Return Freight Insurance Strategies for the Online

Retailer and Insurance Company

Abstract
In online purchases, customers often exhibit considerable hesitations due
to quality uncertainty and return freight fees. In response, online retailers
may buy the Return Freight Insurance (RFI) service from the insurance
companies, who compensate the customers when they return the purchase.
This paper develops a game-theoretic model to investigate RFI strategies of
the retailer and insurance companies. With the RFI service, the insurance
company generally verifies the quality information posted by the retailer to
avoid excessive customer returns that may result from misleading quality
information. Thus, the RFI service not only reduces the customer’s return
freight, but also acts as an imperfect quality signal for customers to mitigate
the quality uncertainty. Our results show that the RFI premium of the
insurance companies is positively associated with the retailer’s store return
rate. When selling high-quality products, the retailer always adopts the RFI
service and charges a markup price. The retailer selling low-quality products
never adopts the RFI service when the return freight fee is very large. As
the return freight fee drops, the retailer selling low-quality products prefers
the RFI service when the signal efficiency is medium. However, if the return
freight fee is very small, only when the signal efficiency is large does the
retailer adopt the RFI service. Moreover, the retailer selling low-quality
products only increases the price when the signal efficiency of RFI is high,
or the return freight fee is small. Our results provide new explanations on
the prevailing of the RFI service for retailers selling products with different
quality and return freight fees.
Keywords: return freight insurance, quality risk, customer return, quality
perception, E-commerce

1. Introduction
Customers often face quality uncertainty risk when shopping online as
they cannot fully understand the true product quality via text description,

Preprint submitted to International Journal of Production Economics May 16, 2022

pictures and videos [1, 2, 3, 4]. For example, customers may not understand
the warm performance of clothing or the make-up retention of foundation
before they use the product [2, 5]. To reduce the quality uncertainty risk,
most online retailers provide return policies, such as the 30-day return policy
of Amazon and the mandatory ”7 days no reason to return” policy in China
1
. These return policies allow customers to return the product if they are
not satisfied with its quality.
However, even if a full-refund policy (e.g., money-back-guarantee (MBG))
is offered, consumers still have to bear the return freight fee, which becomes
an inhibitor for online purchase [6]. Surveys show that 66% of consumers
concern about return freight fees 2 and 79% want free return freight 3 . More-
over, more than 69% of consumers opt out of online shopping because they
are unwilling to bear the return freight fee 4 . Bower and Maxham III [7]
suggest that online retailers should institute a policy of free product return.
To this end, in China, many competitive insurance companies who operate
independently have provided the return freight insurance (RFI) service for
online retailers. For example, more than ten insurance companies, such as
PICC and Huatai Insurance, offer the RFI service on Taobao 5 .
The online retailer is eligible to decide whether to adopt this service. For
example, most retailers of make-up and apparel categories on Taobao provide
the RFI service, whereas few daily necessity retailers offer this service. If
the retailer adopts the RFI service, the competitive insurance companies
determine the unit RFI premium based on the evaluation of online retailers’
quality and return rates, the return freight fee, and the product category 6 .
Afterward, the retailer chooses the RFI provider with the lowest premium
and pays the premium in pace with each transaction via the online platform.
Once the customer returns his purchase, the RFI provider pays him a freight
compensation fee.

1
”New regulations force China’s e-stores to offer hassle-free, 7-day product returns,”
TECHINASIA,2014.[Online]. Available:https://www.techinasia.com/nee-regulations-for-
china-ecommerce-7day-item-returns.[Accessed:5-Jan-2017].
2
UPS and comScore. (2015). Pulse of the online shopper: Empowered shoppers propel
retail change. October 27.
3
https://www.invespcro.com/blog/ecommerce-product-return-rate-statistics/.
4
https://www.emarketer.com/topics/topic/retail-ecommerce-2016.
5
https://m.gxfin.com/article/finance/bx/default/2020-06-17/5298204.html.
6
https://www.finlaw.pku.edu.cn/zxzx/zxwz/239619.html

2
 The retailer may exaggerate the product quality to solicit purchases from
customers. In the presence of RFI, the exaggerated quality leads to more
returns and incurs more compensation costs for the RFI provider. Hence,
the RFI provider generally evaluates the product quality before determining
the RFI premium and is entitled to rescind the contract with high-return-
rate retailers, forcing the retailer to post true quality as much as possible6 .
From the perspective of customers, the RFI service acts as a third-party
quality certificate[8], and can be regarded as a signal of the true quality [9].
Nevertheless, the RFI service is an imperfect quality signal, whose signal
efficiency is associated with the product category. In particular, for some
experience-based products like apparel and make-up, the evaluation of these
products’ performance depends heavily on users’ subjective experience [1,
10, 11], and the retailer is likely to display false quality information. Hence,
the customers’ perceived quality relies on the insurance company’s quality
verification, and the signal efficiency would be high for these experience-based
products [12]. By contrast, for categories like daily necessities and electronic
products, the product quality is objective and straightforward for customers
to evaluate by text description. Thus, the customers encounter less quality
risk, and the signal efficiency of RFI is low.
However, the RFI service makes up for the customers’ return freight fee
and encourages customers to return the product, which causes additional
losses for the retailer and the insurance company. By exploring the impact
of RFI on the retailer and the insurance companies, this study aims to answer
the following questions:

1) When should the retailer adopt the RFI service?

2) How should the retailer set the retail price if the RFI service is adopted?

3) What the RFI premium should the insurance companies charge for each
retailer?

To address these questions, we propose a game-theoretic model consisting

of one retailer and several competitive insurance companies. They serve a
customer population with quality risk and heterogeneous willingness-to-pay
(WTP). We consider two possible scenarios: 1) the retailer does not adopt
the RFI service, and 2) the retailer adopts the RFI service. Under each
scenario, the customer does not observe the true product quality before the
purchase, but can update the belief on the product quality if the RFI service

3
is adopted. The customer makes the purchase decision after observing the
retail price and the RFI service. After receiving the product, the customer
learns the true quality and decides whether to return the purchase. The
customer who returns the product obtains a full refund from the retailer and
a freight compensation from the insurance company if the retailer adopts the
RFI service. Otherwise, the customer only obtains the full refund.
In this study, the customers can be categorized into three classes in terms
of WTP: compulsive customers with high WTP who never return the prod-
ucts, strategic customers with medium WTP who return the low-quality
products but keep the high-quality products, and non-buy customers with
low WTP who never buy the product.
We find that the RFI premium of the competitive insurance companies
depends on the retailer’s store return rate. A high return rate leads to a hefty
premium. Our result further shows that a high signal efficiency decreases
the RFI premium. This result echoes the phenomenon that the insurance
company, AXA, on Suning.com, charges a smaller premium (0.85 RMB) for
make-ups with high signal efficiency, compared with products like food (0.95
RMB) and electronic merchandise (1.00 RMB) 7 .
Some studies [13, 6] indicate that the retailer adopting the RFI service
should pull up the price, to make up for the additional RFI costs. Our
study shows a similar result for the retailer selling high-quality product, and
find that the price markup is attributed to the quality signaling role of RFI.
Contrastively, our result shows that the retailer selling low-quality product
may lower the price when adopting the RFI service, especially when the
return freight fee is so large that only the compulsive customers tend to
make purchases. The rationale behind this is that the quality signaling effect
of RFI dwindles the compulsive customer’s expected utility of the low-quality
product, compelling the retailer to lower the price.
The retailer’s adoption decision of the RFI service is determined by the
trade-off between the sales revenue advantage and the extra RFI costs in-
cluding both the premium and return handling costs. The retailer selling
the high-quality product is always willing to adopt the RFI service as RFI
increases the customers’ purchase utilities due to its quality signaling effect,
and no customers will return the high-quality product. Whereby the retailer
is able to pull up the price and ends up with a high sales revenue. The RFI

7
http://sophelp.suning.com/helpCenter/showHelpDetail/SBZ100003915.htm.

