Working Paper: Behavior-Based Product Return Policies, with James A. Dearden

Abstract:  U.S. consumers are estimated to have returned over $890 billion worth of retail products in 2024, a sharp increase from previous years, highlighting the growing importance of managing product return policies. This paper investigates the optimal design of behavior-based product return policies, specifically focusing on the practice of targeting consumers with histories of excessive wardrobing. We develop a two-period model where a firm begins by offering a money-back satisfaction guarantee and possibly penalizes consumers for histories of excessive wardrobing. In this framework, a firm can choose between two penalty types: targeted returns, which denies future product returns, and targeted sales, which denies future product purchases. Our model identifies three distinct equilibrium policies and explores the trade-off between deterrence and enforcement costs, showing that the optimal policy depends on both consumer loyalty and the firm’s ability to enforce penalties. Importantly, we find that firms in some settings adopt the stricter targeted sales policy, albeit with a higher threshold of product use to trigger the penalty, when consumers have less capacity to misuse returns. Additionally, our analysis reveals that targeted sales policies are not renegotiation-proof and may fail if enforcement mechanisms are not credible. The paper concludes with recommendations for firms to use data-driven, consumer-specific return scores to guide policy implementation, while emphasizing the importance of credible commitment in enforcing return restrictions.