General return contracts for style goods: expected utility approach

Abstract

A return policy is commonly used by retailers to hedge for overstock risk. A number of research studies have developed models to identify when the manufacturer should accept returns. However, few of these studies consider the risk attitude of the decision maker, that is, existing papers assume that both the manufacturer and retailer are risk-neutral. Rather than ignore the risk attitude of the retailer and manufacturer, this paper relaxes this assumption and constructs a general returns model through the expected utility approach. An inventory theoretic model is developed and a menu of discount-return combinations is designed for the feasible solutions of a wholesale price discount and buyback price. It is shown that the decision to join a returns contact considerably depends on the utility functions for both the retailer and manufacturer. That is, the risk attitude is a core factor for the retailer and manufacturer to decide if to sign a returns contact, and without considering the factor in the model, the decision may be biased.

Keywords:

• Risk management
• Utility theory
• Return policy
• Inventory model