowledge that the seller doesn’t, namely, how rough the buyer is on the item. Someone who knows that he uses his dishwasher really hard, or is likely to drop his iPhone into the toilet, or leaves his TV on practically 24 hours a day, may find the warranty to be more valuable to him than the average buyer.

    Thanks for spelling this out.  I’m in the same camp – there are many items where extended warranties are effectively worthless, but there are some where they are decidedly not (see my TV example earlier – that one cost them a heck more than it cost me).  I’m not going to pay an extended warranty on my home router because it will not be abused, staying rather locked away in a utility room, but other things I will.

    • #28
  29. Titus Techera Contributor
    Titus Techera
    @TitusTechera

    I don’t have anything to contribute to the thread, except thanks. This is really clever stuff, both for the rule & the folks with the exceptions. You people are making Ricochet an education in lots of practical things!

    • #29
  30. PHCheese Inactive
    PHCheese
    @PHCheese

    Once while buying a tv the saleman was so obnoxious about the extended warranty that I left and bought elsewhere.

    • #30

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