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Yan Liu and Dan Zhang. 2023. . Forthcoming, Management Science.

Consumers often receive a full or partial refund for product returns or service cancellations. Much of the existing literature studies cash refunds, where consumers get their money back minus a fee upon a product return or service cancellation. However, not all refunds are issued in cash. Sometimes consumers receive credit that can be used for future purchases, oftentimes with an expiration term after which the credit is forfeited. We study the optimal design of credit refund policies. Different from models that consider cash refunds, we explicitly model repeated interactions between the seller and consumers over time. We assume that consumers’ valuation for the product/service varies over time, and that there is an exogenous probability for product returns. Several interesting results emerge. First, a credit refund policy facilitates intra-consumer price discrimination for a single type of consumers with stochastic valuation. Second, an optimal policy often involves an intermediate credit expiration term, under which a consumer with a high product valuation always makes a purchase, while a consumer with a low product valuation may be induced to make a purchase as the credit approaches expiration, leading to a demand induction effect. Finally, a credit refund policy can be more profitable than a cash refund policy and can lead to a win-win outcome for both the firm and consumers under certain conditions. We also consider several extensions to check the robustness of our findings.