The impacts of money-back guarantees in the presence of parallel importation

Abstract

This paper studies the impacts of money-back guarantees (MBGs) in the presence of parallel importation, where a manufacturer sells a product facing customer fit uncertainties in two markets and a parallel importer diverts unauthorized products from the low-price market to the high-price one. The two firms compete in both pricing and MBG strategies. We consider two types of parallel importers, a third-party agent and an authorized retailer in the low-price market, respectively. By applying the certainty equivalent pricing approach, we show that offering MBGs only changes firms’ marginal costs without affecting customers’ purchasing decisions directly. When the net salvage values of returned products are positive in the high-price market, both the manufacturer and the third-party agent offer MBGs. Whenever the manufacturer offers an MBG in the low-price market, there is a price inflation effect that counters parallel importation. Therefore the manufacturer may offer the MBG even if the net salvage value is negative. When the authorized retailer decides refund policies in two markets, the MBG strategy in one market changes the retailer’s profit from the authorized channel and that from the gray market in opposite directions, and has an interaction with the refund policy in another market. No refund may be preferred in either market even if the net salvage value is positive. We find that the manufacturer’s MBG strategy in the high-price market always deters parallel importation while other MBG strategies may achieve Pareto improvements in the equilibrium.