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6 Jan

The Paradox of Extended Warranty

Are extended warranties a good business decision? A good purchase decision?

Let's think about this from first principles.

From the business' perspective:

Extended warranties virtually cost the company nothing to market or sell. They're just additional cash flow. And the service they're promising often doesn't need to be delivered at all for the majority of purchases!

Because the products they insure rarely need repairs. So, it's almost just pure cash adding to the business' bottom line.

From the buyer's perspective:

What does an extended warranty offer?

If you think about it, it's not very different from what term insurance offers — which is peace of mind. And in the case of tech products nowadays, barring a few exceptions, you can't repair most components and the entire device needs to be replaced if something goes wrong.

So, the warranty coverage really helps you in case you need an expensive repair. But the odds of a product breaking down during a typical extended warranty period are quite low.

But then, as biological creatures who care about survival and self-preservation, we are attuned to something called "risk of ruin"protecting against ruinous states that you can't recover from.

Death is a ruin state. You can't come back from death.

Going broke while investing is a ruin state. You can't invest again.

Your expensive Macbook dying on you is a ruin state.

So, we are naturally careful and pay more for avoiding ruin. In fact, think about why people put bulky cases on their expensive smartphones, even though most of them really take away from the aesthetics of the device — aesthetics you paid extra money for. Because it's cheaper and easier to replace a broken cover or a scratched screen protector than it is to replace a broken phone. 

And this isn't some intellectual decision either; most of us get the wisdom behind it quite naturally, even though we may not articulate the exact reasons for our behavior.

Another factor is the reversibility of any decision.

For example, the decision of adding salt to food. Erring on the side of little salt while cooking is always better than erring on the side of more. Because you can always add more salt but you cannot remove extra salt.

Another example would be quoting your expected salary while getting a job offer. It's better to quote a higher salary and not get it than quote a lower CTC and get it. Because you can always negotiate down from an already inflated number, but you cannot negotiate up from a lower number that you yourself offered.

So, some errors are better than others. What defines better here involves having a good imagination of ruin states and how likely they are, and secondly, how reversible a decision is when you are working in uncertainty.

Nevertheless, extended warranties do look like a fascinating paradox at first glance.

On the one hand, it's almost giving away free money to the business. Because the business is by default incentivized to make products that do not fail under the extended warranty period.

And statistically speaking, the chances of you capitalizing on your extended warranty coverage are quite low. But at the same time, it's still a pretty good decision for securing yourself against surprise failures!

This a great example of how we will pay a huge premium for security.

Perhaps, even education, degrees, and institutional labels are products like that.

Think about it.

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