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.