How are Demand and Returns Related ? Theory and Empirical Evidence February 2006

The relationship between demand and customer returns represents an important input to inventory planning models. While poor estimates of this relationship can dramatically increase inventory management costs (de Brito and van der Laan, 2002), there is surprisingly little research on the topic. In this paper we investigate the relationship between demand and returns by comparing how customers’ returns behavior for apparel items varies both across items and within an item. To guide our empirical analysis, we develop an economic model of customer purchase and returns behavior that yields testable predictions. We reject the model that customer return rates are independent of price paid. Instead, we find support for the perceived value hypothesis, which predicts that customer return rates increase with the price paid. This finding has important implications for the coordination of marketing and operations decisions. Our analysis also yields a number of additional empirical insights into customer returns behavior that are expected to generalize to other contexts.