4
adoption decision for the retailer selling low-quality product is somewhat nu-
anced, shaped by the synergistic effect of signal efficiency and return freight
fee. Specifically, when the return freight fee is large (e.g., bulk merchandise),
the retailer is less likely to adopt the RFI service, consistent with the empir-
ical finding of Chen et al. [14]. The rationale is that the large return freight
fee only induces purchases of the compulsive customers, and the quality sig-
naling role of RFI drags the customers’ perceived quality down, resulting in
a low price and low sales revenue. When the return freight fee is medium,
both the compulsive and strategic customers may purchase the product. The
RFI can dwindle the strategic customers’ expected utility to the low-quality
product, attributed to again its quality signaling role, and thus effectively
prevent strategic customers from purchasing. In such a case, the retailer is
more likely to adopt RFI when the signal efficiency is moderate because the
expected utility of the compulsive customers does not diminish too much.
When the return freight fee is so small that the retailer accommodates some
strategic customers, only a high signal efficiency can effectively dissuade the
strategic customers from purchasing the product, thus decreasing the store
return rate as well as the RFI premium. As a result, the retailer with small
return freight fees prefers the RFI service when the signal efficiency is high.
These results give a new explanation of the RFI adoption for retailers selling
products with different return freight fees. For example, both furniture and
apparels are experience products, for which the signal efficiency of RFI is
high. The furniture retailer is less likely to adopt RFI, while the apparel
retailers are more willing to adopt RFI.
The remainder of this paper is organized as follows. Section 2 summarizes
the related literature. We describe our model in Section 3. In Section 4, we
examine the pricing and the RFI strategies of the retailer and the insurance
companies. Section 5 provides concluding remarks. We relegate the proofs
to Appendix A.

2. Literature Review
Our study is related to two main research streams. The first stream is
about RFI, and the second is about customer return.
The extant studies on the RFI service aim to figure out the motives
for online retailers to adopt the RFI service. Wang [15] argues that many
retailers are willing to offer RFI because it acts as insurance and reduces
customers’ purchase risk. Geng et al. [16] consider homogeneous customers,

5
Zhang et al. [8] instead consider heterogeneous customers; both of them
adopt the signaling framework and show that high-quality retailers use RFI
as a quality signal to distinguish themselves from the low-quality ones. Shao
et al. [9] empirically show that consumers regard the RFI service as a sign of
the product quality and a means to reduce the return losses.
Many papers consider an exogenous premium and investigate the value
of RFI for the online retailer. Fan and Chen [13] and Lin et al. [6] find
that the RFI service benefits the retailer when the premium is low and the
compensation is large. They argue that the retailer raises the price to offset
the premium cost, which in turn hurts the demand and the profit. A low
premium or a considerable compensation can alleviate this negative impact
and enhance the customers’ utilities. Chen et al. [17] investigate how the
reselling and agency selling formats affect the value of RFI for e-sellers. They
highlight the role of the e-seller’s unit return loss and show that RFI benefits
e-sellers more under the reselling format. Li et al. [18] incorporate retailer
competition and find that only the retailer with a high return rate can benefit
from RFI. This is because the retailer with a high return rate benefits a lot
from the freight compensation effect of RFI, which enhances its market share
and cannibalizes the competitor’s.
In addition to the retailer’s RFI, the consumer can also purchase the RFI
service from insurance companies. Some studies consider both types of RFI.
Ren et al. [19] formulate a binary model with exogenous customer return
probability and find that the online retailer cannot benefit from both RFI
strategies because the RFI service always reduces the market share. Li et al.
[20] and Li et al. [21] consider the customers’ endogenous return behavior,
and show opposite results that the retailer earns a higher profit with both
types of RFI. The retailer can benefit more from offering RFI to customers
because it grabs all customer surplus under the retailer’s RFI strategy. Zhang
et al. [8] incorporate the insurance company’s decision of providing both
types of RFI. They show customers would like to purchase the RFI service
themselves if the RFI premium is small, but the insurance company cannot
benefit from the customer’s RFI and should only offer the retailer’s RFI, since
both the insurance company and the customers are assumed to encounter
quality uncertainty risk. In this study, we also explore the endogenous RFI
premium of insurance companies, while assuming only the customers face the
quality risk. To enrich the research on RFI service, we further consider the
imperfect signaling effect of RFI, which is captured by signal efficiency. Our
results present that the signal efficiency is an essential driver of the retailer’s

6
RFI adoption strategy.
Our study is also related to the stream of literature on customer re-
turn incurred by valuation uncertainty and quality risk. Some papers con-
sider customer valuation uncertainty and examine the effect on the retailer’s
strategies, such as the partial refund policy [22], the joint decisions of the
service quality and refund policies [23], and the pricing strategy in the pres-
ence of strategic customers [24]. Many papers consider that the product
may not match the customer’s tastes, and the customers are associated with
an exogenous return probability (horizontal quality risk of customers) (see
[25, 26, 27]). Some studies address the vertical quality risk about the satis-
faction to product performance (see [28, 29]). Moorthy and Srinivasan [28]
consider the quality-associated return probability and show that MBG is a
quality signaling tool for high-quality retailers. By examining the endogenous
return behavior, Anderson et al. [29] find that MBG improves customers’ sat-
isfaction and benefits the retailer. The above studies focus on the retailer’s
return policies. In this study, we consider the vertical quality risk and en-
dogenous return behavior and take RFI as a valuable device to cope with the
quality risk. We aim to explore the interaction between the quality percep-
tion and the RFI strategy, which is not included in the above literature.
Finally, our work is related to the stream of customer return literature
considering return hassle cost, e.g., the return freight fee and the restock-
ing fee. The existing literature aims to figure out the effect of interactions
between the return policy and the hassle cost. Davis et al. [30] compare
the MBG policy and the low-hassle policy. They show that the low-hassle
policy is preferred when the product obtains a high salvage value, or can be
resold, or its benefits cannot be consumed in a short period. By highlighting
the role of refining customer type of the MBG policy, Hsiao and Chen [31]
show the opposite result when the consumers’ residual values are similar.
Some studies focus on the impacts of the retailer’s restocking fee. Design-
ing an appropriate restocking fee helps reduce the store return rate [32, 33],
and distinguish the high- and low-type customers [4], and deal with the cus-
tomer’s anticipated regrets [34]. However, few studies concern the impact
of the customer’s return freight fee. Cao et al. [35] empirically show that
post-purchase freight plays a vital role in customers’ satisfaction and their
purchase decisions. From the retailer’s perspective, He et al. [36] argue that
retailers benefit from the free-freight policy when the return freight fee is
relatively high. Lin et al. [6] investigate the retailer’s RFI strategy and show
that a large return freight fee reduces the customer returns and enables the

7
retailer to benefit from RFI. In contrast to the above literature, we highlight
the impact of the return freight fee on the RFI strategies of the retailer and
insurance companies, and our results show that this impact is not monotonic.

3. Model Setting
We consider an online shopping setting with a retailer who sells a product
with MBG to customers. The customers are uncertain of the product quality
before the purchases. To reduce the customers’ quality risk, the retailer can
buy the RFI service, which is provided by several competitive insurance
companies. Each insurance company operates at an efficient scale and is
small relative to the market.
To capture the RFI’s impact, we consider two cases: ”the benchmark
case without RFI” and ”the case with RFI service”. Denote the two cases
by subscripts N and R respectively in the sequential analysis. We represent
the retailer’s RFI adoption decision by the following indicator function:
(
1, if the retailer adopts RFI,
IR = . (1)
0, otherwise.
The retailer sets the price pR if the RFI service is adopted. Otherwise,
it sets the price pN . Remarkably, the retailer knows the product quality but
cannot use prices to signal quality as prices cannot be an effective quality
signal solely [37, 38], and this study mainly focuses on the role of the RFI
service in influencing the customer choice. In brief, the retailer knows the
product quality and knows that the customers do not[39, 40, 41].

3.1. The customer

The market involves a continuum of customers who are heterogeneous in
the willingness-to-pay (WTP) γ for the product quality, where γ ∼ U (0, 1).
Each customer has at most one-unit demand, and the market size is normal-
ized to 1. Let q be the product’s true quality, where q ∈ {qH , qL }. Initially,
the customer does not know the product’s true quality. Let q̄ be the per-
ceived quality of the customer, which is a random variable. Customers decide
whether to purchase the product based on the perceived quality. After the
purchase, the customer then learns the product’s true quality and decides
whether to keep or return it. In consideration of this return behavior, the
consumer seeks to maximize the individual expected surplus at the initial
purchase stage.

