The purpose of this assignment is to let you explore the connectedness between mathematics pricing models and quality calculations. The “warranty” case is only one example. This particular example would come under the heading of “reliability.”
Questions: What price should I charge for the 2-year, 3-year, and 4-year warranties? What expected profit will I earn on each warranty sold?
I own a consumer electronics store called Foocher Shop. Like my competitors, I offer an extended warranty on most products I sell. If you were to buy the 55 inch Samsung Widescreen LED Smart TV on sale now for $1199.99 plus tax, for example, I would offer to let you pay an additional $249.99 plus tax to get your product with a 4-year warranty. (Of course, the product already comes with a 1- year manufacturer’s warranty, so my risk in selling you a warranty is really only for the 2nd, 3rd, and 4th years).
I want you to help me price the warranty offerings for a new item that I am about to sell. It’s the newest version of the Sony 7 camera, which I will sell for $1999.99. I will sell 2-year, 3-year, and 4-year warranties for this camera.
All nine of these factors should influence your calculation:
1. If the camera breaks in the first 13 months, then I will replace it for the customer, and subsequently I will attempt to get a credit back from the manufacturer under the “1 year manufacturer’s warranty.” I estimate a $25 cost to myself each time I process these claims, and that’s assuming that I get manufacturer credit. If the manufacturer doesn’t pay me back for the camera, then I will suffer an additional cost of $850.00 (the wholesale cost of the camera). The manufacturer doesn’t always play fair, and I suffer that additional cost in 1 out of every 20 claims.
2. If the camera breaks in the following years, then the entire cost is mine: $850, plus the $25 cost of processing the claim.
3. The camera’s life expectancy can be modeled by an Exponential distribution, with mean = 19.5 years.
4. Even if the camera does break under warranty, the customer might not claim the warranty. 8% of all covered breaks go unclaimed.
5. When a customer chooses to buy a warranty, I have to do a little paperwork. I estimate the cost of that paperwork at $3.00.
6. When a customer buys a warranty, the salesperson gets paid a commission. The salesperson gets 10% of the warranty price.
7. The Marketing department tells me that all warranty prices must end in ‘9.99’ . I don’t know why, but there it is. $9.99, $19.99, etc. I can’t offer the warranty for $23.72, or any other non-9.99 price.
8. At least 30% of the warranty price should be profit on my bottom line.
9. You can ignore the time value of money. (The accounting department will hold aside reserves in an investment escrow.)
NOTE: The pricing model offered in this assignment is a simplified version of the actual model used by many firms. As the student, you should notice that I have removed an important element from the model: customer demand. An improved model would project sales and revenue as a function of price. I have ignored that aspect in this assignment.