November 29, 2006

Extended Warranties:

Consumer Reports took their best shot. Now the industry has responded, citing the value, price, convenience and savings of time and money as some of the benefits of enhanced service plans.

The effects continue to be felt more than two weeks after the publication of a Consumer Reports special report entitled, "Why you don't need an extended warranty." In the past two weeks, more than 160 different newspapers have run stories about the special report's findings.

Some said it was timed to steal Christmas away from retailers, reducing a complex topic into an easily-remembered "just say no" slogan. Others said consumers are already able to tell the difference between fairly-priced and overpriced extended warranties, and they don't need a magazine's help.

Industry Response

On November 20, the Service Contract Industry Council posted its own full-page ad on page 7A of USA Today, which we've reproduced in shrunken form below. The SCIC also modified its mission statement to extol the benefits of extended warranties. Tim Meenan, the SCIC's general counsel, and the lead person in many of its lobbying efforts, wrote letters to the editors of both the Los Angeles Times and the New York Times. We were told the LA Times letter ran on Nov. 26 under the title of "Expensive purchases warrant protection," but as with most of the newspaper's archives, that content is now available only to registered members.

The SCIC's full-page ad

Click on the image above to see the full-size ad

High Repair Rates

The SCIC made mention in its ad of the repair rate statistics used by the Consumer Reports National Research Center to make its case two weeks ago. In the copy below the snowflakes, the SCIC's ad pointed out that 23 out of the 25 product types on the CR list, which we've spliced into our Nov. 21 article, had double-digit failure rates in their third or fourth years.

Fred Schaufeld, chairman of NEW Customer Service Companies Inc., and one of the co-founders of the SCIC, posted an open letter, a list of service plan benefits, and a page full of notable statistics (a sample: NEW paid $500 million in claims last year).

Schaufeld also took a shot at the magazine's repair rate numbers. His open letter noted that Consumer Reports found some fairly high repair rates for refrigerators with icemakers (37% for side-by-side with icemaker and dispenser, and 20% for top- and bottom-freezer, with an icemaker). "A customer can purchase an NEW service plan for a side-by-side refrigerator for as little as $49," he wrote. "According to this consumer advocacy group, an average repair on that same side-by-side refrigerator will cost $150 -� that�s three times the price of the service plan."

High Repair Costs

Robert Miller, the vice president of marketing at NEW, said he took a closer look at the Consumer Reports repair data, and found some of the figures to be as much as 50% lower than his own internal data. For instance, he looked at the CR statistics for repairs of refrigerators (the two configurations cited above plus a 12% figure for units with no icemaker), and said he found all three to be understated.

"Based on our data, we believe failure rates are a lot higher than Consumer Reports is publishing," he said. And he said that's not just for refrigerators, but also for such items as laptops. Miller said he also found that in 12 different categories, service plans almost always cost less than a single repair.

Miller said he asked some of NEW's service partners for typical repair price quotes -- basically asking them what would they charge a consumer who picked their name out of a phone book. He also asked some major retailers for the price of their shortest service plan for each of the 12 product types. In almost every case, the service plan would cost less than a single repair (with the exception of a lawn tractor, for which the high-priced service plan was $45 above the quoted repair price).

Typical Repair Rates and Service Plan Prices
for 12 Types of Consumer Products

  Product  Consumer Repair 
Price Quote
  Service Plan  
Price Range
  Laptop computer $325 $69 - $200
  Refrigerator: side-by-side, with
    icemaker and dispenser
$255 $50 - $200
  Lawn tractor $255 $130 - $300
  Desktop computer $275 $60 - $160
  Washing machine (front loading) $300 $50 - $130
  Self-propelled mower $125 $40 - $70
  Vacuum cleaner (canister) $70 $30 - $52.50
  Washing machine (top-loading) $200 $50 - $130
  Dishwasher $185 $50 - $130
  Refrigerator: top- and bottom-
    freezer, with icemaker
$225 $50 - $120
  Gas range $225 $50 - $80
  Plasma TV $650 $200 - $400
Source: NEW Customer Service Companies Inc.

One of the problems with failure rate statistics, however, is they always depend on the population sampled. Consumer Reports gets its data from its own labs and from its own subscribers, who tend to be both more sophisticated and more demanding than the typical consumer. Extended warranty administrators know only what goes on within their customer base, and don't know much about what happens to products that were never covered by extended warranties. Manufacturers typically lose visibility of their customer base after the product warranty expires, unless they team up with an administrator to sell extensions.

Stuff Breaks

Still, no matter who's doing the sampling, all agree that stuff breaks. And if 10% of the units break during the second and third years of ownership and the average cost of repair is $240, then each owner stands a 1-in-10 chance of having to pay $240. If they wanted to pool their risk, all 10 owners could each pay $24 into an insurance policy, or five could pay $48 each, or perhaps the three most risk-averse people could each put $80 into the communal repair fund.

