Money back guarantees in retailing: matching products to consumer tastes

Abstract

Retailers often sell products that consumers cannot fully evaluate before purchase. To reduce consumer risk, some retailers offer consumers money-back guarantees (MBGs). We develop a simple model that allows us to determine conditions in which MBGs work best to enhance profits and social welfare. According to our model, the profitability of an MBG for a particular product can be assessed by estimating salvage values of returned merchandise, the probabilities of mismatching the product to consumers, transaction costs of returning merchandise, and consumer value of product trial. Preliminary evidence supporting our theory is presented.