Thinking E-Commerce? Think return policies [pt. I]

This series on return policies originated in my bachelors studies. The first part describes why return policies are used and why it is important to think about them. The second part will describe the costs and benefits of return policies in more detail. The third part will briefly show the model used and present a conclusion. I hope that the series will be interesting to all people working in ecommerce and shopping online in general.

There is a trend in both, E-Commerce and (to a lower extent) in brick-and-mortar to provide better and better service. A large part of the new mantra is the way product returns are handled. Nowadays, online retailers often do not charge customers restocking fees. The most famous example from the start was Zappos allowing customers to return merchandise for free within one year. However, we can observe this trend offline as well: This year Apple abandoned their restocking fee at all apple stores.

The analysis of return policies is highly relevant. Customers make use of their right to return products. It has recently been reported that in the U.S. alone customers return products valued at more than $100 billion annually. Looking at online retailers, the average return rate is 5,6% of sales with high seasonal and category variations. For instance, Zappos had a return rate of 38% in 2008. For high fashion customers return up to 35% of apparel purchased.

Return policies are important for all of us when acting as customers. Returning disappointing or broken merchandise can be painful but is part of the shopping experience. Who hasn’t ever been asked to pay a 15% restocking fee and had to wait inconveniently long in order to return a product? It makes us feel bad, not only because we are frustrated that we have to return a product that we initially thought was right but also because we have to loose time doing it. What a pain! In fact return policies are so important that people will stop shopping at a certain retailer because of the return policy: For instance, if a gift can only be exchanged for store credit and not for cold hard cash. When shopping online, return policies are even more important as they provide value in a risky environment.

First of all, offering a return policy shows that a brand stands behind its products. Moreover, we cannot always be sure that we are buying the right product. Some products can only be evaluated after the purchase (e.g. the fit of a shirt); others require a certain level of knowledge in order to make the right purchase decision (e.g. digital camera). As we cannot observe the product before the purchase, we often cannot make an informed decision. Unpleasant consequences can result from the product not meeting expectations such as use, repair and psychological costs and the time to purchase, use and repair. Only part of the costs can be evaluated at the time of the purchase, though. For durable goods, consumers have to consider not only immediate results of the purchase, such as the price paid, but also longer-term consequences of product ownership, like durability. It is also quite hard to select products that constantly change (e.g. fashion), as well as durable goods that we do not buy often (e.g. refrigerators), or goods where the customer’s characteristics change over time (e.g. children’s clothing size). In these categories return policies are even more important. Lwin and Williams (2006) asked consumers in a study to rate the risk they perceive when buying products over the Internet. The consumers ranked “financial/overpayment”, “improper/infrequent/difficult use” and “poor quality” as their top three risks respectively. As return policies reduce risk for consumers they become more important when more money is at stake, consumers are less self-confident, less familiar with the product or product category and have less experience. In fact return policies are so important that a meta analysis comparing risk relievers (Lwin and Williams (2006)) came to the conclusion that warranty/money-back guarantee ranks first, followed by brand/manufacturer reputation and retailer reputation.

The concept of perceived risk can be used as an explanatory variable: Around 20% of the variance in product preference in empirical studies could be explained by perceived risk. According to Higgins (2002) one of the two motivations that guide people is the prevention focus. It is concerned with security, protection, safety and loss avoidance. The reason why perceived risk is so good at explaining consumer behaviour is because people try to avoid mistakes rather than to maximize utility. Generally speaking, the more risk a customer perceives, the less likely he or she will purchase.

For sellers, return policies have both, economic and reputational effects. Nowadays, most retailers offer return policies. There are plenty of reasons why this is the case: Retailers may be obliged to offer them by law (see table), they may offer them because of competitive pressure, or because it is the norm in their industry.

Table 1 – Comparison of return obligations as prescribed by German law

Return reason Distance Shopping Brick-and-mortar shops
Without any reason Yes No
Without a receipt Yes No
Without the original packaging Yes No
Bad fit Yes No
Food No No
Product is broken Yes – Warranty Yes – Warranty
Product does not function as claimed Yes – Warranty Yes – Warranty

For instance, in the publishing industry it is a conventional industry norm, that retailers can return unsold books to the publishers for a full refund. Retailers use return policies to differentiate themselves from the competition. According to Berry (1986) retailers do not differentiate through the goods they sell, as those do not differ greatly from competition, but through the service they offer. Some companies have successfully created a reputation for great service. Two examples are Zappos and Lands’End. Lands’End describes its guarantee as being unconditional: “If you’re not satisfied with any item, simply return it to us at any time for an exchange or refund of its purchase price.” Another recent example is Best Buy. An important argument for online business is that, return policies do affect churn rates. These examples demonstrate how return policies, which are part of customer service, can be used to build market share.

In today’s world when news can spread virally, service is even more important and offering a great return policy counts towards great service. If a company successfully and quickly resolves complaints the satisfied customer will tell an average of 5 people about the good treatment he received (Kotler & Keller, 2009). However, in extremely positive cases a good customer experience can easily go viral, as demonstrated by the reddit used zambuka42. A reputation for good service reduces perceived risk for consumers. Positive reputation and warranty information are especially important drivers of purchase intention for e-commerce retailers, because of the increased risk in the distance-shopping situation.

The optimal return policy would be beneficial for both buyer and seller. It would give the buyer a certain period of time to evaluate the purchase and think about the advantages and disadvantages. If he comes to the conclusion that the product does not fit his needs he could return it to the seller. The seller may initially profit from increased sales because customers feel safer. If product returns are costly for the retailer he has to carefully adjust his generosity. “Gross margins can be strongly affected by […] return privileges”. The retailer has to weigh the cost and benefits of his return policy. Customers adjust their return and purchase behaviour to the different factors of a return policy. Thus, a return policy can directly affect the retailer’s profitability.

This is why successful companies think about not only forward logistics (sales) but also reverse logistics (returns). Who doesn’t has this one aunt or uncle who keeps getting you stuff you just won’t wear for the world? Amazon has just filed for a patent to solve this problem in a way that is beneficial for us and them. What they do is they allow to convert all gifts from specific persons to things we actually will appreciate. Now that is awesome!