8
3.1.1. Without the RFI service
We first consider that the retailer does not adopt the RFI service (i.e.,
IR = 0). Before the purchase, the customer holds the initial belief that the
product quality will be qH with probability 1/2 and be qL with probability
1/2. After receiving the product, the consumer learns the product’s true
quality q immediately. If keeping the product, the consumer obtains the
utility UNk = γq − pN . If the consumer returns the product, he gets the price
pN back, pays the return freight fee f , and thus gets the utility UNr = −f .
The consumer keeps the product if UNk ≥ UNr , and returns otherwise.
In consideration of the return behavior, the customer’s expected surplus
of purchase can be written as



E UN |IR = 0 = E max{γ q̄, pN − f }
max{γqH , pN − f } max{γqL , pN − f }
= + . (2)
2 2
The customer will make a purchase if his expected surplus is larger than
the product price.

3.1.2. With the RFI service

With the RFI service (IR = 1), the insurance companies generally eval-
uate the product quality to avoid the excessive customer returns led by the
misleading quality information and are entitled to rescind the contract with
high-return-rate retailers, which forces the retailer to post true quality as
much as possible. Customers know this and can reasonably believe that the
posted information is more credible with the RFI service. Specifically, cus-
tomers believe that the retailer with quality q has a larger probability to
′
disclose the true quality q than any other retailer with a quality level q ̸= q.
That is, the RFI service acts as a third-party certificate [42] and helps signal
the true quality to customers. However, such verification may not always
work due to the difficulties in describing the experience-based product’s per-
formance through text and pictures. In a nutshell, the RFI service is an
imperfect signal of product quality.
We assume that, on the observation of RFI, the customer receives a sig-
nal IR = 1, which is informative and reveals the retailer’s true quality with
probability σ, where σ ∈ [0, 1) represents the signal efficiency. With proba-
bility 1 − σ, RFI is uninformative, and the customer holds the initial belief.
Following Lewis and Sappington [43] (see more examples in Kwark et al.

9
[44], Zhang et al.
[45]), we can formulate the customer’s belief formally as
Pr IR = 1|q̄ = y =( 1−σ 2
+ σδyq , where δij is the Kronecker delta distribution
1, i = j,
that satisfies δij = .
0, i ̸= j.
The signal efficiency σ is associated with the product category. For exam-
ple, before using the product, the customers know less about the quality of
experience-based products like apparel and make-up. They rely on the RFI
provider’s quality information verification to form the quality perception [12],
and thus their quality perceptions are more likely to be updated by the RFI
service [10, 11], corresponding to a high signal efficiency σ. By contrast, for
the products (e.g., daily necessities) with objective quality, customers can
easily infer the quality from the text description, and thus rely less on the
RFI’s quality signaling role, implying a low signal efficiency σ.
Using Bayes’ Law, we obtain the conditional probability if the RFI service
is offered.




Pr IR = 1|q̄ = y Pr q̄ = y 1−σ
Pr q̄ = y|IR = 1 =
= + σδyq . (3)
Pr IR 2
′
1+σ
Let q be the false product quality, then we have Pr q̄ = q|I R = 1 = 2
′
and Pr q̄ = q |IR = 1 = 1−σ


2
. Thus, the customer updates his perceived
quality towards the product’s true quality after observing the signal IR = 1.
After receiving the product, the consumer obtains the utility URk = γq−pR
if keeping the purchase. If the consumer returns the product, he gets the
product price pR back and a fraction β of the return freight fee f (β ∈ (0, 1))
from the insurance company, thus obtaining n the utility URr = −(1o− β)f . To
H −qL )
avoid trivial results, we assume that f ≤ min qH −q 2
L
, (1−σ)(q
2(1−β)
to ensure
that the equilibrium demand is always positive. The customer’s expected
surplus of purchase is


E UR |IR = 1
1+σ 1−σ ′
= max{γq, pR − (1 − β)f } + max{γq , pR − (1 − β)f }. (4)
2 2
3.2. The retailer and insurance companies
The retailer first decides whether to adopt the RFI service and sets the
retail price. If the retailer adopts the RFI service, the insurance companies

10
then set the RFI premium. There are many competitive insurance compa-
nies operating on the platform, each of which independently decides the RFI
premium. The retailer then chooses the insurance company with the lowest
premium a. Notably, the retailer sets the sales price before selecting the
insurance company. By doing so, the retailer exempts the insurance compa-
nies from the risk of a disadvantageous retail price, which helps to reduce
the premium. This also echoes practice that after the retailer uses RFI, the
online shopping platform allows insurance companies to adjust the premium
based on the retailer’s real-time data6 .
If the retailer adopts the RFI service, it pays the selected insurance com-
pany (i.e., the RFI provider) the RFI premium a for each product sold. When
the customer returns the purchase, the RFI provider compensates the cus-
tomer βf , where β ∈ (0, 1) . For each returned product, the retailer spends
a handling cost t 8 .
The event sequence can be summarized as follows:
1) The retailer decides whether to adopt the RFI service and sets the
corresponding sales prices.
2) The competing insurance companies determine the RFI premiums, and
the retailer chooses the insurance company.
3) The customers update their beliefs about the product quality and make
purchase decisions, and the retailer pays the selected insurance com-
pany the premium based on the sales volume.
4) The customers learn the true product quality and decide whether to
return their purchases.
The retailer’s profit can be expressed as ΠR (pR ) = pR dkR −tdrR −adR if the
RFI service is adopted; otherwise, it obtains a profit ΠN (pN ) = pN dkN − tdrN .
The retailer’s RFI adoption decision is made by trading off the expected
profits with the RFI service and without the service. The expected profit of
the RFI service provider can be expressed by π(a) = adR − βf drR .
The notations and comments are summarized in Table 1. In the next
section, we investigate the optimal pricing strategies of the retailer without
the RFI service and with the RFI service. We also explore the RFI premium
strategy of the insurance companies under the RFI case. We finally identify
the conditions under which the retailer adopts the RFI service.

8 qH qL
To focus on the cases with customer returns, we assume t ≤ qH −qL .

11
 Table 1: Notations.

Notations Definition and comments

a RFI premium of the RFI provider
pi Sales price under case i, i = {N, R}
IR Retailer’s RFI strategy
γ Customer’s willingness to pay, γ ∼ U (0, 1)
q Product’s true quality, q ∈ {qH , qL }
q̄ Perceived quality
di Total demand under case i, i = {N, R}
dki Volume of keeping the product under case i, i = {N, R}
dri Volume of returns under case i, i = {N, R}
Πi Retailer’s profit under case i, i = {N, R}
π Profit of the RFI provider
t Return handling cost of the retailer
σ signal efficiency of RFI, σ ∈ [0, 1)
f Return freight fee
β Compensation fraction of the return freight fee, β ∈ (0, 1)

4. Analysis
4.1. Benchmark case without RFI
We first consider a benchmark case without RFI (IR = 0) and use back-
ward induction to analyze the customer’s return behavior by comparing
UNk = γq − pN , q = {qH , qL } and UNr = −f . Based on the return behavior,
they can be categorized into three groups
n in terms oof WTP. 1) Compulsive
customers with high WTP γ ≥ max pNqH−f , pNqL−f = pNqL−f : they always
keep the purchase regardless of the quality level; 2) Strategic customers with
medium WTP pNqH−f ≤ γ ≤ pNqL−f : these customers keep the purchase if the
quality is high, but return the purchase if the quality is low; 3) non-buy cus-
tomers with low WTP γ ≤ pNqH−f : they always return the purchase regardless
of the quality level.
In consideration of the customer’s return behavior, we can formulate the
customer’s expected utility at the purchase stage.
(1) The compulsive customer obtains the expected utility E(UN |IR = 0) =
γqH
2
+ γq2L , and the customer will purchase the product if this utility

12
 exceeds the product price pN , i.e., γ ≥ qH2p+qN
L
.
(2) The strategic customer obtains the expected utility E(UN |IR = 0) =
γqH
2
+ (pN2−f ) , and and will purchase the product if γ ≥ pNqH+f .
(3) The non-buy customer obtains the expected utility E(UN |IR = 0) =
(pN −f )
2
+ (pN2−f ) , and thus never buys the product.
Regarding the customers’ return and purchase behaviors, the retailer de-
termines the retail price to maximize the profit. As the non-buy consumers
never purchase, the retailer should determine whether to accommodate only
the compulsive customers or both the compulsive and strategic ones at the
purchase stage. We derive the retailer’s optimal pricing strategy regarding
the targeted customers in Lemma 1 and give an illustration in Figure 1.

