Customization and Returns

Problem Definition: The current retail industry exhibits two historically orthogonal trends: customization and returns. On the one hand, consumers are increasingly searching for products that closely match their preferences. On the other hand, they feel entitled to return the purchased products, whether standard or customized, in case the products do not match their expectations. The firms’ response to these two trends is far from being unique. Even in the same industry, some firms provide ways to customize, while others sell only standard products; likewise, some embrace liberal return policies even for customized products, while others allow returns of only standard products. Given these, at times, opposing practices, yet the lack of research to guide firms, this article analyses firms’ decisions about product customization and returns. Academic/Practical Relevance: Prior research has not studied customization and returns through a unified framework, and, as a result, over-valued customization and under-valued returns. Our work is particularly relevant because customization and returns practices are prevalent in many industries and product categories. Methodology: We develop an analytical model and complement it with a numerical study that is calibrated based on interviews with industry executives. A firm (the Stackelberg leader), decides on which products to carry and on their prices and return policies. Consumers (the followers) decide on which product to purchase and whether to return it or not, based on the initial noisy valuations and on optimally exercising the return option upon experiencing the product and realizing their actual valuations. Results: We show that the firm may decide to sell only standard products, only customized products, or both product types, depending on the two novel measures that we introduce: value-contribution and value-efficiency, in addition to the salvage values for returns. The return policies, too, are determined by these two measures and the salvage values that can be extracted from returns, and become more lenient for higher salvage values. Managerial Implications: In addition to deriving the jointly optimal sales and returns strategy, we demonstrate that under certain conditions the introduction of customized products involves no changes in pricing and return policies for the standard products, which is good news from the organizational perspective. Further, even though returns generally increase with the salvage value, we also show that paradoxically an increase of the salvage value for customized products could result in a lower number of total returns, which is good news both economically and environmentally.