Demand Uncertainty and Returns Policies

Abstract

Manufacturers facing uncertain demand may induce distributors to carry ample stocks of their products by agreeing to accept returns of unsold goods for credit. The authors model the manufacturer's decision to accept returns, showing that this decision depends crucially on the nature of the demand uncertainty. Uncertainty over customer arrivals favors returns, while uncertainty over consumers' valuation of the manufacturer's product leads distributors to set retail prices too high (from the manufacturer's standpoint) when returns are allowed. The authors show that returns can be expected to raise retail prices, while maintaining shrinking distributor margins. Copyright 1995 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.