Study Reveals What Consumers Think Of Extended Service Contracts

Lower-income consumers are more likely to purchase  extended service contracts (ESCs) than those with more disposable income, and consumers are prone to buy ESCs for non-utilitarian items (Blu-Ray players, game consoles) over computers and printers, according to a study released by Carnegie Mellon.

Despite consumer advocate warnings that ESCs are bad deals for buyers, referred to as “money down the drain” by Consumer Reports, the ESC market on consumer tech is big business, accounting for more than 50% of Best Buy’s profit in 2004 (approximately $194.5 million), according to Business Week. Researchers at the Tepper School of Business examined consumers’ tendency toward ESCs, including which products consumers were more likely to cover, which class of consumer were likely to buy ESCs, and retailer actions that most influenced the ESC buying decision. 

Gotta Have My iPod
The study found that consumers would rather insure hedonistic items (“pleasure purchases”) like iPods rather than practical items like printers and computers for two reasons. One, because many fun gadgets stimulate the senses, particularly sight and sound, consumers tend to elaborate their value. Second, consumers seek to minimize the potential emotional loss should the product stop functioning. In other words, we are all very fond of our toys and don’t want them to break.

"Buyers often place more value on pleasure purchases, feel there is a greater risk to their well being if they do not function, and are willing to pay extra to protect them," said Baohong Sun, Carnegie Bosch Professor of Marketing and co-author of the study.

Also of note, consumers may seek to offset the guilt of splurging on a pleasure purchase by doing the seemingly responsible thing of buying a warranty.

Can’t Afford to Replace It
Those in lower income brackets are more likely to buy ESCs than consumers with higher incomes, simply because lower income consumers are more concerned with replacement costs. The study notes that since most consumer electronics are relatively inexpensive compared with other insurable items (cars, homes, jewelry), lower-income consumers don’t mind spending the extra dough. However, ESCs can add literally hundreds of dollars to the cost of an item (currently Best Buy charges $199.99 for Geek Squad’s LCD TV protection plan). Sun notes, “When you consider that low-income buyers are more likely to purchase ESCs, it is evident they can have a perverse impact on consumer welfare. They increase the price of goods for those who can afford it least." 

The Unadvertised Sale
ESCs are big business, with major retailers like BestBuy, and more recently Walmart, counting on them to add big chunks to the bottom line. According to Consumer Reports, stores keep as much as 50% of what they charge for ESCs. As such, the retailers are savvy when it comes to pushing consumers toward ESC purchases. One trick is the unadvertised sale. Consumers are surprised by an unexpected discount on an item offered by a helpful sales rep, which then puts the customer in a position to spend the newfound savings on an ESC. This works on two levels, according to the study. First, consumers may consider the unexpected windfall as “house money” and make an unplanned purchase on an ESC. Too, the instant savings puts consumers in a good mood, which other studies show makes an individual more risk adverse. When feeling well, individuals are more sensitive to feelings of loss and more likely to guard against it.

Links:
http://blogs.consumerreports.org/money/2009/11/why-you-dont-need-an-extended-warranty.html

http://www.businessweek.com/magazine/content/04_51/b3913110_mz020.htm