Optimal Reverse Channel Structure for Consumer Product Returns

C often return a product to a retailer because they learn after purchase that the product does not match as well with preferences as had been expected. This is a costly issue for retailers and manufacturers— in fact, it is estimated that the U.S. electronics industry alone spent $13.8 billion dollars in 2007 to restock returned products [Lawton, C. 2008. The war on returns. Wall Street Journal (May 8) D1]. The bulk of these returns were nondefective items that simply were not what the consumer wanted. To eliminate returns and to recoup the cost of handling returns, many retailers are adopting the practice of charging restocking fees to consumers as a penalty for making returns. This paper employs an analytical model of a bilateral monopoly to examine the impact of reverse channel structure on the equilibrium return policy and profit. More specifically, we examine how the return penalty is affected by whether returns are salvaged by the manufacturer or by the retailer. Interestingly, we find that the return penalty may be more severe when returns are salvaged by a channel member who derives greater value from a returned unit. Also, the manufacturer may earn greater profit by accepting returns even if the retailer has a more efficient outlet for salvaging units.