Product Reliability and Extended Warranty in Supply Chains

Problem definition: We study firms’ reliability and extended warranty (EW) pricing decisions in different supply chain structures. We also consider the product reliability information may or may not be observable by the consumers. Academic/Practical Relevance: This paper contributes to the academic literature by investigating reliability and EW decisions jointly in different supply chains. The results can help practitioners make better reliability and EW decisions, determine how to manage product and EW supply chains, and understand the importance of credibly disclosing reliability information to consumers. Methodology: We use a game-theoretic model to analyze three supply chain models: a centralized supply chain in which the manufacturer sells a product and an optional EW directly to consumers (Model C), and two decentralized models in which the product and EW are sold through a retailer with the EW offered by the manufacturer (Model M) or a third-party insurer (Model I). We also study cases in which consumers cannot observe how reliable the product is and investigate the impact of unobservable quality. Results: We find that the product reliability decision depends on the supply chain structure. On the profit side, the retailer prefers selling EWs offered by a third-party insurer when consumers can observe product reliability but prefers sourcing EWs from a manufacturer when product reliability is unobservable to consumers. We also find that making reliability observable to consumers benefits all parties involved except for the third-party insurer. Managerial Implications: This study offers guidelines on how firms should determine their product reliability and EW prices in different supply chains. In addition, the analysis sheds light on where a retailer should source EWs based on whether the product reliability is observable to consumers or not. Finally, our results highlight the importance of credibly disclosing product reliability information.