Many durable consumer goods can be returned after the sale. This is a good thing for consumers, but presents costs and problems for manufacturers and retailers alike. Normally, the movement of products is studied only in the forward direction, beginning at manufacture and ending with a consumer purchase. But according to Anne Coughlan, a professor of marketing at the Kellogg School of Management, it is important to recognize the potential for returns and learn how best to manage the returns process.

In a new body of research, Coughlan and her colleagues integrated marketing and operations management variables into three separate mathematical models, which they used to determine which factors should be considered in dealing with returned merchandise. Their findings show that intuitive approaches to handling returns are not always optimal.

Less Information, More Sales
Purchasing decisions depend not only on product prices and attributes, but also on the likelihood that consumers will return the products later and whether they will lose money if they do. In the first model, Coughlan and Jeffrey D. Shulman, an assistant professor at the University of Washington, and R. Canan Savaskan-Ebert, an associate professor at Southern Methodist University, investigated how restocking fees and product information influence a consumer’s decision to buy a product in the first place.

For example, a consumer may go to the Hewlett-Packard website to purchase a new computer. The consumer may not be quite sure which of the machines best meets his or her needs, and may know that returning it will trigger a restocking fee. “The potential customer may think, ‘Well, I don’t know enough about this product, and I may want to return it. Since they’re telling me I have to incur a 30 percent restocking fee, I think I may just not buy the product at all,’ ” Coughlan says. The manufacturer has to balance the risk that the consumer may never buy the product against the costs that will be incurred if the consumer ends up returning it.

One option would be to provide the potential buyer with as much information as possible before the purchase decision is finalized. That could minimize the chance that the consumer will return the product after purchase. It is a cheap solution, as far as the retailer is concerned.

But according to Coughlan’s findings, this intuition is not always correct. Instead, it can be profitable to leave consumers a little bit unsure about whether a product fits their preferences, in the hope that they will try a product that they might otherwise never buy to begin with. Once bought, Coughlan says, if a product is close enough to a person’s needs and wants—even though it may not be perfect—the consumer likely will keep it. When consumers are not too picky about their ideal product features, leaving them uncertain about the product’s specifics is profitable because it increases sales volume without increasing returns too much.

As consumers, many of us are familiar with this. “How many times have you seen a shirt or blouse in a store and thought it would go perfectly with a certain outfit, only to find once you have it home that it is not exactly perfect?” Coughlan asks. “We know there are people with some clothing sitting in their closets that they don’t necessarily wear a whole lot, but those items are close enough to make it more attractive to keep them than to go back to the store to return them.”

Efficiency Is Not Always Profitable
In the second model, Coughlan and her colleagues looked at the situation in which a manufacturer sells to a retailer that then sells to the end consumer. In most such cases, the retailer sets the price and the restocking fee. The manufacturer does not have to participate in the returns process—it can say that returns are the retailer’s problem.

However, if the retailer sets policies that reduce sales, the manufacturer will suffer. On the other hand, if the manufacturer does accept returns, its decisions about wholesale price and any refund it may offer a retailer for taking back a product will affect the price the retailer charges to consumers. Its decisions will also affect the retailer’s propensity to charge a restocking fee. Coughlan and her colleagues explored the pros and cons of manufacturers participating in the returns process.

They found that the party that can process returns at lower cost should often—but not always—be the one to handle them. This is because the retailer charges a higher restocking fee than the manufacturer would, which can distort overall pricing policies and consumer incentives to buy the manufacturer’s product. Coughlan explains that as long as the manufacturer’s ability to salvage returned units is not too much lower than the retailer’s, the manufacturer can gain in profitability by handling returns itself, because its involvement leads to better coordination in the joint setting of wholesale price, retail price, and consumer restocking fee. When such coordination happens, total channel efficiency improves, as does the manufacturer’s profitability.

Competition and Restocking Fees
It may seem intuitively obvious that competition will drive restocking fees down—after all, shouldn’t the consumer be expected to choose a retailer that charges a lower fee for accepting returns in a competitive market? But this is not always true, according to the results obtained in Coughlan’s third paper with her co-authors, which compared two scenarios: competing sellers versus a single monopoly seller of multiple products. The results show that under predictable conditions, competition resulted in higher—not lower—restocking fees.

“If a consumer buys my product and finds after purchase that a competing product is a better fit for his or her tastes, the consumer will return my product and use the refund I provide to buy my competitor’s product, leaving me with an item whose salvage value is likely less than the original purchase price,” Coughlan explains.

In contrast to the monopoly situation where that consumer exchanges the first product for another product sold by the same firm, a competing retailer actually loses that consumer to a rival—and incurs the cost of salvaging the returned unit. These forces lead the competing retailers to manage returns volumes by raising restocking fees, particularly when the consumer is not too picky about a perfect match of the product with his or her tastes. In such a situation, more consumers will keep an imperfectly matching product rather than returning it and exchanging for the competitor’s offering. This not only keeps the money in the seller’s hands but also keeps money out of the competitor’s pocket. Conversely, when the consumer buys a product from a monopolist and finds that it is not a great fit with his or her tastes, the company does not have to raise the restocking fee because it knows it will get the money back on the sale of a second product.

Shedding Light on Complex Problems
Coughlan says the ultimate goal of research in this area is to build a general theory that could take into account multiple factors, even if they are too complicated to be modeled all at once. Currently, each of the three models ignores factors that the other two accommodate. But each also deals with factors that neither of the other two address. “In a real-world situation, there would be some mixing of all of these factors together, but that model would be impenetrable,” Coughlan says. “By picking apart the individual effects, you can get some insight about how these factors affect the outcomes.”

Bringing marketing and operations management research together results in more robust insights, she notes. “The literature that is being developed on the borders of these two disciplines is useful because, on the one hand, marketers need to think a little more about the operational side of what we sell—not to ignore the problems of handling inventories, for example.

“Conversely, it causes people who spend their lives on the operational side of the world to think about demand-side strategic or competitive effects that moderate a pure operations point of view, which would otherwise emphasize factors like inventory cost management to the exclusion of demand stimulation activities.” Coughlan and her co-authors hope the cross-disciplinary approach of their studies will advance optimal retail practices.


Related reading on Kellogg Insight

The Outlet Mall: Dumping ground, cannibal channel, or smart strategy?

Really, I Can Return It? Sold! Optimizing your returns policy

A Surprising Secret to Netflix’s Runaway Success: A little uncertainty can go a long way