Lemma 1. (1) The high-quality (q = qH ) retailer sets the optimal price

p∗N = qH +q
4
L
if f ≥ f h , and p∗N = qH2−f if f ≤ f h ;
(2) The low-quality (q = qL ) retailer sets the optimal price p∗N = qH +q
4
L
if
qH −qL ∗ (q +q )f qH −qL
f ≥ 4 (case 2-(i)), pN = qH −qL if f l ≤ f ≤ 4 (case 2-(ii)),
H L

qL +f (qH −qL )t
and p∗N = 2
− if f ≤ f l (case 2-(iii)).
2qH
q h i
−qL
Where f h = qH − qH (qH2 +qL ) , f l = qqHH+3qL
q L − qH −qL
qH
t .

Conventional wisdom tells that the retailer selling high-quality products

should target both the compulsive and strategic customers since all targeted
ones would keep the product. However, a relatively large return freight fee
potentially indicates a low expected utility as well as a shrinking demand
of the strategic customers. In such a case, the retailer only accommodates
the compulsive customers and sets a price independent of the return freight
fee as the expected utility of the compulsive customers is irrelevant to the
return freight fee. As the return freight fee drops, the volume and the ex-
pected utility of strategic customers increase, thus the high-quality retailer
can accommodate both compulsive and strategic customers to expand the
market, and therefore charges a higher price.
For the retailer selling low-quality products, intriguingly, it can employ
the same price as the high-quality retailer if the return freight fee is large
enough (see case 2-(i)). This is because the retailer only accommodates the
compulsive customers, who cannot distinguish between the low-quality and
high-quality retailers. As the return freight fee slightly drops, the volume of

13
 (a) (b)

Figure 1: The Optimal Strategy of the Retailer With Various f . (a) For the High-quality
Retailer (q = qH ). (b) For the Low-quality Retailer (q = qL ). (qH = 0.8, qL = 0.2, t =
0.1, β = 0.5).

compulsive customers shrinks. In such a case, the retailer should decrease

its price to attract more customers as a low price dampens the customers’
motivation to return under the MBG policy, and the volume of compulsive
customers expands with the decrease of the retailer’s price (see case 2-(ii)).
When the return freight fee is low, the high sales price becomes the main
incentive of product return, and thus the retailer should further lower the
price to expand the volume of compulsive customers. However, in such a case,
the low price may also attract strategic customers, which is detrimental to
the retailer’s profit as these strategic customers will finally return the low-
quality products. Therefore, the low-quality retailer’s price decreases more
slowly as the return freight fee falls in case 2-(iii) than in case 2-(ii).
As shown in Table 2, the retailer selling the high-quality product does
not bear any customer return as neither the compulsive customers nor the
strategic customers return the high-quality product. By contrast, the low-
quality retailer sells to both compulsive and strategic customers and carries
some return costs, when the return freight fee is low.

Lemma 2. The retailer’s profit Π∗N has the following properties:

(1) The high-quality (q = qH ) retailer’s profit is non-increasing in the re-
turn freight fee f ;

14
 Table 2: The Corresponding Results in the Benchmark Case.

Quality Region d∗N dr∗

N
1
f ≥ fh 2
0
q = qH qH −f
f ≤ fh 2qH
0
f ≥ qH −q
4
L 1
2
0
q = qL f l ≤ f ≤ qH −q
4
L
1 − qH2f −qL
0
qH (qL −f )−t(qH −qL ) qL −f −t 3f −2t+qL +qL t
f ≤ fl 1− 2
2qH 2qL
− 2
2qH

(2) The low-quality (q = qL ) retailer’s profit is non-decreasing in the return

freight fee f .
Lemma 2 indicates that the return freight fee has the opposite impact on
the retailer profit with different product quality. The retailer selling high-
quality products bears no return handling cost as the strategic customers
always keep the purchase. However, a large return freight fee inhibits the
strategic customers’ purchases, impeding the total demand and harming the
retailer’s profit. Contrastively, for the low-quality retailer, a high return
freight fee enlarges the volume of compulsive customers who never return
the low-quality product and thus benefits the retailer.

4.2. Case with the RFI service

In this section, we discuss the situation where the retailer adopts the
RFI service (IR = 1). Similar to the benchmark case, we first analyze the
customers’ return behavior and categorize the customers into three groups
according to their WTP: 1) Compulsive customers with high WTP γ ≥
pR −(1−β)f
qL
; 2) Strategic customers with medium WTP pR −(1−β)f
qH
≤ γ ≤
pR −(1−β)f
qL
3) non-buy customers with low WTP γ ≤ pR −(1−β)f
; qH
. Based on
the return behavior, we obtain the purchases behaviors of each group of
customers by exploiting their expected utilities.
We then analyze the RFI premium a of RFI provider based on the cus-
tomer’s return and purchase behaviors. Recall that the expected profit of
the RFI provider is π(a) = adR − βf drR . As the insurance companies are
completely substitutable with each other, and the non-selected companies
earn nothing, we assume that π(a) = 0. Then, we have a = (drR /dR ) βf .
With the RFI service, the retailer should pay the RFI premium a with
each product sold, i.e., the retailer’s profit can be written as ΠR (pR ) =

15
pR dkR − tdrR − adR . Given that the RFI premium is set at a = (drR /dR ) βf , the
retailer determines the retail price by solving ΠR (pR ) = pR dkR − (t + βf )drR .
We characterize the optimal price of the retailer and the RFI premium
under the RFI case in Lemma 3 and illustrate the results in Figure 2.
Lemma 3. (1) The RFI premium is a = (drR ∗ /dR ∗ ) βf ;
H −qL )
(2) The optimal price of the high-quality retailer is p∗R = qH +qL +σ(q
4
if
∗ qH (1−σ)(1−β)f
f ≥ F h (case 2-(i)), and pR = 2 − 2(1+σ) if f ≤ F h (case 2-(ii));
(3) The optimal price of the low-quality retailer is p∗R = qH +qL −σ(q 4
H −qL )
if
(1−σ)(qH −qL ) ∗ (qH +qL )qL −σ(qH −qL )
f ≥ 4(1−β)
(case 3-(i)), pR = qH −qL
(1 − β)f if F l ≤
H −qL )
f ≤ (1−σ)(q
4(1−β)
(case 3-(ii)), and p∗R = qL +(1−β)f
2
− (qH −q2qL )(βf
H
+t)
if f ≤ F l
(case 3-(iii)).
h q i
(1−σ)(qH −qL )[qH qL −(qH −qL )t]
1+σ
Where F h = (1−σ)(1−β) qH − qH (qH2 +qL ) , F l = (1−σ)(q H −qL )(qH −βqL )+4(1−β)qH qL
.

(a) (b)

Figure 2: The Optimal Strategy of the High-quality Retailer With Various f and σ. (a)
For the High-quality Retailer (q = qH ). (b) For the Low-quality Retailer (q = qL ).
(qH = 0.8, qL = 0.2, t = 0.1, β = 0.5).

Lemma 3 shows that the premium is determined by the retailer’s store

return rate. This is in line with the practice that the retailer’s return rate
is the main factor for the insurance companies, e.g., Huatai Insurance and
PICC, to determine the RFI premium.

16
 Similar to the benchmark case, Lemma 3-(2) shows that the retailer selling
high-quality products charges a price to accommodate both the compulsive
and strategic customers if the return freight fee is small, or sets a fixed price to
accommodate only the compulsive customers if the return freight fee is large.
The high-quality retailer bears no customer return (see Table 3) and thus can
enjoy an infinitesimally small premium. As Lemma 3-(3) depicts, the retailer
selling low-quality products charges a high price only to accommodate the
compulsive customers and enjoys an infinitesimally small premium if the
return freight fee is large. If the return freight fee is low, the retailer sets a
low price, accommodates both strategic and compulsive customers, and thus
pays a positive RFI premium.

Table 3: The Corresponding Results in the RFI Case.