That's a gross oversimplification of the principles of insurance, but basically, those who choose to be part of the fund have sold their risk to the fund's operator. Those who choose to remain outside the fund retain the risk, and will have to pay out of their own pocket if a repair is ever required. But of course, nobody knows in advance which of the 10 cameras will break, or more specifically, whether they have one of the nine that won't break. That's the problem with extended warranties. You don't know if they're worth it until after their term expires.

Until then, you would have to make your best guess based on all the available data. And if you assume that the average cost of repair is $240, and that there's a 1-in-10 chance of a failure, then clearly a $480 extended warranty is terribly overpriced. But what if the warranty is instead priced at $80 or $90? And what if that's less than the sales tax? It would be very difficult to call that a bad deal.

In the October 24 issue of Warranty Week, we took a look at the price of a Canon EOS 30D camera and its associated extended warranty prices. Of the 41 camera dealers surveyed, we found 12 selling a service contract for less than 10% of the camera's price, including six whose plans were administered by Mack Camera & Video Service Inc. Norman Camera & Video was selling the camera for $1499 and the Mack warranty for an additional $79. 17th Street Photo had the same camera for sale for $1275 and the warranty for $80. PC Nation wanted $1269 for the 30D plus $80 for the three-year extended warranty. B&H Photo had the camera for $1260 and the warranty for $80. Beach Camera wanted $1203 for the camera and $90 for the warranty. also had the camera and warranty at $1203 and $90.

Good Service at Reasonable Rates

Mel Kevoe, president of Mack Camera, said he doesn't want to overcharge his customers. "You want to give a fair price to the consumer so they can get good service at reasonable rates," he said, "and not try to gouge them." He added that consumers also can choose to buy the camera now and defer making a decision about the extended warranty for up to 30 days afterwards, so there's no pressure to buy it right away.

While they're thinking about it, they can go home and research the warranty's terms and conditions on Mack's own Web site. So there's also no pressure to buy before they fully understand what they're getting. And, if they buy the three-year plan, it will run for the full three years, even if there are multiple claims or a replacement during that period.

Barry Warner, Mack's national sales manager, said it's his job to check up on the dealers to see what they're charging for the Mack warranties. "And if they're charging too much, I will notify them," he said. "It's our reputation that's at stake."

Kevoe said it's still profitable, even at current prices. Lately, in fact, the 68-year-old repair company has begun to emphasize the extended warranty business even more. "We also sell to police departments and school systems, and we have a small retail operation," Kevoe said. "But most of our business is geared to the warranty part of it, because it is very profitable." The secret, he noted, is that Mack does its own repairs, and can therefore control its own costs. And, he added, most of his customers are small camera dealers not unlike Mack itself.

Department Store Prices

Even the big department stores, however, aren't exactly gouging their customers. On that same Canon 30D camera, Target sells three-year, $79 extended warranties administered by the Warranty Corporation of America. Wal-Mart also sells $79 contracts, administered by NEW, that run for two years after the manufacturer's warranty expires. Best Buy sells an AIG-administered four-year plan that's priced at $150 for that camera. The cost of each is 10% or less of the camera's price.

Steve Gusa, director of the Performance Service Plan Business Group at Best Buy Co. Inc., said that in this era of Google and blogs, people don't need to rely as much on printed research. Take, for instance, your typical MP3 player. By now they know all about the battery issues, the potential for screen damage, and the limited warranties. And they know what to do: buy an extended warranty that includes battery coverage.

The complexity of other digital products also has an impact on the customer experience, he said. For instance, he noted that Best Buy now sells some mobile phones that include multiple functions such as digital cameras, digital music players, and Internet access with email and Web browsing. In these kinds of products, a component might be improperly installed, or the firmware might not function correctly. Technically, it's not broke, but from the customer's perspective, it doesn't work.

With a notebook computer, the buyer has to think about the lifespan of the battery and the cost of its replacement. With projection TVs, consumers have to face the very real possibility that the lamp will burn out, and will cost hundreds of dollars to replace. With large appliances, consumers have to think about the cost of a single out-of-warranty house call. And so on and so forth.

Cost of Repair

But Gusa suggested that it's probably not a good idea to evaluate the price of an extended warranty simply as a percentage of the covered product's price, because that doesn't take into account the actual cost of repair or the term of coverage. In other words, it might cost just as much to fix a low-priced model as it does to fix a high-priced model.

"For digital cameras as an example, the labor cost to fix the unit would be consistent," he said, regardless of whether it's a hundred-dollar camera or a thousand-dollar camera. The variable is parts cost. "For most products, the process of troubleshooting doesn't vary from unit to unit as much as the parts cost. The expense of the unit doesn't determine the difference."

Therefore, it might very well cost as much to fix an inexpensive unit as it does to fix an expensive unit. But as a percentage of purchase price, the true cost of repair might be 90% of the inexpensive unit's selling price and only 10% of the expensive unit's price.

"Proportionately, it probably costs more to fix inexpensive products than it does to fix more expensive items," he said.

