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June 8, 2009

Retailing Customized Products: Pricing, Inventory and Refund Policies.

Alex Grasas, University of Florida.

Advances in information and manufacturing technologies are changing the retailing industry, allowing firms to offer highly customized products through online retail channels. Such extreme product variety is also forcing changes in consumer return policies. Leaving generous 100% money-back guarantees behind, many online retailers of customized products restrict their product return policies, and not even allow returns in some cases. In this paper, we study optimal pricing, refund, and inventory policies of a customizing firm. The firm sells a type of product that can be customized into a finite set of product variants. The firm also accepts product returns in resalable condition. We consider the problem in single- and multiple-period settings. We find that partial refunds are generally optimal. In fact, the firm sets its refund such that it offsets the cost of product returns. In a single-period setting, partial refunds allow the firm to charge a higher price than the price with no returns allowed. In a multiple-period setting, we show that a salvage-down-to inventory policy is optimal. That is, instead of salvaging all returns (e.g., selling them in a secondary market), the firm decides to keep some of them up to a salvage level to satisfy future demand. We observe that some of the expected savings from being able to carry inventory from one period to another can be passed onto the customers, surprisingly, not in the form of higher refunds but of lower prices (again, compared to the case with no returns allowed). Finally, we develop a heuristic to find a near-optimal price for the multiple-period setting.