Design of Extended Warranties in Supply Chains

Abstract

Consider a supply chain involving an independent retailer and an independent manufacturer. The manufacturer produces a single product and sells it exclusively through the retailer. Using this supply chain framework, we develop a game theoretic model to study two commonly observed practices of selling extended warranties: the manufacturer offers the extended warranty directly to the end consumer, and the retailer selling the product offers extended warranty. We show that, of the two decentralized systems, when the retailer offers an extended warranty, it is for a longer duration and generates more system profit. We compare and contrast the two decentralized models with a centralized system where a single party manufactures the product, sells to the consumer and offers the extended warranty. We identify the different causes of inefficiencies in each of the two decentralized models and propose coordination mechanisms that eliminate the inefficiencies. We also provide contracts to achieve both coordination and a Pareto improvement over a wholesale price contract.

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