Service Escape: Profiting from Customer Cancellations

This paper explores the benefits of letting customers escape from prepurchased service contracts by offering refunds for cancellations. We show that such a policy creates opportunities for in a capacity-constrained service—i.e., collecting cancellation fees from advance buyers who cancel, and then reselling the freed slots. The better the alternative that motivates a cancellation, the more profitable is a refund-for-cancellations policy compared with a no-refund policy that “locks in” customers. In contrast to previous research on money-back guarantees for durable goods, we show that offering refunds for service cancellations can be profitable (1) without charging a higher price compared with a no-refund policy, and (2) even when advance buyers would be willing to abandon the service for no refund. Also, service providers should decrease rather than increase the customer hassle cost of cancellations. Our research also suggests a new profit advantage of advance selling, i.e., capturing some of the consumer-added surplus created when customers find new alternatives (and are therefore willing to pay a fee to terminate the prepurchased contract). Finally, yield-management research typically assumes exogenous “no shows” by advance buyers. We suggest that offering refunds for cancellation reduces the need to reserve capacity for high-paying customers and improves capacity utilization.