Information Acquisition and Refunds for Returns

Abstract

A product exhibits personal fit uncertainty when its consumers have idiosyncratic and uncertain values for it. Often a consumer can learn her long-run value quickly by obtaining the good for a trial period. Money back guarantees of satisfaction are commonly used to lower the cost to consumers of learning their values this way. Increasingly, however, consumers can instead learn about their values before they purchase by, e.g., reading product reviews or consulting experts. We study the effect on a firm’s optimal price and refund of this competing source of information. An efficient outcome would be achieved by setting the refund for a return equal to its salvage value. But a monopoly will, for some parameters, induce consumers to stay uninformed by promising a refund that is greater than the salvage value. This generates an inefficiently large number of returns, which the firm finds worthwhile in order to eliminate the information rents that consumers would obtain by becoming informed. This finding is consistent with the observation that for many products, money back guarantees are generous, as they commonly refund the entire, or almost the entire, purchase price of a product.information acquisition, refunds, money back guarantees, personal fit uncertainty