Expected warranty cost of two-attribute free-replacement

warranties based on a bivariate exponential distribution

H.-G. Kim
a,
*
, B.M. Rao
b
a
Department of Industrial Engineering, Dongeui University, Pusan 614-714, South Korea
b
Department of Applied Statistics and Operations Research, Bowling Green State University, Bowling Green, OH 43403, USA
Accepted 24 August 2000
Abstract
Many warranty policies offered by manufacturers are limited by two factors, typically time since purchase, and
usage of the product. Such policies are referred to as two-attribute (or two-dimensional) warranty policies and can
be described in terms of regions in a plane with one axis representing time and the other axis the usage. In this
paper, we consider two-attribute warranty policies for non-repairable items. The item failures are described in
terms of a bivariate exponential distribution. Analytical expressions are derived for the resulting two-dimensional
renewal function and the cost of warranty. An illustrative numerical example is presented to study the effect of
correlation between the warranty variables on the cost of warranty. q 2000 Elsevier Science Ltd. All rights
reserved.
Keywords: Two-attribute warranty policy; Bivariate exponential distribution; Two-dimensional renewal function; Warranty
cost; Correlation
1. Introduction
A warranty is a contractual obligation of a manufacturer or vendor in relation to product sales and
services. The most common form of warranty is characterized by a time interval called the warranty
period. Such warranties can be classied as free replacement or prorata replacement based on the cost to
the consumer of replacing an item that fails within the warranty period. A two-attribute warranty may be
characterized as a region in two-dimensions (2D) with the horizontal axis representing time and the
vertical axis the usage. A typical example of such a warranty is that offered for new automobiles. Here,
Computers & Industrial Engineering 38 (2000) 425434
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PII: S0360- 8352( 00) 00055- 3
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* Corresponding author. Fax: 182-51-890-1619.
E-mail address: hgkim@hyomin.dongeui.ac.kr (H.-G. Kim).
the warranty is valid until either a pre-specied time limit or a pre-specied usage limit (in miles driven)
is exceeded.
While there is extensive literature (Kao & Smith, 1996; Kim, 1997; Mi, 1997; Rao, 1995) on time
limited warranties, two-attribute warranties received very limited attention (Chun & Tang, 1999;
Moskowitz & Chun, 1994; Murthy, Iskander, & Wilson, 1995; Singpurwalla & Wilson, 1998). For a
complete review of all existing literature on warranty modeling we refer the readers to the excellent
books on the topic by Blischke & Murthy (1994a,b) and a recent survey by Thomas and Rao (1999). The
approaches used to study two-attribute warranties may be classied as either 1D or 2D based on the
nature of the point process used to study the warranty. The 1D approach, as the name suggests, considers
a 1D point process by assuming a relationship between the two-warranty attributes or variables.
Moskowitz and Chun (1994) assumed a linear relationship with non-negative coefcients and modeled
the failures for free-replacement warranties using a conditional Poisson process. Chun and Tang (1999)
followed a similar approach to Moskowitz and Chun (1994) to study the warranty costs under free
replacement and prorata warranties. They determined the effective warranty period and then estimated
the present value of the total future repair cost. A variation of this approach proposed by Singpurwalla
and Wilson (1998) uses an additive hazard approach to modeling failures indexed by two scales. Their
approach consists of decomposing the joint distribution of time and usage by rst selecting a process
appropriate to the type of damage (e.g. shocks, continuous wear or intermittent wear) and incorporating
the effect of usage on time to failure as an additive hazard model.
In order to avoid imposing a relationship between the two warranty variables, one needs to adopt the
2D approach. This approach involves the use of a bivariate probability distribution function for the two
warranty variables. The only published paper using this approach is by Murthy et al. (1995). They
considered four variations of two-attribute warranties and derived results for the expected warranty cost
per item sold for each of the policies. Multivariate Pareto distributions of the rst and second kind as
well as Beta Stacy distribution were considered as candidates for the joint distribution for the two
warranty variables. The numerical results were obtained using a 2D renewal integral equation solver.
As this study amply illustrates, this approach is analytically difcult due to the complexities associated
with the 2D renewal functions.
In this paper, we analyze two-attribute free-replacement warranty policies using the 2D approach. We
consider a simple and elegant bivariate exponential (BVE) distribution to describe the relationship
between the two warranty variables. Relative to the distributions considered in Murthy et al. (1995),
Downton's BVE distribution requires fewer parameters and permits the study of the effect of correlation
between the variables on the warranty costs.
The remainder of the paper is organized as follows: we briey discuss Downton's BVE distribution
and the associated 2D renewal processes in Sections 2 and 3, respectively. In Section 4, we analyze two-
attribute warranty policies and obtain the expected warranty cost per item. In Section 5, we give
numerical examples and discuss some implications for the consumer and the manufacturer. Concluding
remarks are presented in Section 6.
2. Downton's BVE distribution
Barlow and Proschan (1975) and Johnson and Kotz (1972) describe several BVE distributions. Many
of these do not have an explicit joint probability density function and most involve severe restrictions on
H.-G. Kim, B.M. Rao / Computers & Industrial Engineering 38 (2000) 425434 426
the correlation between the two random variables. In this section we describe the analytically simple and
elegant BVE distribution proposed by Downton (1970) and discuss its suitability in modeling two-
attribute warranty modeling.
The joint probability density function for Downton's BVE distribution is given by
f x; y
l
1
l
2
1 2r
exp 2
l
1
x 1l
2
y
1 2r
_ _
I
0
2rl
1
l
2
xy
1=2
1 2r
_ _
where I
n
is the modied Bessel function of the rst kind of nth order and r0 # r , 1 denotes the
correlation coefcient between the random variables X and Y. The marginal density functions of X and Y,
denoted by f
1
x and f
2
y; are exponential with means 1/l
1
and 1/l
2
, respectively (Downton, 1970).
f
p
s
1
; s
2
; the bivariate Laplace transform of f x; y; is given by (Downton, 1970):
L{f x; y} f
p
s
1
; s
2

