Competitive Returns Policies with Salvaging: When Less is More

Abstract

Online retailers are divided over the optimal use of salvaging in their returns policies. Should firms have restrictive returns policies yet unconstrained use of secondary markets for salvaging, thereby risking oversupply and low salvage values? Or should firms have lenient returns policies while limiting the size of their secondary market, thus engaging in repeated and costly refurbishing activities? This paper investigates optimal returns policy decisions in a competitive environment with endogenous salvaging values. The strategic decisions are two components of the retailer's returns policy: price and restocking fee. We consolidate retailer decisions in a duopoly setup under which endogenous salvaging is modeled as an interaction effect between the primary and secondary market. We find that "smart salvaging" is more profitable and consumer friendly than charging customers to return products and then salvaging them en masse at rock bottom prices in secondary markets. More specifically: if there are exchanges and salvage values are below unit cost then, at equilibrium, it is optimal for retailers to increase restocking fees and prices, which increases profits but reduces customer satisfaction. When salvage values exceed unit cost, only prices increase while restocking fees are eliminated; which boosts both profits and customer satisfaction. Moreover, retailers that asymmetrically dominate their competitors in terms of salvaging can significantly outperform them with regard not only to sales and profits but also to returns policy leniency. This is a win-win outcome because it increases the utility of retailers and customers alike.

Keywords: returns policies; pricing; restocking fees; salvaging