Abstract

Returns policies which allow consumers to return products for a refund are commonly offered by manufacturers. In this paper, we characterize the optimal returns policy for a manufacturer who designs a product line to serve several market segments with different preference for quality. We find that when consumers with higher preferences for quality also have a higher cost of returns than consumers with lower preferences for quality, allowing returns for a low-end discourages high-valuation consumers from purchasing that item and achieves better screening. When the screening effect is large enough, the manufacturer allows returns for the low-end item even though the returned good has no salvage value. To reinforce this effect, the manufacturer optimally lowers the quality of the low-end item and thus stretches the product line. Finally, under different conditions of parameters, we describe the product line. Finally, under different conditions of parameters, we describe the manufacturer's optimal returns and the corresponding product qualities.