When to Carry Eccentric Products? Optimal Retail Assortment under Consumer Returns

To understand whether retailers should consider consumer returns when merchandising, we study how the optimal assortment of a price-taking retailer is influenced by its return policy. The retailer selects its assortment from an exogenous set of horizontally differentiated products. Consumers make purchase and keep/return decisions in nested multinomial logit fashion. Our main finding is that the optimal assortment has a counterintuitive structure for relatively strict return policies: It is optimal to offer a mix of the most popular and most eccentric products when the refund amount is sufficiently low, which can be viewed as a form of risk sharing between the retailer and consumers. In contrast, if the refund is sufficiently high, or when returns are disallowed, optimal assortment is composed of only the most popular products (a common finding in the literature). We provide preliminary empirical evidence for one of the key drivers of our results: more eccentric products have higher probability of return – conditional on purchase. In light of our analytical findings and managerial insights, we conclude that retailers should take their return policies into account when merchandising. Consumer return policies and product assortment are typically considered as separate realms of the retailing business. Returns are often viewed as micro and more operational, and assortment as strategic and more marketing related. This state of affairs leads to decisions in each area to be made separately and independently of the other (Stock et al. 2006, Olavson and Fry 2006). We counter this conventional thinking by proving that optimal assortment decisions are fundamentally different when returns are taken into account. Returns are financially important for retailers. The annual value of returned goods in the United estimate puts the industry's annual spending on reverse logistics for processing and disposition of returns at more than $40 billion (Enright 2003). Ever-increasing product variety only serves to per unit returned *Percentage of price. **Restocking fee not specified on the website. make returns even more costly, as it increases the complexity of various processes used for returns In this paper we investigate how the product assortment decision of a price-taking retailer is influenced by its return policy. We treat two basic operational environments, make-to-order (MTO) and make-to-stock (MTS), that allow us to draw a sharp distinction between retail settings that differ on the timing of supply decision. Under MTO (MTS), procurement of products happens after (before) consumers make their purchase decisions. Our demand model …