Consumer Perception and Willingness to Pay for Extended New Home Warranties

Todd Usher is the owner of Addison Homes and pursuing his PhD at Clemson University. He serves on the boards of Energy and Environmental Building Alliance (EEBA) and the National Association of Home Builders (NAHB). and Joe Burgett, PhD, is an assistant professor at Clemson University’s Construction Science and Management. Dr. Burgett is on the Board of the American Institute of Constructors and a member of the Exam Writing Committee.

INTRODUCTION

Innovation is discussed frequently in business as a way of driving continuous improvement and economic growth. The home building industry has been slower than most industries to undergo disruptive innovations. In the study Characteristics of Innovative Production Home Builders by Koebel and Cavell, the authors explain that industries that are not as dependent on science and technology tend to have extended periods between disruptive innovations and focus primarily on refining existing technologies (2006). Home building is clearly one of these industries and has historically lagged behind other industries in the adoption of innovative change. One example of the lag is the typical warranty period provided with a new home in the United States. At typically one year in duration, new home warranties pale in comparison to the warranties of other durable goods such as automobiles.

There is a perception among home builders that innovation has a greater cost than the status quo without providing a balanced return on investment (Koebel, Papadakis, Hudson, & Cavell 2003). However, most home builders view competitive advantage as a major motivation to innovate (Hassell, Wong, Houser, Knopman, & Bernstein 2003). The outcome of this study may identify opportunities in the home building industry for innovation through new home extended warranties and builder provided preventative maintenance programs leading to competitive advantages for home builders who embrace innovation in this area.

LITERATURE REVIEW

It was not surprising that studies on residential new home warranties are essentially non-existent in the literature. The residential new home industry is fragmented and limited in industry groups undertaking public research and development. The limited literature identified relating specifically to new homes in this area of study included a patent application from 2009 that has not been granted (United States Patent No. US2009/0106135 A1 2009), a 1976 Stanford Law Review analysis of the National Association of Home Builders HOW (Home Owners Warranty) program (Kempner 1976), and an article in the Wisconsin Law Review on implied warranties for new homes from the early 1990’s (Sovern 1993).

However, there is substantial literature on warranties in other industries, specifically the automotive industry in which two-dimensional warranties are common. Two-dimensional warranties incorporate a usage element (typically mileage with automobiles) and a time element. While two-dimensional warranties are not useful for residential homes (there is no way to capture usage of a home), the concepts covered in some of the research could be applicable to new homes. Where relevant, this research has been cited.

There is significant literature on the economic reasons for a warranty provision including the theories of insurance and signaling (Chu & Chintagunta 2011). Both theories are based on the concept that warranties lower the risk associated with a purchase. The insurance theory of warranties relates to the obligation of a seller to compensate the buyer in the event of a failure of the product. This theory relies on the concept of the consumer being risk averse. Without an aversion for risk, the insurance theory is not a factor since those who are risk-neutral are willing to bear all of the risk. Similarly, those buyers who are more risk averse will purchase warranties of longer duration to mitigate risk. It can be inferred from this theory that longer warranties will appeal to buyers who are more risk averse.

Signaling theory of warranties examines the use of warranties as indicators of product quality when there is information asymmetry. Information asymmetry typically occurs when buyers are not fully informed of the product quality before purchase due to the variability in product quality for a given product. Therefore, sellers may signal product quality using warranties (Chu & Chintagunta 2011).

Signaling theory of warranties operates on several assumptions. One assumption is that companies offering warranties not only have a legal obligation, but also have an incentive to honor warranty claims due to repeat purchase or word-of-mouth positive impacts (Boulding & Kirmani 1993). Another assumption is since a warranty claim results in cost to a company, the warranty itself is an indicator that a company has higher confidence in its product. Companies with lower quality products will have higher warranty costs and companies with higher quality products will have lower warranty costs. This results in companies with higher quality products being able to offer warranties that are greater in length. An example of signaling theory in practice occurred in the automotive industry. In 1999, Hyundai Motors changed their new car powertrain warranty from 5 years / 60,000 miles to 10 years / 100,000 miles. After this change in warranty, Hyundai Motors’ U.S. market share climbed from 1.1% to 4%. To the contrary, in 2002, Volkswagen reduced their powertrain warranty from 10 years / 100,000 miles to 5 years / 60,000 miles and in the subsequent three years, U.S. sales of Volkswagen cars declined 30% (Choi & Ishii 2010). Hyundai dealer Rick Case Hyundai in Fort Lauderdale, Florida doubled the Hyundai factory warranty in 2008 to 20 years / 200,000 miles and realized a unit sales increase of ten percent in the first year. The owner of the dealership notes that the coverage gives buyers peace of mind (Harris 2009). These illustrate a likely relationship between the warranty coverage and consumer demand for vehicles (Choi & Ishii 2010).

