Are Extended Warranties Worth It? Harvard Debates Consumer Reports

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Who do you think knows more about business? Consumer Reports, or the Harvard Business Review? Think carefully before you reply, because upon your response hinges the answer to another question:

Is it a good idea to buy an extended warranty, or not?

Let Us Present the Arguments

According to Consumer Reports -- the shopping bible of thrifty Americans everywhere -- there are precious few instances in which it pays to buy an extended warranty on a product you purchase.

Citing "extensive research" from years of study, and feedback from its tens of thousands of members, Consumer Reports argues convincingly that when an appliance breaks, it usually costs about as much to get it fixed or replaced as it would have cost to buy an extended warranty.

Seeing as the purpose of buying an extended warranty is to get an appliance fixed or replaced years in the future, when dollars are worth less due to inflation, you probably wind up losing money on each extended warranty that you purchase.

That's if you're lucky.

Because as CR points out, even when consumers do buy extended warranties, they don't always get to use them. This is because manufacturers and retailers get to pick the time periods for which they sell warranties, and pick the level of quality they build into a product.

Combine these two abilities with the oodles of data they've collected from years of past product sales and warranty repairs on those products, and a warranty-hawker is well-positioned to make sure any warranty that it sells expires before the product actually breaks.

Result: According to CR, "most repairs do not occur during the limited time period covered by the extended warranty."

But Before You Decide ...

Clearly, CR is not enthused about this whole extended warranty thing. And yet, a just-as-esteemed publisher -- the Harvard Business Review, via its Blog Network -- says that Consumer Reports is wrong to knock 'em.

In a column last year, pricing strategy consultant and HBR blogger Rafi Mohammed took CR to task for making a "blanket judgment" that extended warranties are a bad deal. (Consumer Reports did in fact concede that in some circumstances extended warranties are warranted, such as when buying a repair-prone brand where the warranty is comprehensive and cheap.)

However, according to Mohammed, "not only poorly informed people ... are duped into buying" extended warranties ... because he "often buy[s]" them too!

Mohammed argues that even though Consumer Reports' basic point that extended warranties are rigged in favor of the seller is correct, there's still value in the product because:
  • Being a fixed-price product, an extended warranty limits the risk of a surprisingly big repair bill.
  • Under a warranty, repair is the warrantor's responsibility, so a customer needn't find his or her own repair shop.
  • Some warranties offer extra conveniences, such as free on-site repair.
In illustration of which, Mohammed offers up the example of his own Dell (DELL) notebook, which broke down "not long after" he purchased it. Because he had bought a warranty (for about a third of the cost of the computer), Dell repaired it 24 hours later, on-site. And good for him, but ...

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If you look at this situation from a slightly different perspective, what really happened here is that: First, Dell sold Mohammed a POS* computer. Then Dell charged him an extra one-third of the sticker price for an optional warranty. Finally, Mohammed was "lucky" enough to get to use that warranty.

That hardly seems a glowing endorsement for either Dell or its warranties -- especially since the notebook broke "not long after" Mohammed bought it, and so repair was probably already covered (for free) under the manufacturer's warranty. Even if the notebook took a bit longer to break, if it was bought with a credit card, repair would likely have been covered under the warranty-extending features of most MasterCard (MA), Visa (V), and AmEx (AXP) cards -- again, for free.

Get What You Pay For

Granted, the on-site repair and 24-hour service of Mohammed's Dell warranty sound like nice features -- although not even all Dell warranties offer such service. But this actually raises another point: cost.

According to Consumer Reports, stores tend to earn 50 percent or better gross profit margins on warranties they sell. That's more than twice what Best Buy (BBY), for example, grosses on actual merchandise that it sells.

That fact right there tells you that most warranties probably aren't worth the price. The high profit margin on this "product" tells you it's not costing the stores much to offer warranties. Whether this is because the services included aren't as valuable as Mohammed suggests, or because most warranties expire unused, either way, if you do choose to buy an extended warranty understand that chances are good that you're simply paying for peace-of-mind and probably not much else.

* POS = "Presumed to have an Operating System."

Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends American Express, MasterCard, and Visa. The Motley Fool owns shares of MasterCard.

Are Extended Warranties Worth It? Harvard Debates Consumer Reports
In the wake of a number of high-profile cruise ship disasters, the cruise industry announced this week that it had approved a passengers' bill of rights. The document, which the industry says will be legally binding, mainly concerns passengers' rights in instances where a ship has become disabled.

It resembles a similar bill of rights for airline passengers that the Department of Transportation drew up in 2011. Those rules concerned procedures for dealing with lengthy tarmac delays, lost baggage, and similar issues.

That got us thinking: If cruise ship passengers and air travelers have their own bills of rights, why shouldn't shoppers?

Sure, visitors to retail stores typically don't encounter situations as maddening as being stranded on a floating hotel where the bathrooms don't work, or trapped in a cramped coach-class seat while their flight sits on a tarmac for hours. But the shopping experience is still riddled with frustrations, and less-savvy shoppers are often taken advantage of by dodgy pricing, pushy salespeople and inconsistent policies.

