I can remember the old days, the simple days when buying a consumer electronics product or appliance meant that you’d get to the cash register and their big question was “how do you want to pay for that?” Not any more, though: the big question of the twenty-first century is “did you want to buy an extended service warranty with that?”
You’ve heard it too. In fact, you can even buy extended service warrantees here on line. Just Google “extended warranty” and be prepared for thousands of questionable sites pushing various bad deals. Because, don’t be confused about it, in almost every single case, extended service warranties are a very bad deal for the consumer.
But for the corporation, they’re manna from heaven, a windfall of profits that can even be woven into corporate spreadsheets to make the entire business more profitable.
Two of the biggest companies in this space are Best Buy and Circuit City.For the 2003-2004 fiscal year, Best Buy generated staggering profit margins on contracts of 60%, and Circuit City had a profit margin of over 50%.
But the numbers don’t stop there. According to an article in BusinessWeek from a few months ago, Best Buy calculated that extended-service contracts account for a whopping 45% of their operating profits (amazing, given that the contracts only represent 4% of their overall sales). That number pales beside Circuit City, where 100% of their operating profits were produced by extended-service contracts.
Without extended service warranties, Circuit City would have reported a loss, rather than a profit, for the fiscal 2003-2004 year. In that period extended-service contracts were worth $326 million in sales.
Here’s how these warranties work: Say you splurge and buy a $3000 flat-panel TV. The extended service contract would cost an additional $400, of which Best Buy pays out $160 to the third-party insurer, keeping the additional $240 as pure profit. Nice! Especially when you consider that in the highly competitive, highly commoditized consumer electronic business, their actual profit on the sale of the TV might be as low as $100.
But then again, go into Best Buy and pick up a cheapo Magnavox DVD player for $39.99 and you’ll find that the four-year extended service contract will cost you an additional $49.99, more than buying a second unit and storing it in your attic. Or go into CompUSA and buy a $59.99 Netgear router and you’ll find that the extended contract costs $17.99. Not too bad, until you read the small print and find out that Netgear’s already got you covered for the same three years of the CompUSA extended contract. CompUSA 1, you 0.
Retailers often duplicate contracts that you can buy from manufacturers too. Consider this: Toshiba sells an extended service warranty for a Satellite laptop (a $1000 computer) for $199. A similar, though less comprehensive, warranty from CompUSA costs a cool $369.99. Less coverage, more money, more profit for the retailer.
Across the entire business ecosystem, extended service contracts and warranties now account for $15 billion dollars annually. And they’re all set up so that the company selling the contract keeps over half the value of the transaction. That’s $7.5 billion in pure profit. A sweet deal for retailers, no question!
But for consumers, isn’t it a rip-off? Like all insurance, of course, you’re betting against the house, paying in to a system that you hope you’ll never have to get paid back from because of an accident, a health problem, etc. There are some products that analysts think might be worth covering, including laptops and exercise equipment, but most products either fail in their first year, victims of faulty parts (and covered under the original warranty) or work fine for years until parts wear out, at which point the extended service contract has also expired.
As I learned with the extended service contract for my Toyota Prius, if you are convinced that you want to buy the warranty, shop around and find the best price: you have an entire year after purchase to extend the warranty and certainly don’t need to be pressured into it by a salesperson at the point of purchase.
Extended-service contracts are like so much else in our world, another case of buyer beware.