In the home building industry, many builders claim product quality in their advertising, but do not use new home warranties as a signal of product quality. This appears to be a potential opportunity for home builders. Research has shown that while some consumers tend to overestimate the cost and likelihood of product failure influencing their purchase of an extended warranty, most consumers behave emotionally in their purchase of extended warranties. The emotional benefit of having an extended warranty results in the purchase. (Huysentruyt & Read 2010). There is evidence in the literature that the average maximum willingness to pay for an extended product warranty approaches the market price suggesting that this emotional drive can be substantial.

Home builders create one of the most expensive products that American consumers purchase (Bureau of labor Statistics 2018), yet rarely stand behind their product by providing an extended warranty. In fact, owning a home is the most significant capital expenditure for American consumers, followed by owning an automobile (Bureau of labor Statistics 2018). The typical lifespan of an automobile in the U.S. is eleven and one half years (IHS Automotive, 2015; United States Department of Transportation 2017). The standard duration automobile warranty provided in the auto industry today is a three year / 36,000 mile warranty (Edgerton 2010). New homes, in contrast, have standard included builder warranties ranging from six months to two years (Evans, 2018; U.S. Federal Trade Commission 2005). The average lifespan of a new home ranges widely based largely on opinion. Most sources claim average lifespans of fifty to one hundred years or more for a home built today (Swiss Life Group 2018; Geffner 2010). Many also note that regular maintenance can result in a home lasting much longer.

Warranty Ratio

The literature on typical warranty length and lifespan for new homes and automobiles uncovered an idea for relative comparison of the two products with respect to warranty coverage. This measure is the warranty ratio, defined as the ratio of the typical warranty period in years to the average lifespan of the product. A comparison of relative warranty length as a percentage of average lifespan demonstrates a disparity between common warranties on new homes and the base warranty on most automobiles. The typical lifespan of an automobile in the U.S. is eleven and one half years (IHS Automotive 2015; United States Department of Transportation 2017). The shortest standard duration of automobile warranties provided is a three year / 36,000 mile warranty (Edgerton 2010). The warranty to lifespan ratio for the shortest automobile warranties is twenty six percent – indicating that the base warranty for an automobile covers the vehicle for twenty six percent of its average lifespan. New homes, in contrast, have standard builder warranties ranging from six months to two years (Evans 2018; U.S. Federal Trade Commission 2005). The average lifespan of a new home ranges widely based largely on opinion. Most sources claim average lifespans of fifty to one hundred years or more for a home built today (Swiss Life Group 2018; Geffner 2010). Many also note that regular maintenance can result in a home lasting much longer. To develop a conservative estimate of warranty to lifespan ratio for new homes, the new home warranty is assumed to be two years and the lifespan of the home is assumed to be fifty years. The resulting warranty to lifespan ratio of four percent – indicating that the standard warranty for a new home covers the home for four percent of its average lifespan.

Comparing the warranty ratios of the two most expensive purchases made by Americans in their lifetime, the difference is great. More specifically, the lowest duration standard new automobile warranty has more than seven times the coverage relative to average lifespan as a standard new home warranty. Further, while many automobile manufacturers offer longer standard warranties (Edgerton 2010), there are not many home builders offering warranties greater in length than 2 years (Evans 2018).

The disparity in warranty coverage between the two most significant financial expenditures faced by most Americans could be a substantial opportunity for home builders. The automotive industry has capitalized on longer warranties as a successful strategy for gaining market share (Choi & Ishii 2010). From this research, it appears that this opportunity also exists for home builders. In addition to gains in market share, home builders may also realize closer connections with clients resulting in the potential for greater brand loyalty, referral business, and customer satisfaction.

