Outsourcing strategy in the presence of the customer returns

In this paper, we examine a manufacturer's choice of outsourcing contractor, either a competing contractor or a non-competing contractor. Both the manufacturer and the competing contractor (which also produces a product in its own brand) face customer returns. We find that the manufacturer's optimal outsourcing strategy depends strongly on two factors: the efficiency of production and sale of its brand relative to that of the competing contractor in its own brand, and the ratio of the qualities of the two brands. The competing contractor, on the other hand, always prefers to produce for the manufacturer. Interestingly, we find that when the manufacturer chooses to outsource to the non-competing contractor, both the wholesale and retail prices of the manufacturer's product decrease, while they increase if the competing contractor is chosen. In addition, the competing contractor may be chosen even if it charges a higher wholesale price than the non-competing contractor does. We find that the manufacturer and the competing contractor should offer money-back guarantees if they can efficiently recover value from any returns. We further show that when a non-competing contractor is chosen, money-back guarantees offered by the manufacturer and the competing contractor can benefit at least one firm and may even achieve a win-win situation. When the competing contractor is chosen, both the manufacturer and the competing contractor can either benefit (Pareto improvement) or suffer (prisoner's dilemma) from money-back guarantees. These results are different from those in existing studies in the literature.