Risk sensitivity in distribution channel partnerships: implications for manufacturer return policies

The manufacturer return policy is widely regarded as a means for channel partners to share risk. However, existing studies of this popular institutional practice use frameworks that assume risk-neutrality of all parties.This report analyzes how sensitivity to risk affects both sides of the manufacturer-retailer relationship under various scenarios of strategic power, and how these dynamics are altered by a return policy. A key finding is that the penalty for ignoring risk sensitivity can be substantial. This will suggest an informational motive affecting the use of return policies, a consequence of the potential difficulty of inferring another party’s risk sensitivity and the positive incentive for deception.