Opportunity

Given this disparity, it appears as if there may be an opportunity for home builders to differentiate themselves from their competition by offering an extended warranty. However, for a builder to offer this added coverage, they must first have a path to mediate the risk associated with warranty claims. Lack of proper maintenance is a frequent cause for equipment/building failure. Home owners do not typically insure that the recommended preventative maintenance is performed on their home. One opportunity for mitigating the risk of extended warranty claims is for the builder to provide preventative maintenance such as HVAC tune ups, filter changes, termite inspections, and inspection for moisture related issues.

This research seeks to address two primary research questions. First, what is the market’s perception of an extended home warranty as measured by “psychological comfort”? The second question addresses the market opportunity for a builder provided preventative maintenance program as a means of mitigating the builder’s risk of extended warranty claims.

METHODOLOGY

No theoretical constructs or methods applicable to new home extended warranties were found in the existing literature. The literature did, however, provide ideas around which new theoretical constructs were created for this study. The constructs developed for this study are psychological comfort, perceived value, and amount willing to pay. A structured survey was developed using a six point Likert scale to measure these constructs. The 1 - 6 scale correlated to the following responses; 1) strongly disagree, 2) disagree, 3) somewhat disagree, 4) somewhat agree, 5) agree and 6) strongly agree.

Survey Instrument

The structured survey consisted of 46 items that the respondents answered online. The survey incorporated skip logic questions in order to exclude participants that did not meet the study’s criteria of owning a home or planning to purchase a home in the next six months. Participants answering that they did not currently own a home were then directed to an item asking if they planned to purchase a home in the next six months. If participants answered that they were not planning to purchase a home in the next six months, the survey ended. The survey utilized composite scoring of multiple correlated questions to measure the key constructs psychological comfort and builder perception. This approach asks similar questions in different ways, correlates the responses, and averages the scores into a single measure. This approach dilutes potential bias with the way a question is phrased and strengthens the reliability of the response. For other measures, such as willingness to pay for a service, individual questions were used.

Definitions of the terms “extended warranties” and “preventative maintenance” were provided to the respondents in order to provide a consistent interpretation of their meaning. The following definitions were provided with the questions related to them.

An extended warranty refers to a 12-year warranty provided by the builder of a new home. (The most common warranty provided in the new home market today is a 1-year warranty. There are third party warranties which extend the base warranty to 2-years and cover structural defects for 10 years. A 12-year warranty was selected to differentiate from possible respondent association with 10-year 3rd party structural warranties)

Preventative maintenance on a home includes an annual checkup on the heating and cooling system, air filter changes, inspection for moisture related problems, and termite inspection.

Participant Population

A total of 162 survey responses were received. A data acquisition service (MTurk) was used to collect 47 surveys and the other 115 were collected from a convenience sampling predominately from the MidAtlantic region of the United States. The self-reported demographic information received indicated a wide range of survey respondents. Table 1 provides some descriptive statistics of the respondents; however, the most frequent demographic response (mode) for the survey takers was that they were 48 years old, white, female, held a bachelor degree and had an income between $125,000 to $149,999. 

Table 1

FINDINGS

Demographics

The five demographic questions (age, income, gender, race and education) in the survey were reviewed for correlation. There was no meaningful correlation to the demographic responses and any other aspects of the questionnaire. The one exception to this is with education and the perception of the home building industry which will be discussed in the next section.

Perception of Home Building Companies

To explore the value of an extended home warranty for potential customers it is important to understand their overall perception of the organization that would provide the warranty. Five questions related to various characteristics of home building companies were asked in the survey. The question responses were analyzed to have substantial correlation. The resulting composite score from the questions was used to measure the construct of builder perception. The individual characteristics specifically measured were dependability, trustworthiness, reliability, credibility and the overall home building experience. See Table 2 for a summary of the responses. The survey showed that the overall perception of home builders is modest at best. On a six point Likert scale, the composite score for builder perception was 3.8 which is between “somewhat disagree” and “somewhat agree.” It is also worth noting that none of the 162 respondents indicated they “strongly agreed” that home building companies are dependable or trustworthy. This lackluster perception of the homebuilding industry spanned across all five demographics surveyed. The highest correlation coefficient between the home building industry and the measured demographics was -.26. The slight negative correlation indicates that the more educated a person was, the lower the opinion they had of the industry.

