Consumer return policies in competitive markets: An operations perspective

Abstract

Abstract The recent literature argues that offering consumer returns, such as money‐back guarantees (MBGs), reduces quality differentiation in competitive markets. We show that this argument does not hold in general. We propose a new certainty‐equivalent approach, which shows that offering product returns only changes the two firms' marginal costs without affecting their quality differentiation. Our proposed approach directly reveals that asymmetry of salvage values may overturn the recent finding that MBGs help the low‐quality firm. Since MBGs only lead to marginal cost reductions, we show that each firm should adopt MBGs in equilibrium irrespective of the competitor's choice. We then examine the role of offering consumer returns in determining the firms' competitive product strategies. We demonstrate that offering MBGs does not directly affect the quality differentiation choices, and discuss the impacts of production technology and consumer valuation.