Analysis of decisions involved in offering a product warranty

Abstract

Every day, competitive proposals are submitted to the Department of Defense for anything ranging from weapons to service and support contracts to dual-band ship-based radar systems. A company's competitiveness against other potential contractors is riding on its ability to design superior products at an affordable cost to the customer. Part of offering an affordable product comes in the form of a warranty. It is difficult to quantify the risks and rewards of offering a warranty. Reliability engineers are often asked to evaluate the risk of offering a warranty on a system. Offering a warranty on an unproven technology is obviously very risky. However, not providing some form of guarantee on their products also comes with risk, as it infers added life cycle costs to the customer, particularly if the competition is offering a warranty. The goal of any company is to identify a way to examine and manage risks associated with offering a warranty, versus not offering a warranty. A working model was developed, which can be used to evaluate optimal warranty terms and conditions to maximize net present value (NPV). The NPV is calculated from a series of future cash flows derived from product sales and expenses associated with warranty program costs. The Warranty Costs and Decision Model can be refined continuously and be improved for actual use by any defense contractor. Additional data could be collected to minimize the amount of assumptions, such as the probability of winning a contract under certain conditions, etc. The current model as presented, however, demonstrates the power of the @RISK software tool, and the type of complex analyses that can be easily performed. As defense contractors continue to try to improve their proposal processes and contract win percentages, development of a warranty cost and risk analysis tool, like the one presented here, offers an edge over the competition. Being able to quantify risk and opportunity associated with many unknowns is advantageous over making those types of decisions based on "gut feel" and intuition alone.