Demand Uncertainty, Returns Policies and Upstream R&D

Abstract

Returns policy has been an essential part of contractual obligations between the upstream and downstream firms in the supply chain. However, as the increase in demand uncertainty recently, the costs of returns policy have become more and more expensive for upstream firms. To investigate whether the upstream suppliers can adopt some active actions to cope with the uncertain market demand, we establish a dynamic model with a two-tier market structure under demand uncertainty. Specifically, we study the upstream suppliers’ cost-reducing R&D activities under both full returns policy and no returns policy. Compared to no returns policy, full returns policy motivates the downstream retailer to order more stocks, but it requires the upstream suppliers to undertake all the potential returns risk caused by demand fluctuation. To avoid the potential returns loss under full returns policy, the upstream supplier has a stronger incentive to undertake R&D activities to reduce costs, especially when the demand fluctuation is higher. Furthermore, the upstream suppliers will invest more R&D as the increase in product differentiation under both full returns policy and no returns policy, since the impact of upstream supplier’s R&D on its own wholesale price become weaker as the increase in the product differentiation, but the impact on its rival’s wholesale price become stronger. We also analyze the equilibrium results in the numerical simulation method. All of the results show that, under some conditions, the combination of full returns policy and upstream suppliers’ R&D enable them to earn more money.