Quality Region d∗R dr∗

R
1
f ≥ Fh 2
0
q = qH (1+σ)qH −(1−σ)(1−β)f
f ≤ Fh 2(1+σ)qH
0
H −qL )
f ≥ (1−σ)(q
4(1−β)
1
2
0
H −qL )
q = qL F l ≤ f ≤ (1−σ)(q
4(1−β)
2(1−β)f
1 − (1−σ)(q H −qL )
0
qL (βf +t) [2qH qL −βqL −t(qH −qL )](qH −qL )
1 + 2q2 − 2 q
f ≤ Fl H
(3+σ−4β)f +(1−σ)(qL −t)
2qH L
2(1−β)f
2(1−σ)qH
+ (1−σ)qH

A high signal efficiency improves the customer’s utility regarding the high-
quality product but reduces the counterpart of the low-quality product. In
addition, the high-quality retailer bears no customer returns and RFI pre-
mium, and thus is willing to expand the market. Hence, along with the
increase of the signal efficiency, the high-quality retailer prefers to accommo-
date both the compulsive and strategic customers and improve the price,e, as
shown in Figure 2(a). By contrast, the retailer with low-quality should take
into account the potential returns of the strategic customers and is unwilling
to accommodate the strategic customers. Moreover, the strategic customers
are less likely to purchase the low-quality product when the signal efficiency
is high. Thus, the low-quality retailer should focus only on the compulsive
customers if the signal efficiency is high (see Figure 2(b)).

Proposition 1. The optimal retail price p∗R has the following properties:

17
 (1) For the high-quality retailer, the retail price is non-increasing in the
return freight fee f , and is increasing in the signal efficiency σ;
(2) For the low-quality retailer, the retail price: (i) is decreasing in the
return freight fee f when f ≤ F l , qqHL ≤ 2β−1
β
; (ii) is non-decreasing in
f otherwise;
(3) For the low-quality retailer, the retail price: (i) is increasing in the
H −qL )
signal efficiency σ when F l ≤ f ≤ (1−σ)(q4(1−β)
; (ii) is non-increasing
in σ otherwise.

The high-quality retailer tends to accommodate both the compulsive and

strategic customers. Nevertheless, when the return freight fee is high, the
strategic customers are reluctant to purchase. In such a case, the retailer
should either lower the price to attract the strategic customers, or employ a
fixed price to focus only on the compulsive customers. When it comes to the
low-quality retailer, it is clear that, given the price, the volume of compulsive
customers is non-decreasing in the return freight fee, whereas the volume of
strategic customers is decreasing in the return freight fee. In addition, the
volume of strategic customers increases with the difference between the low
and high quality. As analyzed above, when the return freight fee is small,
the low-quality retailer has to accommodate some strategic customers, which
harms the retailer’s profit. When the return freight fee is low, and the volume
of the strategic customers (the difference between the low and high quality)
is small, the retailer tends to decrease its price to expand the volume of
compulsive customers along with the increase of the return freight fee, since
the volume of the strategic customers shrinks. However, when the volume of
the strategic customers or the volume of the compulsive customers is large,
the retailer should increase its price to accommodate only the compulsive
ones along with the increase of the return freight fee.
Proposition 1-(1) and 1-(3) show the impact of the signal efficiency σ.
With the high-quality product, the retail price is positively associated with
the signal efficiency because a large signal efficiency improves the customer’s
expected utility by signaling the high quality. When the quality is low, the
intuition tells that the retail price should be decreasing in the signal effi-
ciency as a high signal efficiency reduces the customer’s purchase utility and
impedes the demand. Intriguingly, the retail price increases in the signal
H −qL )
efficiency when the return freight fee is medium (F l ≤ f ≤ (1−σ)(q 4(1−β)
).
With a moderate return freight fee, both the compulsive and strategic cus-
tomers may purchase. In the absence of RFI, the low-quality retailer may

18
set a relatively low price to expand the volume of compulsive customers as it
has to accommodate both the compulsive and strategic customers. By con-
trast, with RFI, the signaling effect of RFI effectively prevents the strategic
customers from making purchases. Thus, the retailer can improve the retail
price only to accommodate the compulsive customers, especially when the
signal efficiency is high.
As the RFI premium is affected by the retailer’s store return rate, we
then investigate the impacts of the return freight fee and the signal efficiency
on the retailer’s store return rate.

Lemma 4. The equilibrium return rate drR ∗ /d∗R is decreasing in the return
freight fee f and the signal efficiency σ.

Intuitively, a large return freight fee reduces the return rate. A large signal
efficiency impedes the strategic customers’ purchases and the subsequent
returns by signaling the true quality. Thus, a high signal efficiency reduces
the return rate

Proposition 2. The RFI premium a∗ is first increasing in the return freight

fee f when the return freight fee is small, but is decreasing in the return freight
fee f when the return freight fee is large. The RFI premium a∗ is decreasing
in the signal efficiency σ.

Proposition 2 indicates that the RFI premium is non-monotonic with the

return freight fee. The premium is determined by the unit compensation fee
and the retailer’s store return rate. When the return freight fee is small,
the retailer sells to both the compulsive and strategic customers and the
return rate is rather stable. Thus, the RFI premium is mainly determined
by the compensation fee, and is increasing in the return freight fee. When
the return freight fee is large, the retailer tends to accommodate only the
compulsive customers and thus the return rate decreases quickly in the return
freight fee. In such a case, the RFI premium is decreasing in the return
freight fee. Moreover, the signal efficiency affects the RFI premium through
influencing the return rate, and an efficient signal leads to a small premium.
For example, on Suning.com, AXA insurance company charges a smaller
premium for make-ups (0.85 RMB) than electronic products (1.00 RMB).
Finally, we analyze how the return freight fee and the signal efficiency
affect the retailer’s profit under the RFI case.

19
Proposition 3. The retailer’s profit Π∗R has the following properties:
(1) The high-quality (q = qH ) retailer’s profit is non-increasing in the re-
turn freight fee f , and is increasing in the signal efficiency σ;
(2) The low-quality (q = qL ) retailer’s profit is non-decreasing in the return
freight fee f ; the profit is decreasing in the signal efficiency σ if f ≥
(1−σ)(qH −qL )
4(1−β)
, is inversely U-shaped in the signal efficiency σ if F l ≤ f ≤
(1−σ)(qH −qL )
4(1−β)
, and is increasing in the signal efficiency σ if f ≤ F l .

Note that a large return freight fee always impedes the purchase of the
strategic customers. The high-quality retailer does not bear the customer
returns and prefers accommodating both the compulsive and strategic cus-
tomers. As a result, a large return freight fee is harmful to the high-quality
retailer. In contrast, the strategic customers will return the low-quality prod-
ucts. Thus, the purchase of the strategic customers is detrimental to the low-
quality retailer. Therefore, the low-quality retailer’s profit is non-decreasing
in the return freight fee.
For the high-quality retailer, the high signal efficiency increases the cus-
tomers’ perceived quality and expected utility. Thus, it enhances the pur-
chase motivation of the compulsive and strategic customers. The high-quality
retailer aims to sell to both groups of customers, and can obtain a larger profit
when the signal efficiency is high than it is low.
For the low-quality retailer, the high signal efficiency lowers both the
compulsive and strategic customers’ perceived quality and expected utility,
dragging their purchase motivation down. The diminished purchase motiva-
tion of the compulsive customers reduces the actual sales volume and thus
harms the retailer’s profit (reduced sales effect). On the other hand, the
decreased purchase motivation of the strategic customers reduces potential
returns and benefits the low-quality retailer (reduced return effect). When
the return freight fee is large, only the compulsive customers will buy the
product. Obviously, the reduced sales effect dominates, and the price and
profit of the low-quality retailer are decreasing in the signal efficiency. When
the return freight fee is small, both the compulsive and strategic customers
will buy the product. Thus, the reduced return effect dominates, the low-
quality retailer’s profit is increasing in the signal efficiency. When the return
freight fee is medium and the signal efficiency is low, both the compulsive
and strategic customers may buy the products In such a case, the reduced
return effect dominates, whereby the low-quality retailer’s profit is increasing

20
in the signal efficiency. When the return freight fee is medium and the signal
efficiency is large, the strategic customers are effectively inhibited. Hence,
the reduced sales effect again dominates, and the low-quality retailer’s profit
decreases in the signal efficiency. Overall, the low-quality retailer’s profit
is inversely U-shaped in the signal efficiency when the return freight fee is
medium.