l
1
l
2
l
1
1s
1
l
2
1s
2
2rs
1
s
2
: 1
Similarly, F
p
s
1
; s
2
; the bivariate Laplace transform of Fx; y; the cumulative density function of f x; y
is given by:
L{Fx; y} F
p
s
1
; s
2

f
p
s
1
; s
2

s
1
s
2
:
From the properties of Laplace transforms, we have
f
p
n
s
1
; s
2
f
p
s
1
; s
2

n
2
and
F
p
n
s
1
; s
2

1
s
1
s
2
f
p
s
1
; s
2

n
3
where the superscript (n) denotes n-fold convolution. It is also known from Downton (1970) that when
r 0
F
n
x; y P
n
l
1
xP
n
l
2
y; 4
where P
n
x is the incomplete gamma function dened as follows:
P
n
x
_x
0
u
n21
exp2u du
Gn
: 5
A requisite property of f x; y is that the conditional expectations of X and Y must be increasing
functions of the other variable (Murthy et al., 1995). From Downton (1970) we have,
EXuY y
1 2r
l
1
1r
l
2
l
1
y
and
VarXuY y
1 2r
l
1
1 2r
l
1
12r
l
2
l
1
y
_ _
:
H.-G. Kim, B.M. Rao / Computers & Industrial Engineering 38 (2000) 425434 427
Clearly, EXuY y as well as VarXuY y increase linearly with y. This property coupled with the
very small number of parameters and the analytical elegance makes this a good choice in two-attribute
warranty model.
One limitation of this distribution is that the marginal distributions of X and Y are necessarily
exponential. However, when this condition is satised to an acceptable degree, this property greatly
simplies the tting of the distribution because the only other parameter that needs to be estimated is the
correlation coefcient r. This represents a signicant advantage because in real life item failure data
available to the manufacturer is usually not sufcient to estimate large number of parameters with
precision.
3. 2D renewal processes
A 2D renewal process is a sequence of independent and identically distributed non-negative random
variables {X
n
; Y
n
; n $ 1} with common joint distribution function Fx; y: Let Nx; y denote the
number of renewals over the rectangle 0; x 0; y; with the origin being a renewal point. {X
n
; n $
1} is a sequence of independent and identically distributed random variables with common distribution
function F
1
x Fx; 1 and denes the univariate renewal counting process N
1
x: Similarly, the
sequence {Y
n
; n $ 1} is a 1D renewal process with common distribution function F
2
y F1; y
and denes N
2
y: From Hunter (1974) we have,
Nx; y min{N
1
x; N
2
y}
Analogous to the univariate theory, the 2D renewal function M
r
x; y ; ENx; y is given by:
M
r
x; y