We'd love to see a self-policing effort by the industry to assure shoppers that they can expect certain standards of treatment when they walk into a store. Here are a few things we would include in a shopper's bill of rights.

When retailers run sales and coupons, they include fine print that limits what the deal actually applies to. In most cases, it's relatively harmless -- it defines the effective dates of the promotion, and may exclude select items like gift cards and jewelry.

But problems arise when retailers go totally overboard and try to exclude half the store. Department stores like Sears (SHLD) and Macy's (M) tend to hold sales that exclude dozens of brands from the discount, and earlier this year Guitar Center took some heat for a coupon that excluded more than 300 brands.

Sure, in a perfect world everyone would read and understand the fine print. But it's not unreasonable for someone to see "20 percent off everything" and assume that it applies to most of the merchandise in the store.

Photo: Consumer Media

It's bad enough when there's a ton of fine print in the ad. It's even worse when store employees are inconsistent about applying those terms.

The other day I was shopping at Banana Republic (GPS), which was having a 40 percent off sale. I found an item I liked and confirmed that it wasn't excluded in the fine print, but a cashier insisted that the discount did not apply. Only when I threatened to leave empty-handed did she check with a manager and apply the discount.

It's understandable that the price of certain big-ticket purchases -- cars, TVs, and so on -- will depend in part on your ability to successfully haggle down the price. But whether or not a store fairly applies the terms of a deal should not be contingent on your willingness to make a scene.

Photo: nichole.c, Flickr.com

It's not just the fine print on coupons that's often left to the interpretative whims of cashiers and associates. Corporate policies on everything from returns to price-matching are often poorly understood or selectively applied by front-line employees.

In our review of store price-match policies, we noted a report from Cheapism that found that some stores were inconsistent in their application of those policies. At Walmart (WMT), for instance, cashiers insisted on seeing competitors' ads to perform a price-match, despite a company policy that explicitly says that you don't need to show them.

We know it's not easy to educate every last employee about every last policy, especially at an enormous company like Walmart. But those policies don't mean much if the people who have to follow them haven't read them. Which segues nicely into ...

Photo: Walmart, Flickr.com

Retail employees also need to be informed about the products they're selling, so that they can give accurate advice to shoppers.

That means if you're buying a TV, you have the right to an employee who can tell you the difference between plasma and LED. If you're buying a bra, you have the right to a saleswoman who can properly fit you. If you're buying a computer, you have the right to a salesperson who can tell you whether or not you really need to pay for an antivirus program.

Having smart salespeople makes good business sense for retailers -- Best Buy (BBY), for instance, has realized that well-informed customer service is one of the few advantages it can wield over online competitors. But it's also a matter of consumer rights: If you're misled into buying the wrong TV, bra or software product and then find that you can't return it, that's money out of your pocket.

"Is there anything I can help you find?" is no longer the only question you're asked at a retail store. Store associates and cashiers may ask you to sign up for store credit cards and rewards programs; upon checkout, they might also ask for your zip code and email address.

Of course, you have every right to say no to these questions. But sometimes they won't take no for an answer -- I have dealt with pushy associates eager to get commissions on credit card applications, as well as cashiers insisting that I reveal my email address.

But giving them your email address invariably means getting marketing emails, and your zip code can be used to locate you and send you catalogs. Meanwhile applying for a store credit card can temporarily lower your credit score. Shoppers should be notified of the downsides involved with saying "yes" to any of these questions. And salespeople shouldn't be allowed to pressure you after you've said "no."
You're legally entitled to the price on the price tag. But there are still plenty of shenanigans happening in the background.

One trick: Creating the illusion of a discount by touting a high "original price" next to the ticket price. Kohl's (KSS) is dealing with a lawsuit claiming that it misled customers in this way, while J.C. Penney (JCP) was recently accused of fabricating prices to make its discounts look better.
And while we're at it, let's keep barcodes honest, too. Some retailers have dealt with barcode-scanning shoppers by covering the barcode on the box with one of their own creation; the custom code will confuse any price-comparison app. Retailers don't have to tell you all about the lower price you can get from a competitor, but they shouldn't actively hinder you from making an informed purchase.

There are a lot of things we wish retailers would do better. We hate having to wait in long lines at checkout, for instance. We hate that every retailer has its own return policy to pore through, with various exclusions and time limits. And we wish retailers didn't feel the need to hand us a mile-long receipt covered in promotions and surveys when we're just buying a pack of gum.

We left those grievances out of our proposed bill of rights, because this isn't meant to be a shopping wish list -- the focus here is on basic standards of fairness and honesty that will protect the shopper.

Still, we may have missed a few. If there are certain rights that you feel every shopper should be guaranteed, we'd love to hear about it. Give us a shout in the comments or send an email to Matt.Brownell@teamaol.com.

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