Mitigating Uncertainty in Digital Era: Dynamic Pricing and Return Policies with Consumer Pre-purchase Evaluation 


Student thesis: Doctoral Thesis

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Award date21 Jan 2021


E-commerce has experienced an incredible boom over the past decade. Despite its rapid expansion, the primary concern is that consumers are uncertain about product valuation due to the lack of physical inspection. The valuation uncertainty may hinder consumers’ purchase intention ex-ante and lead to high return rates for firms. Consumers can resolve uncertainties through engaging in costly evaluation tasks or learning from others. Meanwhile, online sellers can devise return policies or improve consumer ex-ante product knowledge to help consumers mitigate uncertainties. This dissertation studies how online firms can strategically maneuver their pricing strategies and return policies to mitigate consumers’ valuation uncertainties and achieve profitability by endogenizing consumers’ evaluation, purchase and return decisions.

In the first study, we develop a two-period model to explore how a monopolist can manipulate its pricing strategy to leverage consumers’ costly evaluation and consumer reviews to mitigate uncertainties. Our results show that under homogeneous evaluation costs, the monopolist can benefit from inducing evaluation when the evaluation cost is sufficiently low. It is because encouraging evaluation resolves uncertainties and enables the firm to screen consumers by charging a high price. The firm’s price increase with evaluation costs when it prevents evaluation. Under heterogeneous consumers, the seller would induce low-cost consumers to discover their true product value through costly evaluation tasks in the first period. Consumer reviews shared by these consumers provide a basis for consumer learning and firm learning, thus further removing uncertainties in the second period. Further, our analysis shows that although consumer reviews can render both positive and negative learning outcomes, consumer reviews can have an asymmetric but positive impact on the sellers’ profit. The intuition is as follows. The monopolist can benefit from favorable reviews but mitigate the adverse effect of unfavorable reviews by adjusting his second-period price to surpass remaining consumers’ evaluation intentions.

The second study analyzes the optimal price and restocking fee decisions of two horizontally differentiated firms. By endogenzing consumers’ deliberation, purchase, and return decisions, we explore the relationship between two uncertainty-mitigating mechanisms: offering lenient return options and improving consumer pre-purchase knowledge. We obtain several results. First, the ex-ante evaluation option and the ex-post return option are substitutes under monopoly. Both options allow the seller to screen consumers and charge high prices. Thus, the seller will induce evaluation with the no-return policy when the evaluation cost is sufficiently low; otherwise, it will discourage evaluation with the free return policy. Surprisingly, under competition, lowering consumers’ evaluation costs would lead to lower restocking fees, higher selling prices, and lower profits for both firms, suggesting that these two uncertainty-mitigating mechanisms complement each other. Because uninformed consumers have higher chances to return than informed consumers, firms are more willing to induce consumers to engage in costly evaluation and make informed consumption. As evaluation costs increase, firms would lower their selling prices to induce evaluation. Recall that consumers can reduce uncertainties through the ex-ante evaluation or the ex-post return. They are willing to pay more for the return options when the ex-ante evaluation becomes more expensive. Thus, firms can charge higher restocking fees to recoup costs because increasing evaluation costs will lead to more returns than sales. We also examine the asymmetric case where one firm allows returns while the other does not. We find that firms always have incentives to provide return options since the firm with return options would always obtain higher profit than its competitor without return options. Moreover, lowering consumers’ evaluation costs would lead to a higher selling price and more generous return policy for the firm with return options, but a lower selling price for the firm without return options. Our results suggest that firms should carefully tailor their return policies when investing in improving consumer product knowledge before purchase.