1
n1
F
n
x; y 6
where the subscript r has been included in the denition of the renewal function to highlight that it is a
function of r. Let S
1n


n
i1
X
i
; and S
2n


n
i1
Y
i
denote the points of the nth renewal for the
sequences {X
n
; n $ 1}; and {Y
n
; n $ 1}; respectively. Clearly,
PS
1n
# x F
n
x; 1 F
n
1
x;
and
PS
2n
# y F
n
1; y F
n
2
y:
Since the marginal distributions of X and Y are exponential, the 1D renewal functions M
1
x and M
2
y
are given by:
M
1
x l
1
x; and M
2
x l
2
y: 7
Applying Laplace transformation to both sides of Eq. (6) and using Eq. (3), we obtain the bivariate
Laplace transform of M
r
x; y as:
M
p
r
s
1
; s
2

f
p
s
1
; s
2

s
1
s
2
1 2f
p
s
1
; s
2

:
H.-G. Kim, B.M. Rao / Computers & Industrial Engineering 38 (2000) 425434 428
Substituting for f
p
s
1
; s
2
) from Eq. (1) and simplifying, we obtain:
M
p
r
s
1
; s
2

l
1
l
2
s
1
s
2
l
2
s
1
1l
1
s
2
11 2rs
1
s
2

:
Some algebraic manipulation yields
M
p
0
1 2rs
1
; 1 2rs
2

1
1 2r
3
M
p
r
s
1
; s
2
8
where M
p
0
s
1
; s
2
) is the Laplace transform of M
p
r
s
1
; s
2
) when r 0: By appealing to the scale change
property of 2D Laplace transforms (Hunter, 1974), it can be seen that
L M
0
x
1 2r
;
y
1 2r
_ _ _ _
1 2r
2
M
p
0
1 2rs
1
; 1 2rs
2
: 9
Using Eqs. (8) and (9), we obtain
L M
0
x
1 2r
;
y
1 2r
_ _ _ _

1
1 2r
M
p
r
s
1
; s
2
;
which upon inversion yields
M
r
x; y 1 2rM
0
x
1 2r
;
y
1 2r
_ _
: 10
From Eqs. (4) and (6),
M
0
x; y

1
n1
P
n
l
1
xP
n
l
2
y: 11
Eqs. (10) and (11) provide a convenient means of evaluating M
r
x; y: Established numerical methods
can be employed to compute the 2D renewal function M
r
x; y using Eq. (5). The authors have used the
well known package Mathematica for this purpose.
4. Two-attribute free-replacement policies
In this paper we study two of the four two-attribute warranty policies (labeled A and B) proposed by
H.-G. Kim, B.M. Rao / Computers & Industrial Engineering 38 (2000) 425434 429
Fig. 1. Warranty region for Policy A.
Murthy et al. (1995). Let c denote the manufacturer's cost of each replacement and EC, the expected
warranty cost. We use the superscripts A and B for the two types of policies.
4.1. Policy A
The warranty coverage ends when either the maximum usage limit or maximum time limit are
exceeded. For this policy, the warranty region is the rectangle 0; W 0; U as shown in Fig. 1,
where W and U are the warranty limits for time and usage, respectively.
Let N
A
W; U denote the number of failures occurring under Policy A. Clearly, N
A
W; U
NW; U; and the expected warranty cost is given by
EC
A
W; U cMW; U
with MW; U obtained from Eqs. (5), (10) and (11).
4.2. Policy B
The warranty coverage ends when both the maximum usage limit and the maximum time limit are
exceeded. For this policy, the warranty region is given by two innite strips shown shaded in Fig. 2.
Let N
B
W; U denote the number of failures having occurred under Policy B. This is related to the 2D
renewal process and the 1D processes as:
N
B
W; U Max{N
1
W; N
2
U} N
1
W 1N
2
U 2NW; U:
The expected warranty cost is given by
EC
B
W; U cM
1
W 1M
2
U 2MW; U;
where M
1
W and M
2
U are obtained from Eq. (7) and MW; U from Eqs. (5), (10) and (11).
H.-G. Kim, B.M. Rao / Computers & Industrial Engineering 38 (2000) 425434 430
Fig. 2. Warranty region for Policy B.
Table 1
Numerical example
Usage EX
i
1=l
1
(years) EY
i
1=l
2
10
4
miles) EY
i
=EX
i

