Limiting the consequences of consumer moral hazard under generous warranty plans

Firms often try to communicate the unobservable quality of their products through the use of signals, which are communication devices that are economically attractive only to firms that sell high quality products. Extensive warranties are one such device. A firm selling high-quality products that offers an extensive warranty will likely not suffer adverse economic consequences since the product will not break down and therefore the warranty will not be redeemed. Therefore, extensive warranties can separate firms selling high-quality products from those selling low-quality ones. Unfortunately, the offer of an extensive warranty can sometimes fail to signal quality because consumers may redeem the warranty even though the product performed well. Such consumer moral hazard raises the high-quality firm's cost of signaling to an unacceptable level, and consequently, extensive warranties may fail to signal.; Yet, one frequently sees extensive warranties in several settings that are rife with consumer moral hazard (e.g., clothing from catalog companies, furniture, etc.). How do these firms offer extensive warranties while limiting consumer moral hazard? That question is the focus of this research. It is argued that consumers vary in their ability to engage in warranty redemption based on their (a) opportunity cost of time, and (b)  quality consciousness and on their (c) perception of effort needed to maintain product quality. These differences will impact warranty redemption differently depending on the nature of the product.; The two factors—opportunity cost of time and quality consciousness are crossed in a two factor experiment and replicated at two price levels and for two product types, to examine whether warranty redemption rates vary systematically. Data from these web experiments indicates that warranty redemption behavior is affected by perception of the effort needed to maintain quality. Warranty redemption behavior unrelated to breakdown is affected by all three factors, whereas warranty redemption related to breakdown is most affected by the perception of effort needed and not by the two individual characteristics. Our findings confirm the existence of this form of consumer moral hazard and provide researchers and practitioners with insight into this phenomenon.