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Supply Chain Coordination for False Failure Returns

College of Management, Georgia Institute of Technology, 800 West Peachtree Street, Atlanta, Georgia 30332-0520
Department of Supply Chain and Information Systems, Smeal College of Business, Pennsylvania State University, University Park, Pennsylvania 16802
Robert H. Smith School of Business, University of Maryland, College Park, Maryland 20742
mark.ferguson{at}mgt.gatech.edu
dguide{at}psu.edu
gsouza{at}umd.edu

False failure returns are products that are returned by consumers to retailers with no functional or cosmetic defect. The cost of a false failure return includes the processing actions of testing, refurbishing (if necessary), repackaging, the loss in value during the time the product spends in the reverse supply chain (a time that can exceed several months for many firms), and the loss in revenue because the product is sold at a discounted price. This cost is significant and is incurred primarily by the manufacturer. Reducing false failure returns, however, requires effort primarily from the retailer, for example informing consumers about the exact product that best fits their needs. We address the problem of reducing false failure returns via supply chain coordination methods. Specifically, we propose a target rebate contract that pays the retailer a specific dollar amount per each unit of false failure returns below a target. This target rebate provides an incentive to the retailer to increase her effort, thus decreasing the number of false failures and (potentially) increasing net sales. We show that this contract is Pareto improving in the majority of cases. Our results also indicate that the profit improvement to both parties, and the supply chain, is substantial.

Key Words: consumer returns; closed-loop supply chains; supply chain contracts
History: Received: August 12, 2004; accepted: March 16, 2006.

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