Psychological Comfort of an Extended Warranty

As part of the evaluation of the value home buyers would place on an extended warranty, the study looked at the construct of “psychological comfort” provided by an extended warranty. The psychological comfort construct was measured on seven items adapted from the work of Ahmad and Butt (2012) and Simon (1993). See Table 3 for a summary. Interitem correlation was evaluated for the seven items in the survey showing strong correlation between the items. From the survey results, there does appear to be an elevated level of psychological comfort with an extended warranty. The composite response for psychological comfort was 4.9 (agree) out of six with the most frequent response being 6 (strongly agree). Additionally, we can use the average perception of the warranty value to gauge correlation to what they would be willing to pay and acceptance to a builder provided maintenance program.

Willingness to Pay for an Extended Warranty

With the establishment that survey respondents see value in an extended warranty, the next key point to understand is how much they are willing to pay for it. Two questions were asked to evaluate this. The first question asked the “amount that you would be willing to pay” and the second was what “would be a fair investment” for the 12-year extended warranty. For both questions, the response options were $0, $20, $40, $60, $80 and $100 per month. The findings are summarized in Table 4 and show that the respondents indicated that $37 a month would be a fair price for the warranty.Table 2

Table 3 & 4

Builder Provided Maintenance Program

For an extended warranty program to be successful, managing the builder’s cost of the warranty is just as impactful as what the home buyers are willing to pay. One of the leading causes of warranty claims, legitimate or not, has a root cause of non-existent or improper maintenance. Lack of timely HVAC filter replacement, clogged roof gutters, failure to maintain water flow away from the home and a host of other factors can reduce the useful life of equipment and overall building performance. Home builders are often called back for warranty claims that are the result of lack of maintenance and either fix the issue at their own expense to maintain a positive relationship or refuse to do the work and risk harming the relationship. One way to manage the risk of improper or nonTable 4: Willingness to Pay for Extended Warranty Survey Question Average Mode Std Dev. Min Max Check amount that you would be willing to pay per month for a 12-year extended warranty on your home. $36 $40 $26 $0 $100 What, in your opinion, would be a fair investment per month for a 12- year extended warranty on a home? $39 $20 $23 $0 $100 Average Willingness to Pay for Extended Warranty $37 $30 $25 $0 $100 existent maintenance is to offer a program where the builder provides preventative maintenance for the owner. This has the benefit of an added service for the builder but also reduces the chance of a warranty claim. A builder provided preventative maintenance program, as a risk mitigation option for the extended warranty program was investigated with this study.

To make sure the respondents had a consistent understanding of what “preventative maintenance” was the following definition was provided. “Preventative maintenance on a home includes an annual checkup on the heating and cooling system, air filter changes, inspection for moisture related problems, and termite inspection.” The responses indicated that home owners appreciate that home maintenance is important. When asked to rate the statement “It is important to perform annual preventative maintenance on a home,” the home owners had an average response of 5.4 (between “agree” and “strongly agree”). They were also  supportive of the concept of the builder providing this service for them. When asked to evaluate the statement “Subscribing to an annual preventative maintenance plan on my home would give me peace of mind” they scored it at 4.7 out of a possible 6. This was a positive response indicating that they perceived value in it. However, a better gauge of perceived value was the response to the questions regarding what they would be willing to pay. Two questions were asked related to the cost of a preventative maintenance service. Similar to the questions regarding warranty cost, the first question asked the “amount that you would be willing to pay” and the second was what “would be a fair investment” for a preventative maintenance program. For both questions, the response options were $0, $20, $40, $60, $80 and $100 per month. The results, shown in Table 5, indicate that home owners are willing to pay $27 a month.

CONCLUSIONS AND RECOMMENDATIONS

The study made several key findings valuable to the home building industry. First, the overall opinion of home building companies by the survey respondents was not high. This indicates an opportunity for home building companies to differentiate themselves from their competition. The study evaluated if an extended home warranty and a builder provided preventative maintenance program were services that respondents valued and what they would be willing to pay for them. This study observed that respondents had a positive association with a builder extended 12-year warranty and would have higher psychological comfort if such a warranty was included with their home. The respondents indicated they would be willing to pay an additional $37 a month for an extended warranty. This is in line with 3rd party home warranty services currently available to home owners. The National Association of Realtors estimates that these third party home warranty services range from $300 - $600 per year (Ericson 2017). The study also found that respondents had a positive association with a builder provided preventative maintenance program and would be willing to pay on average $27 a month for it. The prices willing to pay for the warranty and maintenance program had large standard deviations indicating that a significant portion of the population would be willing to pay more than the average.