4.3. With RFI vs. Without RFI

In this section, we firstly compare the retailer’s prices with and without
the RFI service. Then, we compare the retailer’s profits in the two cases to
explore the condition under which the retailer adopts the RFI service.

Proposition 4. The high-quality retailer always charges a larger price with

the RFI than without the RFI, i.e., p∗R ≥ p∗N . The low-quality retailer
n charges
H −qL )
a smaller price with the RFI than without the RFI when f ≥ max (1−σ)(q 4(1−β)
,
o
qH −qL
4
, and when f ≤ min{F l , f l } . However, the low-quality retailer
charges a higher price with the RFI than without the RFI when the return
freight fee is small and the signal efficiency is large.

When the product quality is high, the signaling effect of RFI improves the
utility of the compulsive and strategic customers who keep the high-quality
product, boosting the sales. In such a case, the appearance of RFI endows
the high-quality retailer with certain capability to pull up the price. This
finding is consistent with the result that the retailer should raise the price
by adopting the RFI service in the literature (e.g., Fan and Chen [13], Lin
et al. [6]), where they argue that price markup is driven by the extra RFI
premium. Interestingly, our work gives a new explanation for this result from
the view of signaling effect of RFI.
By contrast, our result shows that the RFI may compel the low-quality
retailer to lower the price, especially when the return freight fee is large, as
illustrated in Figure 3. This rationale is that the quality signaling effect of
the RFI drags the compulsive customer’s quality perception down to the true
quality, as well as the expected utility. However, the retail price with the
RFI may be larger than the price without RFI when the signal efficiency is
high and the return freight fee is small (The specific conditions are shown
in Table A.9 in the Appendix A). Without the RFI, in addition to the
compulsive customers, the strategic customers may buy the products when

21
 (a) qH = 0.8, qL = 0.2. (b) qH = 0.8, qL = 0.4. (c) qH = 0.8, qL = 0.6.

Figure 3: p∗R ≥ p∗N for the low-quality Retailer. (t = 0.1, β = 0.2)

the return freight fee is small, which is harmful to the low-quality retailer,
as aforementioned. With the RFI, the high signal efficiency decreases the
strategic customer’s utility and effectively inhibits their purchases. In such
a case, the low-quality retailer can increase the sales price to focus on the
compulsive customers only.
We then investigate the retailer’s adoption decision about the RFI service
by comparing its profits with the RFI service and without the service.

Proposition 5. The high-quality retailer always adopts the RFI service.

The low-quality retailer adopts the RFI service under some conditions: 1)
the return freight fee is small and the signal efficiency is large; 2) both the
return freight fee and the signal efficiency are medium. Otherwise, the low-
quality retailer does not adopt the RFI service.

The RFI adoption decision of the retailer depends on the trade-off be-
tween the sales revenue advantage (pR dkR − pN dkN ) and the RFI cost (t(drR −
drN ) + adR ), including both the extra return handling cost and the RFI pre-
mium. When the product is of high quality, no customers will return the
purchases. Moreover, the RFI service prompts the customer’s purchase util-
ity from the high-quality retailer due to its quality signaling effect. Thus,
the high-quality retailer always adopts the RFI service and raises the price.
This finding aligns with the practice that most retailers in Tmall.com, where
only high-quality retailers on Taobao.com can join, offer the RFI service.
The RFI adoption decision of the low-quality retailer is rather nuanced.
As is shown in Figure ?? (the colored area represents the low-quality retailer
prefers adopting the RFI service), this decision is dependent on the signal
efficiency and the return freight fee (the specific conditions under which the

22
low-quality retailer adopts the RFI service are shown in Table A.10 of Ap-
pendix A). When the return freight fee is large, only the compulsive cus-
tomers buy the products. The RFI service does nothing to the return cost.
However, the RFI service reduces customers’ expected utility to low-quality
products due to the quality signaling effect, compelling the retailer to lower
the price and then end up with a low sales revenue. Hence, no low-quality
retailer adopts the RFI service when the return freight fee is large. This
result is consistent with the empirical finding in Chen et al. [14] and gives
a theoretical explanation that the online retailers selling bulk merchandise
(e.g., furniture) are unlikely to adopt the RFI service.

(a) qH = 0.8, qL = 0.2. (b) qH = 0.8, qL = 0.4. (c) qH = 0.8, qL = 0.6.

Figure 4: Optimal RFI Strategy for the Retailer. (t = 0.1, β = 0.2)

When the return freight fee is medium, both the compulsive and strategic
customers may purchase the product. As aforementioned, due to the signal-
ing effect of RFI, the low-quality retailer can use the RFI service to effectively
prevent strategic customers from purchasing the product. However, the sig-
nal efficiency should be medium so that the expected utility of compulsive
customers does not decrease too much. As a result, the low-quality retailer
adopts the RFI service when the return freight fee and the signal efficiency
are moderate.
When the return freight fee is small, the low-quality retailer accommo-
dates some strategic customers regardless of the adoption of RFI. In such
a case, only a high signal efficiency can effectively prevent some strategic
customers from purchasing the products, and thus decreases the store return
rate and the RFI premium. As a result, the low-quality retailer adopts the
RFI service when the return freight fee is small and the signal efficiency is
high. This result is in line with the phenomenon that the retailers selling
make-ups and apparel categories, for which the signal efficiency is high and

23
the return freight fee is very small in comparison with the sales price, are
more willing to adopt the RFI service.

5. Conclusions
As the return policy has been widely adopted, the return freight fee be-
comes a new barrier for customers to purchase online. To reduce this adverse
effect, online retailers in China offer the RFI service. In this paper, we ex-
amine the retailer’s and the insurance companies’ RFI strategies with the
consideration of quality risk. The insurance companies evaluate and ver-
ify the quality information posted by the online retailer to avoid excessive
customer returns. The RFI service acts as an imperfect quality signal for
customers to mitigate the quality uncertainty, and it further reduces the cus-
tomer’s return freight when returns occur. Regarding these two effects, we
build an analytical framework to investigate the retailer’s RFI strategy and
its impact on the retail price and the RFI premium.
We find that the insurance company should determine the RFI premium
mainly based on the retailer’s return rate. The retailer selling the high-
quality product can always employ the markup price with the adoption of
RFI, whereas the low-quality retailer cannot. The retailer’s adoption decision
of the RFI service is made by trading off the sales revenue advantage and
the increased product return cost. Our result shows that the retailer selling
the high-quality product is always willing to adopt the RFI service, but the
retailer selling the low-quality product only prefers the RFI service when
both the signal efficiency and the return freight fee are medium, or when the
signal efficiency is high and the return freight fee is small.
Future research may pay more attention to the consumers’ concern on
horizontal quality, the joint effects of RFI with other information disclosure
strategies. Furthermore, the effect of a more complex market structure (i.e.,
competitive market) is of interest. Another important issue is to investigate
the coordination of RFI strategies between the third-party platform and the
insurance company.

24
Appendix A.
Proof of Lemma 1. Under the benchmark case without RFI, the insurance
companies do not need to charge the RFI premium, and we normalize the
premium as 0. Hence, we mainly analyze customers’ purchase and return
behaviors to formalize the demand and customer returns, and explore the
retailer’s pricing strategy regarding the customer’s best reactions.
We use the backward induction to solve the problem from the customer’s
return behavior. By comparing UNk = γq ≥ UNr = pN − f , we cate-
gorize the customers into three groups in terms of WTP. 1) when γ ≥
max{ pNqH−f , pNqL−f } = pNqL−f , the customer who makes a purchase always keeps
the product regardless of the quality level, and we regard them as the com-
pulsive customer; 2) when pNqH−f ≤ γ ≤ pNqL−f , the customer keeps the product
with high quality but returns the low-quality one, regarded as the strategic
customer; 3) when γ ≤ pNqH−f , the customer always chooses to return the prod-
uct, we regard them as non-buy customer. Regarding these return behaviors,
we analyze the customer’s purchase behavior as follows.

(1) When γ ≥ pNqL−f , the compulsive customer obtains the expected utility
E(UN |IR = 0) = γq2H + γq2L , and the customer will make a purchase
when this utility exceeds the product price pN , i.e., the customer with
γ ≥ qH2p+q
N
L
will make a purchase.
pN −f pN −f
(2) When qH
≤γ≤ qL
, the strategic customer obtains the expected
utility E(UN |IR = 0) = γq2H + (pN2−f ) , and the customer with γ ≥ pNqH+f
will make a purchase.
(3) When γ ≤ pNqH−f , The non-buy customer obtains the expected utility
(pN −f ) (pN −f )
E(UN |IR = 0) = 2
+ 2
, and the customer never buys the
product.

