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Reply to "do returns policies intensify retail competition?".

Article Excerpt
Returns policies are common in many sectors of retail distribution. Padmanabhan and Png (1997) showed that with demand uncertainty, a returns policy could improve manufacturer profitability under certain conditions. Wang (2004) showed that returns policies do not change manufacturer profitability when demand is certain and retailing is competitive. We show that returns policies do increase manufacturer profitability by attenuating retailer price competition when demand is low and intensifying competition when demand is high. Importantly, this effect holds only in the presence of demand uncertainty. Further, the conditions under which a returns policy raises the manufacturer's profit are weaker when retailing is a duopoly than when retailing is a monopoly. This suggests that returns policies serve both to manage competition and mitigate demand uncertainty.

Key words: returns policies; retail competition; demand uncertainty; pricing

History: This paper was received January 28, 2004, and was with the authors 1 month for 1 revision; processed by Z. John Zhang.

1. Introduction

Marketing, operations management, and economics researchers have been interested in the conditions under which returns policies coordinate channels and supply chains (Pasternack 1985, Marvel and Peck 1995, Padmanabhan and Png 1995, Butz 1997, Cachon and Lariviere 2002, Granot and Yin 2002, Rao and Mahi 2003). (1)

Padmanabhan and Png (1997) showed that with demand uncertainty, a returns policy could improve manufacturer profitability under certain conditions. They further claimed that, even in the absence of demand uncertainty, a returns policy could raise manufacturer profitability by dampening price competition between retailers. However, this claim was disproved by Wang (2004), who showed that returns policies do not change manufacturer profitability when demand is certain and retailing is competitive.

In this paper, we show that returns policies do increase manufacturer profitability by helping it better manage price competition between retailers but that this effect holds only in the presence of demand uncertainty. Interestingly, the conditions under which a returns policy raises the manufacturer's profit are weaker when retailing is a duopoly than when retailing is a monopoly. This suggests that returns policies serve both to manage competition and mitigate demand uncertainty. (2)

2. Model

Let the information structure and sequence of actions be as follows. Initially, all parties are uncertain about the state of primary demand, which could be low or high ([theta] = 1 or h, respectively). The probability of demand being low is A. In the first stage, the manufacturer sets a distribution policy comprising a wholesale price w and whether to accept returns. In the second stage, the retailers independently order stocks [s.sub.i]. Then, in the third stage, the true primary demand state is revealed to all parties, and the retailers independently set prices, [P.sub.i[theta]], i = 1, 2, = 1, h. (3) Let demand at retailer 1 be

(1) [q.sub.10] = [[alpha].sub.[theta]] - [beta][p.sub.1[theta]] + [gamma][p.sub.20].

Demand is more sensitive to the retailer's own price than the competitor's price (i.e., [beta] > [gamma]). Information is symmetric: specifically, [lambda], [[alpha].sub.[theta]], [beta], and [gamma] are known to all.

2.1. No Returns

In this case, the manufacturer sets a...