Discussion

From the builder perspective, the most significant apprehension in offering an extended warranty is risk. However, if the home is built well and is properly maintained, the risk of costly repairs for a home should be minimal. An option that could differentiate a home builder from their competition is to offer a 12- year warranty along with a preventative maintenance program as a choice for all of their new homes. We define preventative maintenance in this study as builder provided annual checkup on the heating and cooling system, air filter changes, inspection for moisture related problems, and termite inspection. Our survey indicated that the home buyers would pay on average $37 a month for the warranty and $27 a month for the builder provided maintenance totaling at $64 a month or $768 annually. Assuming a discount rate of 5%, the net present value of $768 annually over 12 years is $6,919. In other words, the survey suggests that home buyers would be willing to pay $6,919 more for their home if this service was provided. The survey did not ask about the value of the respondent’s home. However, if we assume annual income can be a surrogate for home value, the data suggest no meaningful correlation of value or willingness to pay for either the extended warranty or the builder maintenance program and new home price. As such, on a percentage basis higher end homes would have a smaller impact whereas more economical homes would have a more significant increase in upfront costs.

The expected costs of warranty claims and providing the maintenance is a critical aspect of the builders evaluation on whether this is a service they are willing to provide. Estimating those costs is beyond the scope of this study but worth evaluating in the future. However, what may be the most important benefit to the builder is the face-to-face contact with the home buyer that an annual inspection would afford. The data from remote monitoring could also be automated into a monthly “home health report” giving the builder another point of contact monthly. Continuing the relationship has a host of benefits including generating leads for remodel/ upgrade work in the home, positive word of mouth advertisement and potential repeat business with the customer’s next home.

Table 5

Limitations and Future Research

There are a number of limitations to this study. First, the demographics of the sample population was not representative of the U.S. population. The sample population was comprised of eighty percent college educated respondents which had a slight negative correlation (-.26) with the measure of home builder perception. This slight correlation indicates a difference in the perception of homebuilding companies by those respondents with a college education. This would be an area of awareness and interest for future study. Eighty-four percent of the respondents were White / Caucasian and sixty-seven percent were female. For future studies, a sample population that is more representative of the overall U.S. home buyer / home owner population would likely provide more representative data. The sample population was disproportionally located in the mid-Atlantic region of the eastern United States. Perceptions related to extended home warranties might vary based on geographical location within the U.S. due to regional viewpoints, the age of the housing stock in different regions, and even the relative cost of housing in various regions.

Relative cost of homes was a second limitation of this study. The study did not control for nor ask about the cost of a participants’ home. If the survey had asked this question, the responses could have been reviewed based upon the price range of the home each participant currently owned. The price of the home that a participant lives in could be correlated with the participant’s income or wealth, which may influence one’s perspective on extended new home warranties. Some warranty research indicates that as wealth increases, the perceived need for product warranties decrease. This would be an interesting area for future research. The participants in this study were home owners. With the study focus of understanding the perceptions of consumers on extended new home warranties, this may have been a limitation of the research.

Future research results may provide more accurate results by limiting surveys, interviews, and other means of data collection to participants who are currently shopping for a new home. Participants who are in the process of shopping for a new home should be more in tune with the research questions as they relate to new homes.

In addition to addressing the limitations of the research identified, future areas of research relating to extended new home warranties might include surveying home builders and/or home building company leaders to understand their perspectives on extended new home warranties. If the literature is correct, the researcher would expect that home builder perspectives might contradict the perspectives of home buyers regarding extended new home warranties. The specific scopes of extended new home warranties could also be explored to determine the optimal balance of warranty coverage, home owner perception, and warranty cost. Insurance companies who provide home builder extended warranty coverage might also be surveyed to understand what coverages are offered in the marketplace and the most common warranty claims. Understanding consumer perceptions of third party warranty companies (insurance companies) would be important if a third party warranty (insurance company) is considered. 

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