Returns Policy and Quality Risk in E-Business

In this paper, we investigate the interplay between the returns policy, the pricing strategy, and the quality risk. We define quality risk as the possibility of product misfit, defect, or unconformity with the consumers' perception. These notions of quality risks differ in return policy restriction, residual values, and whether it is possible to unambiguously reduce the probability of mismatch. Using a stylized two-segment market setting, we demonstrate that consumer returns are offered only when the high-segment consumers incur a higher hassle cost, and both the quality risk and the valuation of the low segment are moderate. Moreover, it is possible to wisely design the returns policy that eliminates all inappropriate returns. Furthermore, the seller with a high quality risk may offer a refund that exceeds the selling price, which provides a theoretical ground and specific operating regime for the satisfaction guaranteed policy used in some e-tailers. On the other hand, when the quality risk is relatively low, further improvement on mitigating the quality risk may not necessarily benefit the seller. Finally, we observe that the restocking fee may be non-monotonic in product quality; thus, a more generous returns policy does not necessarily indicate a lower quality risk.