Note that γ ∼ U (0, 1), by summarizing, we obtain the volume of the com-
pulsive and strategic customers as follows.
(1) The volume of compulsive customers is 1 − γC , where γC = max{ pNqL−f ,
2pN
qH +qL
};
pN −f
(2) The volume of strategic customers is qL
−γS , where γS = min{ pNqL−f ,
pN +f
qH
}.

25
As a result, the demand is represented as dN = 1 − γC + pNqL−f − γS , the
volume of return is drN = pNqL−f − γS , and the volume of keep is dkN = 1 − γC .
Before we turn to analyze the retailer’s pricing strategy, we first find the
value size of γC and γS to identify the demand and return volume.
(qH +qL )f pN −f
(1) When pN ≥ qH −qL
, we have γC = qL
, γS = pNqH+f ≤ γC ;
(qH +qL )f
(2) When pN ≤ qH −qL
, γC = 2pN
qH +qL
, γS = pNqL−f .
Next, regarding the value of γC and γS , we separately analyze the high-
quality (Case I) and low-quality (Case II) retailer’s pricing strategy.
Case I: q = qH
As for the retailer who sells the product with q = qH , we first consider two
cases conditional on pN ≥ (qqHH+q L )f
−qL
and pN ≤ (qqHH+qL )f
−qL
, respectively. Then,
we combine these two cases to find the optimal retail price.
Case 1: pN ≥ (qqHH+q L )f
−qL
Under this condition, the demand is dN = 1 − γS = 1 − pNqH+f , and no
customers will return the product because of quality satisfaction. Then, the
high-quality retailer solves the following program:
pN + f
max ΠN = pN dN = pN (1 − ) (A.1)
pN qH
(qH + qL )f
s.t. ≤ pN ≤ qH − f.
q H − qL
where the constraint guarantees the demand is greater than 0.
2
For this program, we have ∂∂pΠ2N = − q2H < 0, i.e., the profit function is
N
a concave function of price pN . Given the concavity of the profit function,
(1)
the optimal retail price pN is either interior pN = qH2−f or at the corner of
(1)
pN = (qqHH+q L )f
−qL
. The Lagrangian of ΠN is L = ΠN +µ1 (qh −f −pN )+µ2 pN −
(qH +qL )f
(1)
qH −qL
. dpN = 0 and µ1 = µ2 = 0 yields pN = qH2−f . For qH2−f to be larger
dL

−qL )
than (qqHH+qL )f
−qL
, we have f ≤ qH3q(qHH+qL
. Moreover, we find qH2−f is always
dL dL
smaller than qH − f (i.e., µ1 = 0 always holds). Letting dp N
= 0, dµ 2
= 0 and
(1) (qH +qL )f (3qH +ql )f −qH (qH −qL )
µ1 = 0 yields pN = qH −qL
and µ2 = qH (qH −qL )
. µ2 > 0 requires
qH (qH −qL )
f≥ 3qH +qL
.
qH (qH −qL ) (1)
In summary, when f ≥ 3qH +qL
, pN = (qqHH+q
−qL
L )f
, the corresponding
(1) (qH +qL )f (qH −qL −2f ) −qL )
profit is ΠN = qH −qL
; otherwise, when f ≤ qH3q(qHH+q L
, the price
(1) qH −f (1) (qH −f )2
becomes pN = 2
, the corresponding profit is ΠN = 4qH .

26
 (qH +qL )f
Case 2: pN ≤ qH −qL
(qH +qL )f
When pN ≤ qH −qL
, the
number of strategic customers shrinks to zero, thus
the demand becomes dN = 1 − γC = 1 − qH2p+q N
L
, and all customers always
keep the product. Then the retailer solves the following program:
2pN

max ΠN = pN 1 − (A.2)
pN qH + qL
(qH + qL )f
s.t. pN ≤ .
q H − qL
2
We also find that ∂∂pΠ2N = − qH +q
4
L
< 0, i.e., the profit is a concave function
N
of price pN . Given the concavity of the profit function, the optimal retail
(2)
price pN is the interior solution pN = qH +q 4
L
when f ≥ qH −q 4
L
with profit
(2) (2)
ΠN = 8 , and the corner solution pN = qH −qL when f ≥ qH −q
qH +qL (qH +qL )f
4
L
with
(2) (qH −qL −2f )
profit ΠN = (qH +qL )f
qH −qL
.
Finally, we compare the profit under Case 1 and Case 2 to find the
−qL )
optimal one. First, note that qH −q 4
L
< qH3q(qHH+qL
, so we compare the retailer’s
qH (qH −qL ) qH −qL qH (qH −qL ) qH −qL
profit regarding f ≥ 3qH +qL
, 4 ≤f ≤ 3qH +qL
, and f ≤ 4
.
−qL ) (1) (qH −qL −2f ) (2)
(1) when f ≥ qH3q(qHH+qL
, ΠN = (qH +qL )f
qH −qL
≤ ΠN = qH +qL
8
. Then
∗ qH +qL
we conclude that the optimal price is pN = 4 .
−qL ) 2
, ΠN = (qH4q−f
qH −qL (1) (2)
(2) when ≤ f ≤ qH3q(qHH+q
4 L H
)
≤ ΠN = qH +q
8
L
when
q
(1) (2)
f ≥ f h = qh − qH (qH2 =qL ) , and ΠN ≥ ΠN when f ≤ f h . Then
we conclude that the optimal price is p∗N = qH +q 4
L
when f ≥ f h , and
∗ qH −f
pN = 2 when f ≤ f h .
2
, ΠN = (qH4q−f (qH −qL −2f )
(1) (2)
(3) when f ≤ qH −q
4
L
H
)
≥ ΠN = (qH +qL )f
qH −qL
. Then we
∗ qH −f
conclude that the optimal price is pN = 2 .
In summary, the optimal retail price p∗N for the retailer with q = qH is shown
in Table A.4:
Case II: q = qL
As for the retailer who sells the product with q = qL , we also consider two
cases conditional on pN ≥ (qqHH+qL )f
−qL
and pN ≤ (qqHH+qL )f
−qL
, respectively. Then,
we combine these two cases to find the optimal retail price.
Case 1: pN ≥ (qqHH+q L )f
−qL
Under this condition, the demand is dN = 1 − γS = 1 − pNqH+f . However, only

27
 Table A.4: The Optimal Pricing Strategy of the High-quality Retailer.

Condition p∗N
qH +qL
f ≥ fh 4
qH −f
f ≤ fh 2

the compulsive customers keep the product, i.e., dkN = 1 − γC = 1 − pNqL−f ;

the strategic customers choose to return the low-quality product afterwards,
i.e., drN = pNqL−f − γS = pNqL−f − pNqH+f , and the retailer with q = qL has to
bear the return handling cost tdrN . Hence, the retailer solves the following
program:
pN − f
pN − f pN + f

max ΠN = pN dkN − tdrN = pN 1 − −t − (A.3)
pN qL qL qH
(qH + qL )f
s.t. ≤ pN ≤ qL + f.
qH − qL
Where the constraint guarantees the demand is greater than 0.
2
We find that ∂∂pΠ2N = − q2L < 0, i.e., the profit is a concave function
N
of price pN . Given the concavity of the profit function, we solve program
(A.4) through the Lagrange function L = ΠN + µ1 (qL − f − pN ) + µ2 pN −
(qH +qL )f
(1)
qH −qL
, and find that the optimal solution is the interior solution pN =
qL +f (qH −qL )t qH −ql
 (qH −qL )t  (1)
2
− 2qH
when f ≤ f l
= qH +3qL
q L − qH
(with profit ΠN =
[qH (qL −f −t)+tqL ]2 +4qH qL (qH +2t)f (1) (qH +qL )f
4qL qH2 ); and the corner solution pN = qH −qL
when
(1) (qH −qL −2f )
f ≥ f l (with profit ΠN = (qH +qL )f qH −qL
).
Case 2: pN ≤ (qqHH+q −qL
L )f

