Return policy is a strategic tool widely used by firms to build long-term relationship with their consumers. We develop a novel O2O (online to offline) competition model to address how the competitive return policies can be employed to coordinate the O2O distributions under the manufacturer – traditional retailer supply chain where the manufacturer opens an online channel to compete with the traditional retailer. Our results show that utilizing the revenue sharing plus profit sharing mechanisms, the manufacturer and the traditional retailer can employ different return policies for their respective channels to coordinate the O2O distributions and achieve a Pareto solution for all parties in a manufacturer – traditional retailer supply chain. Particularly when the product is becoming increasingly compatible with online sales, the value of the differential of return policies would further increase for both the manufacturer and the retailer.

Introduction

Return policy plays a significantly important role in the business market. Return policy is a strategic tool widely used by firms to build long-term relationship with their consumers. Allowing consumers to return the purchased products protects consumers who experience product misfit, a wrong order, and other problems. Having a wellthought-out return policy is the key to attracting and keeping consumers and an offered return policy potentially increases consumer’s willingness to purchase the products (Bechwati and Siegal, 2005; Jeng, 2017; Zhang et al., 2017) and improves market demand, which in turn creates a competitive advantage for firms (Yan, 2009; Zhang et al., 2017). However, product returns also increase monetary costs for firms. For example, even if products are returned in an original condition, retailers (e.g., merchants in the apparel and consumer electronics industry) often cannot directly put the returned items back in shelves. The apparel may be out of season upon return and electronics may have become outdated. For such products, retailers have to discount the merchandise or liquidate it, which increases the return related costs (Brohan, 2005). According to the report of marketwatch.com on June 18, 2015, the value of products consumers returned to retailers worldwide exceeds $642.6 billion annually. In addition, the report of marketwatch.com on December 21, 2016 further shows that Americans return more than $260 billion in goods each year. Therefore, the return policy is a set of tradeoffs for a firm – a generous return policy can increase sales revenue by inducing more consumers to purchase, but also increases the quantity of product returns and leads to substantially higher costs. As a result, designing and employing an optimum return policy become critically important to firms.