AI Adoption, Privacy Concerns, and Return Policies in Online Retailing

ABSTRACT Product misfit is a major cause of product returns in online retailing. To reduce consumers' concerns, retailers often offer return shipping insurance, but this policy increases firms' operating costs. With the development of artificial intelligence (AI), retailers also use AI tools to help consumers better evaluate product fit before purchase and reduce return probability. However, AI adoption requires investment and may raise consumers' privacy concerns, which makes its economic value uncertain. We develop a game‐theoretic model incorporating product misfit probability, the fit improvement effect of AI, consumers' privacy costs, return shipping insurance, and firms' pricing decisions, as well as compare equilibrium outcomes across four scenarios: no insurance and no AI (NN), AI only (NA), insurance only (RN), and the joint use of insurance and AI (RA). We find that AI adoption does not always improve prices or profits; its value depends on the effectiveness of AI in improving product fit, the associated investment cost, and consumers' privacy concerns. Because stronger product fit improvement is accompanied by a higher AI investment cost, changes in AI effectiveness affect the retailer and the manufacturer differently. Return shipping insurance reduces consumers' financial burden associated with returns but increases the retailer's expected return‐related cost. Therefore, the joint use of AI and insurance is beneficial only under appropriate combinations of AI effectiveness, AI investment cost, return‐related cost burden, and privacy concerns; otherwise, insurance without AI may yield more stable supply chain performance. These findings highlight the importance of coordinating AI adoption, return policy design, and privacy management.