Manufacturer’s contract choice and retailer’s returns management strategy

Abstract

Managing customer returns is a supply chain issue; manufacturers typically manage them through buyback contracts, while retailers can attempt to recover a product’s salvage value, or sell it as an open-box item. This paper investigates returns management strategies by developing a game theoretical model for a supply chain with a manufacturer (Stackelberg leader) and a retailer (the follower) facing customer returns. The manufacturer chooses either a buyback or a wholesale-price contract. Under a wholesale-price contract, the retailer either salvages or resells returned products. We identify the optimal returns management strategy. We show that each of the three strategies may achieve Pareto improvement for both supply chain members, and for the customers and society. The retailer’s choice to resell or not depends on its inspection cost, or the system efficiency of the supply chain in reselling a returned product relative to that in selling a new product. The manufacturer’s choice of contract depends on whether it can salvage a returned product more efficiently than the retailer, and on the retailer’s unit inspection cost of the returned product. We capture a few identifiable quantities and thresholds that help the manufacturer and the retailer to simplify decision making.