There is a significant difference in price between a water heater with a 5-year manufacturer’s warranty and one warranted for 10 years. A couple of years ago I pondered why this is so. What is the difference between the two products?
So we did a little “reverse engineering” and spent a day taking apart a 5-year and a 10-year heater. First, we weighed the two products on the industrial scale, and found they weight exactly the same, to the pound.
Then I had my crew take the units apart screw by screw, nut by nut, panel by panel, doing exactly the same procedure in the same order with each heater. At every step we compared the parts removed and the remaining assemblies. Each time we found exactly the same components. When we finished stripping the heaters to irreducible parts, we could find one difference between the two products – the decal! One product was warranted for five years, the other 10.
Insurance Biz: What does this mean? It means simply that this particular manufacturer was not only in the water heater business, but the insurance business as well.
A warranty is nothing but an insurance policy. In each case the provider agrees to cover the costs related to specified events over a specified time period in return for a small payment from each party covered. In the business, the warranty premium usually is built into the price of the product, although in the water heater example, the difference in price between the 5- and 10-year models can be considered “premium” for warranty coverage for that extra 5-year period.
The key to making money in the insurance-warranty business is making sure that the cumulative premium payments add up to more than the pay-outs to cover the obligations. Insurance people rely on the laws of probability, expressed via actuarial tables, to make sure their income is greater than their pay-outs. If they do their math correctly and charge high enough premiums, they are virtually guaranteed to make money.
Contractor Opportunity: Do not think for a moment that I am criticizing the water heater manufacturer. I admire their cleverness. I merely wish to point out to my fellow contractors that you have the same opportunity to earn money in the insurance business, and I think you should take advantage of it.
Anyone can offer extended warranties on selected products. Take that water heater with a 10-year warranty. By charging an additional premium, a contractor could guarantee the unit for an additional 10 years, for a total of 20. The manufacturer would reimburse the contractor if something went wrong during the first 10 years of coverage, while the contractor would have to absorb any cost of replacement for the next 10.
But why stop there? Let’s take the concept of extended warranties to the ultimate by asking whether it might be profitable to offer lifetime warranties of certain selected products.
Lifetime Warranties: Wouldn’t this obligate you to do some expensive repairs free of charge when one of the units malfunctions? Yes it would, and you would be compelled to fulfill your end of the bargain.
However, the object is to build up a sizeable monetary reserve from sales of these warranty policies that is more than enough to cover the cost of warranty service calls. Again, this is how the insurance business operates.
For example, if, God forbid, your house burns down, it’s almost certain your home insurer will lose money on your policy, because odds are you haven’t paid nearly enough in insurance premiums to cover that large of an expenditure. However, he counts on the fact that reserves built up from many other fire insurance clients, whose homes don’t burn down, will amount to more than the total cost of claims.
Of course, given enough time, all merchandise fails. Under a lifetime warranty, aren’t you leaving yourself vulnerable to more obligations than you reasonably might be able to cover years down the road?
Not if you do you homework and apply the relevant actuarial data to your warranty terms. For instance, real estate actuarial tables show that the average home owner moves every seven years, though this varies in different parts of the country. The key is to write the warranty like an insurance policy, which is not transferable by the policy holder. So if the home owner moves away, the contract is voided. The new owners must purchase their own coverage.Thus, a “lifetime” warranty really extends only seven years, on average. An extended warranty also would be voided if the building owner installs a new unit or parts purchased from anyone except the firm that issues the warranty.
This is not just a theory I concocted, my friends. Various PHC contractors in different parts of the country have successful extended warranty programs covering water heaters, relief valves and other products. With so many other of our competitive edges being eroded, extended warranties represent an area of sorely needed potential business growth.