Is an extended warranty worth the price?

Home Office Computing, Nov, 1992 by Cliff Roth

When You Need One, and When You Don't

There you stand in the electronics store. You've just committed yourself to spending hundreds--perhaps thousands--of dollars on some shiny new computer system, fax machine, printer, or other piece of high-tech gear. You're thinking about the investment as you open your wallet. You're vulnerable. And then comes the inevitable pitch: "How about an extended warranty?" the salesperson asks. Suddenly, all the insecurities you had when making this purchase decision hit you like a brick. Isn't it reliable? Doesn't it have its own warranty? How often do these things break?

Extended warranties are among the most profitable things an electronics store sells. They're often pure profit. Some discount-electronics stores sell products at close to cost, because they know a good proportion of customers can be persuaded to buy an extended warranty.

When evaluating salespeople, many store owners care more about the total of extended warranties sold than about the total number of units sold.

FOLLOW THE MONEY

Legally speaking, most of the plans that are commonly called extended warranties are actually service contracts. A warranty is a statement by the manufacturer that its product is free of defects, as specified. A service contract is a separately purchased insurance plan that covers the cost of repairs after the manufacturer's warranty expires. A service contract can provide for reimbursement of an independent repair facility, or it can stipulate that repairs be done by the manufacturer or by the store's own service department.

You don't have to be an actuarial genius to figure out how outrageously overpriced most service contracts are. In general, 5 to 15 percent of all electronic equipment will need repair in a three-year period. Consumer Reports magazine publishes detailed frequency-of-repair comparisons for many products. Its most recent published surveys don't cover computer equipment, but they do show that about 6 percent of CD players, 4 percent of 13-inch color televisions, and about 15 percent of VCRs need repair within three years.

Let's say the likelihood that a particular piece of equipment will need repair in three years is 10 percent. Let's estimate that this $1,000 piece of equipment (a computer or laser printer) might typically require a $200 repair when it breaks. If there's a 10 percent chance you'll need a $200 repair on a $1,000 piece of equipment, then the real cost of insurance for three years should be around $20. That's 2 percent of the equipment price.

Indeed, at 2 or 3 percent of the equipment price, a three-year service contract would be a very good deal. But a typical three-year service contract costs more than 15 percent of the purchase price, and service contracts costing as much as 33 percent or more of the purchase price are not uncommon.

WHAT PRICE SERVICE?

I recently purchased an Iomega Bernoulli removable-hard-disk-drive system at J & R Music World, a discount computer store in New York, for $500. The system came with a one-year warranty on the hard-disk drive and a five-year warranty on the removable disk drive. The store itself made no attempt to sell me an extended warranty, but as soon as I opened the box I found an offer from the manufacturer encouraging me to buy one of three service contracts.

"Silver Service," the cheapest type, costs $90 for the second year (after the one-year warranty expires) and $80 for each additional year. For three years of covered repair service (extending the warranty by two years, that is) I'd have to pay $170 -- that's 34 percent of what the system cost. And a full three-year extension. bringing the total warranty period up to four years, would cost $250-50 percent of the price!

This arithmetic glosses over the fact that the disk itself already has a five-year warranty. If you subtract the retail price of the disk--about $140--from the original purchase price, then the real cost of the extended warranty works out to be 47 percent for a two-year extension and 69 percent for a three-year extension.

And that's just for the cheapest contract. Iomega's "Gold Service" provides overnight replacement of defective products and costs $110 for the second year and $100 for each additional year. For less than the cost of five years of "Gold Service," you could purchase a second system, put it on a shelf, and keep it ready for action in case the first drive breaks. (The top-shelf "Platinum Service" adds data recovery, for about $200 a year. But that goes beyond ordinary repairs.)

In fairness to Iomega, I should point out that the $500 street price reflected a hefty discount off list, and that their prices are being used here purely as an example.

WATCH OUT FOR WEIGHTLESS WARRANTIES

Unlike the insurance industry, the service-contract industry is mostly unregulated. A service-contract company can legally charge consumers 10, 20, or 100 times the actual repair cost to cover all its contracts. Prices are determined by the market.

Some retailers write their own service contracts. When the Crazy Eddie chain of discount-electronics stores went out of business in the late 1980s, some two million former customers were stuck with worthless contracts. Home America, of Phoenix, also made thousands of service contracts worthless when it went out of business.