Also, Gusa noted that there is likely to be a qualitative difference in the low- and high-priced extended warranties. For instance, some of the lowest-priced offerings may not take effect until after the manufacturer's warranty expires. The administrator may help the consumer find out how to contact the manufacturer, but the retailer will not accept the unit or arrange for a pick-up.

In contrast, Best Buy will accept the unit from the consumer in person and then will figure out whether the claim falls under the manufacturer's or the administrator's warranty. Best Buy will pay for the shipping and will take responsibility for the unit until it's handed back to the consumer.

"If you don't have the same infrastructure, you don't have the same cost," he said. "Full service makes a difference as far as pricing."

Gusa added that Best Buy has a "no lemon" policy that allows for three repair attempts and then a replacement. If the extended warranty didn't begin until after the manufacturer's warranty ended, this could mean that repair attempts made by the manufacturer didn't count. But since Best Buy is the middleman in either case, it counts all repair attempts from the time of purchase.

Create Connectivity

Extended warranties, he said, provide an opportunity to "create connectivity" with the customer for three or four years after their initial purchase. "And we know that when our customer needs us and we can take care of them, they will better connect with us and our brand," he said. "This provision is important to the long-term health of our business because it keeps our customers happy and connected to us."

Gusa said that Best Buy has in recent years tried to enhance its after-the-sale offerings -- to become a place to bring products for service and support, to ask questions, or get help with an installation.

"The consumer wants a higher degree of service, and in today's marketplace, we're just responding to what our consumers say they expect from us," he said. That goes not only for the availability of a place to drop off items for repair, but also for the house calls performed by the Geek Squad. "Customers want us to deal with them on their terms."

Gusa said he thinks consumers are becoming more demanding, not just in terms of repair, but in terms of service in general. "Customers want to know that they're important, and they want to be able to talk to someone when they have a problem," he said. "Geek Squad is more than just repair. It's about software updates, firmware updates, virus protection, spyware protection, security, and general PC health. It's about a range of service and support options. It isn't just about fix."

Convenience & Value

Dan Tafel, general manager of national sales at Service Net Solutions LLC, said he sees two primary benefits coming from service plans: convenience and value. The convenience comes from knowing who to call when something breaks. The value comes from additional coverages, such as accidental damage protection, and enhanced service levels, such as in-home repairs.

"Anyone who's cracked the Yellow Pages and tried to find the right service provider to come out to your home at the right time has experienced a nightmare," Tafel said. In contrast, repairs sought under an extended service plan would begin after a call to a toll-free telephone number. The appeal is somewhat akin to what drives membership in the AAA. Anywhere your car breaks down, you know you can get a tow truck with one phone call. In cases involving major appliances, it's probable that the plan administrator will be able to arrange a service appointment during that initial call.

For home theater systems, an extended warranty can help the consumer avoid the inevitable finger-pointing that could result when multiple companies are involved. "Trust me, if you call up about the TV, they're going to blame it on the electrician," Tafel said. "He's going to blame it on the people who put in the speakers, or wired the receiver. That is an absolute nightmare. People want one number to call, just to get it fixed. They don't want to spend eight hours of their time scheduling different service providers, or taking the system apart so they can bring the digital receiver over to Dish TV so they can repair it."

Even with small and standalone products, extended warranties can be an added convenience. Tafel said that Service Net sells digital camera service plans that allow for next-day replacements, even while the client is on vacation. They could call it in, and the replacement unit would arrive at their hotel via Federal Express.

"It's convenience and enhanced value," Tafel said. "What Consumer Reports is not calculating is the convenience and enhanced value. They simply calculate what a service repair costs, and how often it breaks." They're not counting wasted time or lost usage. So in that respect, time isn't money in their cost-benefit analysis.

Enhanced Warranties

Tafel also noted the benefits of several service plan enhancements that have appeared in recent years. For instance, neither manufacturer's warranties nor extended warranties usually cover accidental spills or drops. But extended warranties featuring accidental damage protection are now available in many states, although insurance regulations vary widely. Where ADP is sold, however, an extended warranty would cover a latte in the keyboard or a digital camera falling into the ocean. And so, for the clumsy and the accident-prone, an extended warranty with ADP could prove to be quite valuable.

With mobile phones, handheld computers, digital music players and laptops, there's also the issue of the data within. What happens to all your personal data if the unit is deemed unrepairable? What if the failure is in the disk drive itself? A replacement doesn't get you back your data. And let's face it, nobody backs up their data like they're supposed to do. But a data recovery option as part of an extended warranty might prove to be extremely valuable.

Tafel said he sees data recovery services as another part of the enhanced value of an extended warranty -- aspects that consumers are coming to appreciate more after they lose a disk or two. "Whether it be a laptop or an iPod," he said, "and whether the value is in a replacement plan on the product, in accidental damage protection on the product, or in data protection on the product, there is consumer demand for enhanced value."

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