Extended warranties are mechanisms for price adjustments during recessions

If you have ever walked into a big-box store to buy a new refrigerator or television, you have likely been met with the familiar question: "Would you like to add the extended warranty?"

While many shoppers see these as a nuisance or a high-pressure sales tactic, new research co-authored by Barry Scholnick, Eldon Foote Chair in International Business at the Alberta School of Business reveals that these "add-ons" are actually a hidden source of savings for consumers during tough economic times.

The study, published in the journal International Economic Review, found that while the sticker prices of major appliances and electronics rarely change during a recession, the cost of their extended warranties experiences a sharp decline. This "hidden" discount allows stores to lower the total cost of a purchase to close a deal without ever marking down the price of the fridge or TV itself.

"Local stores use discounts on extended warranties to make consumers less price-sensitive and boost durable-goods sales," says Scholnick.

The power of the salesperson

By analyzing 10 years of data from a major Canadian retailer — spanning over six million purchases — the researchers discovered a pattern they call "procyclical add-on pricing", where prices are reduced as the economy declines.

Unlike the price of the actual product, which is often set at a corporate headquarters, warranty prices are frequently decentralized. This gives local store managers and sales staff the discretion to "throw in" a warranty at a steep discount to convince a hesitant shopper to buy. During the Great Recession, these discounts became so aggressive that many warranties were effectively given away to keep sales moving.

A blind spot for inflation

The research also highlights a significant gap in how we measure the cost of living. Because official inflation figures, like the Consumer Price Index (CPI), primarily track advertised sticker prices, they often miss these unadvertised discounts at the checkout counter.

“We estimate that about 37 per cent of items in the Canadian consumer basket have 'add-on potential' meaning the real cost of living during a recession might be lower than official government stats suggest.”

— Barry Scholnick

Key takeaways

• Warranties are price "levers": While the price of a "base good" like a washing machine stays steady, retailers use the warranty price to adjust the total cost of the transaction based on the state of the business cycle (e.g. recessions).
  
  
• Recessions drive "hidden" savings: During economic downturns, consumers are more likely to get a free or discounted warranty as sales staff work harder to secure a sale.
  
  
• The CPI misses the full picture: Official inflation reports may overestimate costs because they do not account for unadvertised discounts on add-ons, which are prevalent in about 37 per cent of consumer goods.
  
  
• Negotiation happens at the local level: Because warranty prices are rarely advertised and often left to the discretion of the local store, there is more room for consumers to negotiate these costs than the price of the product itself.

Read the full article in International Economic Review at DOI:10.1111/iere.12710.

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