Implications of retailer-owned digital twins services: The trade-offs between customer experience, misfit returns reduction, and investment costs

Many prominent retailers, including Walmart, Kroger, IKEA, and Amazon, utilize Digital Twins (DTs) to enhance customer experience and reduce misfit returns by creating virtual replicas of products, service systems, shopping environments, and customer interactions. However, prior studies on DTs have mainly centered on applications within the manufacturing sectors, thereby overlooking the development of DT services owned or operated by retailers. To fill this gap, our models analyze how retailer-owned DT service is shaped by the trade-off between customer experience, misfit returns reduction and investment expenditures, as well as investigate its impact on the manufacturer's equilibrium decisions and profits. Our analysis indicates that higher levels of product misfit and consumer return losses incentivize retailers to adopt DTs. Furthermore, although retailer-owned DT may benefit manufacturers and lead to Pareto improvements, manufacturers should be cautious, as higher DT adoption costs for ‘inefficient’ retailers can result in a win-lose situation. This occurs because retailer-owned DTs, while potentially enhancing the manufacturer's equilibrium quality and wholesale prices, can also incentivize ‘inefficient’ retailers to raise retail prices further, which reduces the optimal sales volume and negatively impacts the manufacturer's overall profits. In addition to confirming the robustness of our main findings, our two extensions further reveal that, (i) there is an inverted U-shaped relationship between retailers' incentives for DT adoption and consumers' privacy concerns, and (ii) previous-period misfit returns diminish retailers' incentives for DT adoption.