Xiao Huang and Dan Zhang. 2020. Service Product Design and Consumer Refund Policies. Marketing Science, 39(2): 285-457.
Customers often exhibit considerable uncertainty in their service valuations. In response, firms may tailor their products and allow service cancellations. We consider the joint product customization and refund policy decisions of a monopolistic firm selling to a heterogeneous customer population with imperfect signals on their valuations. Our results shed light on how customers' valuation uncertainty, characterized by the valuation heterogeneity and signal quality, drives the interaction between product line and refund policy designs. In particular, when the valuation heterogeneity is high, the firm may choose to offer a single quality level with full refund, leading to a variety reduction in the product line. In contrast, when the valuation heterogeneity is low, the firm will always offer a full product line without any refund. At moderate valuation heterogeneity, both qualities and refunds are subject to more customization, and partial refund can be optimal when the signal quality is high, even though our setup does not involve aggregate demand uncertainty, capacity limitations, competition, or channel conflicts. Interestingly, despite its appeal, generous refund terms do not increase aggregate customer surplus. Furthermore, the firm may not have incentives to reduce customers' valuation uncertainty even if doing so is costless. We verify the robustness of our results and discuss their practical implications.