Light 4 2.0 0.5

Medium 3 3.0 1.0
Heavy 2 4.0 2.0
H.-G. Kim, B.M. Rao / Computers & Industrial Engineering 38 (2000) 425434 431
Table 2
Expected number of failures for Policy A: r 0:5
U Usage W
0.5 1.0 1.5 2.0
0.5 Light 0.0447 0.0735 0.0920 0.1039
Medium 0.0412 0.0723 0.0957 0.1133
Heavy 0.0417 0.0816 0.1119 0.1369
1.0 Light 0.0816 0.1369 0.1742 0.1994
Medium 0.0723 0.1293 0.1741 0.2093
Heavy 0.0735 0.1369 0.1914 0.2381
1.5 Light 0.1119 0.1914 0.2474 0.2867
Medium 0.0957 0.1741 0.2381 0.2901
Heavy 0.0920 0.1742 0.2474 0.3123
2.0 Light 0.1369 0.2381 0.3123 0.3662
Medium 0.1133 0.2093 0.2901 0.3577
Heavy 0.1039 0.1994 0.2867 0.3662
Table 3
Expected number of failures for Policy B: r 0:5
U Usage W
0.0 0.5 1.0 1.5 2.0
0.0 Light 0.0000 0.1250 0.2500 0.3750 0.5000
Medium 0.0000 0.1667 0.3333 0.5000 0.6667
Heavy 0.0000 0.2500 0.5000 0.7500 1.0000
0.5 Light 0.2500 0.3303 0.5515 0.7830 1.0211
Medium 0.1667 0.2921 0.4277 0.5710 0.7200
Heavy 0.1250 0.3333 0.4184 0.5131 0.6131
1.0 Light 0.5000 0.4184 0.6131 0.8258 1.0506
Medium 0.3333 0.4277 0.5374 0.6592 0.7907
Heavy 0.2500 0.5515 0.6131 0.6836 0.7619
1.5 Light 0.7500 0.5131 0.6836 0.8776 1.0883
Medium 0.5000 0.5710 0.6592 0.7619 0.8766
Heavy 0.3750 0.7830 0.8258 0.8776 0.9377
2.0 Light 1.0000 0.6131 0.7619 0.9377 1.1338
Medium 0.6667 0.7200 0.7907 0.8766 0.9756
Heavy 0.5000 1.0211 1.0506 1.0883 1.1338
5. Numerical examples
We consider the example used by Murthy et al. (1995), which refers to the warranty offered for an
automobile component with time and age measured in units of years and usage in units of 10
4
miles. Three
usage levels namely, light, medium, and heavy have been chosen. The mean age EX
i
; the mean usage EY
i

and the mean usage rate between failures EY

i
=EX
i
for the three usage levels are given in Table 1.
Tables 2 and 3 show the expected number of failures under warranty for the three usage levels, and
various warranty limits when r 0:5: For Policy B, either W or U can be zero, in which case the policy
H.-G. Kim, B.M. Rao / Computers & Industrial Engineering 38 (2000) 425434 432
Fig. 3. Surface and contour plots for EN
A
W; U:
Fig. 4. Surface and contour plots for EN
B
W; U:
reduces to a single attribute policy. If U 0; the policy becomes the traditional free-replacement
warranty with a warranty period W. When W 0; the policy corresponds to a similar warranty based
on a usage limit U.
The expected number of failures under warranty increases with warranty limits W and U for Policies A
and B. It can be seen that EN
B
W; U . EN
A
W; U for a given W and U. As can be anticipated,
Policy B offers better coverage to light and heavy users as seen by comparing the expected number of
failures. For light users with W U; the ratio EN
B
W; W 3 EN
A
W; W decreases from about 7.4
when W 0:5 to 3.1 for W 2:0: For small W and U the manufacturer's obligations cease very early
with very few claims under Policy A, whereas the manufacture has to service the warranty for a long
time under Policy B. These results are similar for the heavy users. Policy A is the only policy that is
currently offered by manufacturers.
For policies A and B, Figs. 3 and 4 show the 2D surface and contour plots of the expected number of
failures as a function of W and U for 0 # W; U # 2 for medium usage and r 0:5: The lowest contour
corresponds to the expected number of failures equal to 0.03 and 0.075 and subsequent contours correspond
to the expected number with 0.03 and0.075 increments, respectively. The effects of correlation between two
warranty variables on the expected number of failures are shown in Figs. 5 and 6. Positive correlation
increases the expected number of failures for Policy A but reduces it for Policy B.
H.-G. Kim, B.M. Rao / Computers & Industrial Engineering 38 (2000) 425434 433
Fig. 5. Effect of correlation on EN
A
W; UW U 1:
Fig. 6. Effect of correlation on EN
B
W; U W U 1:
6. Concluding remarks
We have studied two-attribute free-replacement policies through 2D renewal processes based on
Downton's BVE. Downton's BVE distribution yields an analytical expression for the renewal function
and permits the representation of correlation between the two variables. The results obtained here are
useful in establishing warranty coverage regions and warranty reserves for two-attribute warranty
policies.
We are currently exploring the possibility of applying the results of this paper and estimating the
parameters of the BVE distribution using real data. The two-attribute free-replacement policies for
repairable items and two-attribute prorata warranty policies are worthy of further study.
Acknowledgements
The authors are very grateful to the anonymous referee for his/her meticulous and painstaking review
and detailed comments which greatly improved the paper. This research has been supported by Dongeui
University, Korea, while H. G. Kim was a Visiting Scholar at the Department of Applied Statistics and
Operations Research, Bowling Green State University.
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H.-G. Kim, B.M. Rao / Computers & Industrial Engineering 38 (2000) 425434 434