Managing retail channel overstock: markdown money and return policies

This paper studies a manufacturer-retailer channel facing unknown demand. When the wholesale relationship comprises only a per-unit price that exceeds the manufacturing cost, the retailer’s inventory strategy will not properly reflect the channel’s overstock and understock costs. A number of researchers have advocated manufacturer return policies to remedy this misalignment of incentives, but none explain the reality that “markdown money” is sometimes paid to retailers expressly to avoid product returns. We formulate a model that distinguishes between these practices, and determine conditions under which each will be more desirable with respect to channel coordination and individual firm performance.