Selling extended after-sales service warranty: The impact on channel cooperation and consumer surplus

Offering consumers the option of buying extended warranties when selling durable consumer goods is a relatively new practice in Chinese industry. In this paper, we try to explore this practice in a setting where a manufacturer sells a kind of product via a retailer, the channel members try to optimize their long run average profit, and consumers take warranty length as a signal of the product quality. Both consumers´ reservation price and product quality are known by the retailer in terms of prior distribution. Through modeling, we find that, channel members under traditional selling, no matter in centralized or decentralized case, do offer longer warranty and higher price for products with higher quality. Under the new practice, the warranty length for a customer increases with product quality, but the price decreases with product quality. Besides, we can see that consumer surplus decreases with the product quality under traditional selling at least in the centralized operation, but it increases with product quality under the new practice. What´s more, to solve the double information asymmetry problem in decentralized cooperation, we propose a nested menu to model the decision process.