Should Companies Allow Returns of Customized Goods?

The push-pull effects of customization

Published: Tuesday, November 29, 2022 - 13:02

In the age of mass production, the demand for customization is increasing. Customers prefer products catered to their individual needs and preferences over standard items—albeit at a cost.

Fortunately, recent advances in information technology, logistics, and advanced manufacturing processes such as robotics and 3D printing have enabled firms to customize products at scale.

In the highly competitive sportswear landscape, for instance, Nike and Adidas offer customizable shoes, while Puma sells only standard shoes. But even though the two sportswear giants seem to see the value of offering customized goods, their approaches to returns policy differ. At the time of this writing, Adidas only allows returns of standard products; Nike accepts returns of both standard and customized products.

In practice, returns of customized products is a tricky problem for businesses. While standard products can be resold, that’s usually not the case for customized items. After all, what is stylish to one may be outlandish to another. Moreover, who would buy a pair of sneakers embroidered with another person’s name? In such cases, should firms allow returns of customized goods? And under what conditions?

A three-dimensional problem

Dollars and cents matter when deciding when to allow product returns. Put simply, companies must weigh product return costs against the potential sales increase arising from allowing them. We’re not looking at trivial numbers. In the United States, 21 percent of online orders, worth some $218 billion, were returned in 2021, according to the National Retail Federation, up from 18 percent in 2020. In the clothing and shoes category, returns can hit 40 percent. The Covid-induced online shopping boom has only amplified the scale of this.

However, although consumers have come to expect lenient returns policies (thanks to the prevalence of online shopping), companies that offer only customized products tend to disallow returns because the value of these products can’t be salvaged. To the company, returned customized goods simply translate to high costs.

Companies that offer both standard and customized products see increased complexity. Not only do these companies need to consider the prices, costs, demand, and returns for standard and customized products separately, but also the interaction between products. It’s a three-dimensional dilemma: how to coordinate pricing, product line, and returns strategies that both increase profits and reduce returns. That is, companies must decide whether to offer standard, customized, or a mix of both product types, as well as the respective product returns policies.

In a study on customization and returns, my co-authors and I developed a joint framework that captures the complexity of this three-dimensional trade-off. By modeling the interactions between standard and customized products, we enable product owners to jointly analyze product-line strategy (customized and/or standard) and product-returns strategy (allow or disallow returns, and whether to impose restocking fees/penalties).

In addressing this three-dimensional problem, we took a consumer behavior perspective, as opposed to prior studies that mainly focused on price, return refund, and demand uncertainty. In a nutshell, consumers seek to maximize satisfaction derived from a product, and should they feel dissatisfied by the experience they would return it.

We examined the question via a model of strategic interactions (called the “Stackelberg game” model) in which the company decides on prices and returns policies for its customized and standard products. In response, consumers decide which product to buy and whether to return the product after experiencing it. Both parties act strategically: Consumers consider possible returns in their purchase decisions, while the company incorporates the consumers’ anticipated purchase and return response into its pricing and returns policy decisions.

Our findings show that manufacturers and retailers can reduce product returns—surprisingly—by relaxing returns policy of customized products. In general, the case for companies moving toward product customization is clear: Consumers recognize the value of products tailored to their needs and are willing to pay more for them. By allowing returns of customized products, companies can boost demand by reducing consumers’ risks of buying these relatively more expensive products.

For companies that offer a mix of standard and customized products, a more relaxed returns policy acts as a behavioral nudge that not only increases overall demand but also pushes consumers to switch from standard products to customized ones, which are less likely to be returned. Conversely, should a company implement a no-returns policy for customized products, it pushes customers toward standard products, which are more likely to be returned.

Reducing uncertainty though customization

Another rationale for companies to offer customized products is to reduce uncertainty. The huge volumes of consumer data generated from online shopping, user subscription, and point-of-sale systems have helped companies to build more accurate profiles of their customers and therefore reduce uncertainty in demand.

Yet, while consumer data help companies know their customers, consumers may sometimes not “know” themselves, especially when making a first purchase in a new product category. This can result in uncertainty in demand and returns behavior. A study based on Nike’s customizable shoes shows that consumers who otherwise “lack precise knowledge of what they want” can “understand their preferences more clearly” through experimentation via a customization interface.

The process of customization is thus a journey of self-discovery for consumers. As consumers become more certain of their individual needs and preferences, they are more likely to find that the product they customize is a better match and are less likely to return it. In fact, companies that offer customized products report a significant reduction in product returns.

Win-win for companies and consumers

From the point of view of consumer behavior, companies selling standard goods can increase customer satisfaction by offering customized products. To boost demand, they can nudge consumers to purchase these higher-value items by allowing returns.

The organizational barriers to customization may also be lower than perceived. Our results show that while the addition of customized products would affect demand for the existing standard products, it may not affect the optimal pricing of these existing goods. Companies can also make customization more feasible by making customized items more salvageable, adopting technology to lower costs, reducing customization fees, and improving the user interface for customers.

Our study shows that a win-win situation is achievable through a smart combination of customization and returns strategies. If customers could be persuaded to purchase higher-value customized products with lower return rates instead of lower-value standard products with higher return rates, it sure looks like a win-win-win: higher profits, fewer product returns, and more satisfied customers.

First published Nov. 14, 2022, on INSEAD’s Knowledge blog.

About The Author

Anton Ovchinnikov

Anton Ovchinnikov is an INSEAD visiting professor of technology, operations, and decision sciences. He is also a distinguished professor of management analytics and Scotiabank Scholar of Customer Analytics at the Smith School of Business of Queen’s University in Canada.