You want a DVD player, but the selection is bewildering. More often than not, consumers use warranties to help them choose products: a long warranty may signal the manufacturers confidence in its product, while a short one might signal a hope that the warranty fails before the product does.
Once youve found your dream machine, theres still sales staff, often pushing extended warranties. Why? Its all part of screening, a strategy in which manufacturers offer a price/warranty menu and buyers choose their preferred combination. Extra protection might not be necessary, but it is surely profitableretailers can make as much as 75% of their gross income from extended warranty sales.
In this recent working paper, David A. Soberman, Assistant Professor of Marketing, INSEAD, examines what happens when warranties signal and screen simultaneously. He asks how signalling affects the sellers ability to screen and how information about quality is conveyed to the buyer. If a warranty both signals and screens, what are the implications for the selling process?
His model focuses on a situation in which a monopolistic seller offers a product and an optional extended warranty to a varied market with two types of buyers. The products quality is unobservable by consumers and the different buyer types are unobservable for the sellers. Thus the seller must use warranties to signal quality and also to screen buyers.
The findings indicate that signalling can limit the sellers ability to screen, particularly when buyers are willing pay significantly more for higher quality products. Thus, to signal the seller generally lengthens base warranties and shortens the optional coverage, making the options for each type of buyer more similar.
For empirical data, this model is applied to the Toronto used car market. Fieldwork suggests that used car sellers are well aware of how warranty policy can be used to simultaneously signal and screen.
The insights provided by the model may well extend beyond warranties. After all, warranties arent the only situation in which buyers seek a measurable product whose quality is variable and difficult to evaluate in advance. It would be fruitful, concludes the author, to examine simultaneous signalling and screening in a broader context across several markets, such as service contracts or health insurance.