Optimal Warranty Length and Selling Price to Maximize the Profit

Abstract

This study focuses on the problem of determining the optimal coverage period and selling price of warranted products from the manufacturer’s perspective. We first consider how to maximize the profit per unit under the assumption that the product can be sold or the demand is independent of the warranty policy. Then we try to maximize the total profit for a planning period for the case where the demand for the product depends on the warranty coverage period and selling price. Since the warranty period and the selling price should be positively correlated, we first solve the profit maximization problem with the warranty depended demand under the constraint that the selling price is a linear function of the warranty coverage period (warranty based pricing). Furthermore, we investigate the case when such a constraint is removed (non-warranty-based pricing). Optimizing on two independent decision variables, the coverage period and the selling price, certainly improves the total profit. Under the two variable optimal conditions, it is observed that while the positive relationship between the optimal coverage period and the optimal price is confirmed, it is more complex than a linear one. We also find that the profit advantage for the non-warranty-based pricing over the warranty-based pricing is more significant for shorter coverage period. However, when the coverage period exceeds a threshold value, such a profit advantage becomes insignificant. The results of this study provide practitioners with useful insights in designing the profit optimal product warranty in highly competitive market.