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Signaling Quality with a Money-Back Guarantee: The Role of Transaction Costs

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Author Info

  • Sridhar Moorthy

    (University of Rochester)

  • Kannan Srinivasan

    (Carnegie Mellon University)

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    Abstract

    Direct marketing is witnessing explosive growth. As consumers increasingly purchase products from their homes, their ability to judge the quality of products they buy is significantly reduced. In this paper we study how money-back guarantees can signal product quality in such environments. We interpret product quality broadly to mean both the level of attributes promised as well as the firm's consistency in delivering on those promises. Key aspects of our formulation are the explicit consideration of transaction costs, and alternative signals of product quality. Transaction costs are the costs the seller or buyer faces when redeeming a money-back guarantee. We show that money-back guarantees signal quality by exploiting the higher probability of returns for a lower quality product, and the attendant higher transaction costs. However, if the seller's transaction costs are very large, then there are less costly ways to signal, namely charging a high price. We compare the signaling performance of (1) price, (2) price with uninformative advertising, and (3) price with a money-back guarantee. Whereas uninformative advertising does not work at all in our model, under certain conditions a money-back guarantee is necessary to signal, and under other conditions, a money-back guarantee is a useful supplement to price.

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    File URL: http://dx.doi.org/10.1287/mksc.14.4.442
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    Bibliographic Info

    Article provided by INFORMS in its journal Marketing Science.

    Volume (Year): 14 (1995)
    Issue (Month): 4 ()
    Pages: 442-466

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    Handle: RePEc:inm:ormksc:v:14:y:1995:i:4:p:442-466

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    Related research

    Keywords: money back guarantee; warranty; signaling quality; transaction costs; separating equilibrium;

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    Citations

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    Cited by:
    1. Aydm Alptekinoglu & Alex Grasas León, 2011. "When to carry eccentric products? Optimal retail assortment under consumer returns," Economics Working Papers 1272, Department of Economics and Business, Universitat Pompeu Fabra, revised Nov 2012.
    2. Xiao, Tiaojun & Shi, Kuiran & Yang, Danqin, 2010. "Coordination of a supply chain with consumer return under demand uncertainty," International Journal of Production Economics, Elsevier, vol. 124(1), pages 171-180, March.
    3. Heiman, Amir & McWilliams, Bruce & Zilberman, David, 2001. "Demonstrations and money-back guarantees: market mechanisms to reduce uncertainty," Journal of Business Research, Elsevier, vol. 54(1), pages 71-84, October.
    4. Chen, Yongmin & Hua, Xinyu, 2010. "Ex ante Investment, Ex post Remedy, and Product Liability," MPRA Paper 22031, University Library of Munich, Germany.
    5. Yi Qian & Qiang Gong & Yuxin Chen, 2013. "Untangling Searchable and Experiential Quality Responses to Counterfeits," NBER Working Papers 18784, National Bureau of Economic Research, Inc.
    6. Bhargava, Hemant K. & Sun, Daewon, 2008. "Pricing under quality of service uncertainty: Market segmentation via statistical QoS guarantees," European Journal of Operational Research, Elsevier, vol. 191(3), pages 1189-1204, December.
    7. Carlyle Farrell & Gervan Fearon, 2005. "Renting Goodwill in International Marketing Channels: An Analysis of Pricing Strategies and Bargaining Power," Atlantic Economic Journal, International Atlantic Economic Society, vol. 33(3), pages 285-296, September.
    8. Chen, Jing & Grewal, Ravneet, 2013. "Competing in a supply chain via full-refund and no-refund customer returns policies," International Journal of Production Economics, Elsevier, vol. 146(1), pages 246-258.
    9. Alessandro Acquisti, 2014. "Inducing Customers to Try New Goods," Review of Industrial Organization, Springer, vol. 44(2), pages 131-146, March.
    10. Jung, Heonsoo, 2011. "Signaling quality with new product preannouncements: Vaporware and the role of reference quality," Journal of Business Research, Elsevier, vol. 64(11), pages 1251-1258.
    11. Levine, David I. & Cotterman, Carolyn, 2012. "What Impedes Efficient Adoption of Products? Evidence from Randomized Variation in Sales Offers for Improved Cookstoves in Uganda," Institute for Research on Labor and Employment, Working Paper Series qt7qk8m53w, Institute of Industrial Relations, UC Berkeley.
    12. Doyoung Kim & Jacques Lawarree & Dongsoo Shin, 2004. "Exit Option in Hierarchical Agency," Econometric Society 2004 North American Winter Meetings 269, Econometric Society.
    13. Nizovtsev, Dmitri & Novshek, William, 2004. "Money-back guarantees and market experimentation," International Journal of Industrial Organization, Elsevier, vol. 22(7), pages 983-996, September.
    14. Anthony J. Dukes & Rajeev K. Tyagi, 2009. "Pricing in vitro fertilization procedures," Health Economics, John Wiley & Sons, Ltd., vol. 18(12), pages 1461-1480.
    15. Aydin Alptekinoglu & Alex Grasas, 2012. "When to Carry Eccentric Products? Optimal Retail Assortment under Consumer Returns," Working Papers 680, Barcelona Graduate School of Economics.
    16. Toktay, B. & van der Laan, E.A. & de Brito, M.P., 2003. "Managing Product Returns: The Role of Forecasting," ERIM Report Series Research in Management ERS-2003-023-LIS, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.
    17. Liu, Jian & Mantin, Benny & Wang, Haiyan, 2014. "Supply chain coordination with customer returns and refund-dependent demand," International Journal of Production Economics, Elsevier, vol. 148(C), pages 81-89.
    18. Davis, Scott & Hagerty, Michael & Gerstner, Eitan, 1998. "Return policies and the optimal level of "hassle"," Journal of Economics and Business, Elsevier, vol. 50(5), pages 445-460, September.

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