When pN ≤ (qqHH+q L )f
−qL
, only a proportion of the compulsive
customers would
2pN
like to purchase, i.e., the demand is dN = 1 − γC = 1 − Hence, the
qH +qL
.
retailer bears zero return risks, it solve the following program to obtain the
optimal price.
2pN

max ΠN = pN 1 − (A.4)
pN qH + qL
(qH + qL )f
s.t. pN ≤ .
q H − qL

28
 2
We also find that ∂∂pΠ2N = − qH +q
4
L
< 0, i.e., the profit is a concave function
N
of price pN . Given the concavity of the profit function, the optimal solution
(2) (2)
pN is the interior solution pN = qH +q 4
L
when f ≥ qH −q 4
L
with profit ΠN =
(2)
qH +qL
8
, and the corner solution pN = (qqHH+q L )f
−qL
when f ≥ qH −q4
L
with profit
(2) (qH −qL −2f )
ΠN = (qH +qL )f
qH −qL
.
Finally, we compare the profit under Case 1 and Case 2 to find the
optimal one. First, note that f l ≤ qH −q
4
L
, so we compare the retailer’s profit
qH −qL qH −qL
regarding f ≥ 4 , f l ≤ f ≤ 4 , and f ≤ f l .
(1) (qH −qL −2f ) (2)
(1) when f ≥ qH −q
4
L
, ΠN = (qH +qL )f
qH −qL
≤ ΠN = qH +qL
8
. Then we
∗ qH +qL
conclude that the optimal price is pN = 4 .
qH −qL (qH +qL )f (qH −qL −2f )
(1) (2)
(2) when f l ≤ f ≤ 4
, ΠN = qH −qL
= ΠN . Then we
conclude that the optimal price is p∗N = (qqHH+q L )f
−qL
.
(1) [qH (qL −f −t)+tqL ]2 +4qH qL (qH +2t)f (2) (qH −qL −2f )
(3) when f ≤ f l , ΠN = 4qL qH2 ≥ ΠN = (qH +qL )f qH −qL
.
∗ qL +f (qH −qL )t
Then we conclude that the optimal price is pN = 2 − 2qH .
In summary, the optimal retail price p∗N for the retailer with q = qL is shown
in Table A.5. □
Table A.5: The Optimal Pricing Strategy of the Low-quality Retailer.

Condition p∗N
f ≥ qH −q
4
L qH +qL
4
f l ≤ f ≤ qH −q
4
L (qH +qL )f
qH −qL
f ≤ fl qL +f
2
− (qH2q−qHL )t

Proof of Lemma 2. To explore the impact of the return freight fee f on

the retailer profit without RFI, we take the derivative of the equilibrium
profit Π∗N with respect to f .
Case I: q = qH
qH +qL
(1) when f ≥ f h , Π∗N = 8
. It is obvious that Π∗N is independent of f.
)2 dΠ∗N
(2) when f ≤ f h , Π∗N = (qH4q−f
H
. Taking its derivative, we have df
=
H −f
− q2qH
< 0.

29
In summary, we conclude that the high-quality retailer’s profit Π∗N is non-
increasing in f .
Case II: q = qL
(1) when f ≥ qH −q
4
L
, Π∗N = qH +q
8
L
. It is obvious that Π∗N is independent of
f ..
(qH −qL −2f )
(2) when f l ≤ f ≤ qH −q
4
L
, Π∗N = (qH +qL )f
qH −qL
. Taking its derivative,
dΠ∗N
we have df
= (qH − qL ) − 4f , which is larger than 0 in this interval.
[qH (qL −f −t)+tqL ]2 +4qH qL (qH +2t)f
(3) when f ≤ f l , Π∗N = 4qL qH2 . Taking its deriva-
dΠ∗N 2[qH (qL +f −t)+tqL ]+4(qH +qL )t
tive, we have df
= 4qL qH
> 0.
In summary, we conclude that the low-quality retailer’s profit Π∗N is non-
decreasing in f . □

Proof of Lemma 3. Under the RFI case, we start with the customer’s re-
turn behavior, similar to the benchmark case. Through analyzing customers’
purchase and return behaviors, we formalize the demand and customer re-
turns. Then we solve the insurance companies and retailer’s pricing strategies
regarding the customer’s best reactions.
By comparing URk = γq ≥ URr = pN −(1−β)f , we categorize the customers
into three group like the benchmark case.
(1) when γ ≥ max{ pR −(1−β)f
qH
, pR −(1−β)f
qL
} = pR −(1−β)f
qL
, the customer who
makes a purchase always keeps the product regardless of the quality
level, we regard them as the compulsive customers;
(2) when pR −(1−β)f
qH
≤ γ ≤ pR −(1−β)f
qL
, the customer keeps the product with
high quality but returns the low-quality one, regarded as the strategic
customers;
(3) when γ ≤ pR −(1−β)f
qH
, the customer always chooses to return the product,
regarded as the non-buy customers.
Given three types of customers, we analyze the their purchase behaviors as
follows.
pR −(1−β)f
(1) When γ ≥ qL
, the compulsive customer obtains the expected
′
utility: E(UR |IR = 1) = (1+σ)γq
2
+ (1−σ)γq
2
,where q = {qH , qL } is the
′
product true quality and q represents the false quality. The customer
will make a purchase when this utility exceeds the product price pN ,
2pR
i.e., the customer with γ ≥ (1+σ)q+(1−σ)q ′ will make a purchase.

30
 pR −(1−β)f pR −(1−β)f
(2) When qH
≤γ ≤ qL
, the strategic customer’s utility be-
′
(1+σ) max{γq, pR −(1−β)f } (1−σ) max{γq , pR −(1−β)f }
comes: E(UR |IR = 1) = 2
+ 2
,
and the customer with γ ≥ γ1 (q) will make a purchase, where γ1 (q)
′
pR −(1−β)f } , pR −(1−β)f }
solves (1+σ) max{γ1 (q)q,
2
+ (1−σ) max{γ1 (q)q
2
= 0.
pR −(1−β)f
(3) When γ ≤ qH
, the non-buy customer obtains the expected
(pR −(1−β)f ) (pR −(1−β)f )
utility E(UR |IR = 1) = 2
+ 2
, and the customer
never buys the product.
Note that γ ∼ U (0, 1), by summarizing, we obtain the volume of the
compulsive and strategic customers as follows.
(1) The volume of compulsive customers is 1−γC , where γC = max{ pR −(1−β)f
′ ′
qL
,
2pR
(1+σ)q+(1−σ)q ′
};
pR −(1−β)f ′ ′
(2) The volume of strategic customers is qL
−γS , where γS = min{γ1 (q),
pR −(1−β)f
qL
}.

As a result, the demand is dR = 1 − γC + pR −(1−β)f

′ ′
qL
− γS , the volume of return
is drR = pR −(1−β)f
′ ′
qL
− γS , and the volume of keep is dkR = 1 − γC .
Next, the retailer chooses the insurance company with the lowest pre-
mium a, and pays the premium to the selected insurance company with each
transaction. As for the insurance companies, the expected profit of the RFI
service provider can be expressed by π(a) = adR − βf drR . As the insurance
companies are completely substituted with each other, and the non-selected
companies earn nothing, we have π(a) = 0. Then, we have a = (drR /dR ) βf .
Next, regarding the customers’ behaviors and the RFI premium, we an-
alyze the retailer’s pricing strategy when q = qH and q = qL , separately.
Case I: q = qH
′ ′
When q = qH , we first find the exact value of γC and γS to obtain the demand
and the return volume.
[(qH +qL )+σ(qH −qL )](1−β)f ′ pR −(1−β) ′
(1) When pR ≥ (1+σ)(qH −qL )
, we have γC = qL
, γS =
(1+σ)pR +(1−σ)(1−β)f ′
(1+σ)qH
≤ γC ;
)+σ(qH −qL )](1−β)f ′ ′ pR −(1−β)f
(2) when pR ≤ [(qH +qL(1+σ)(q H −qL )
, γC = 2pR
(qH +qL )+σ(qH −qL )
, γS = qL
.
Given the above facts, we analyze the retailer’s pricing strategy regarding
)+σ(qH −qL )](1−β)f )+σ(qH −qL )](1−β)f
pR ≥ [(qH +qL(1+σ)(qH −qL )
and pR ≤ [(qH +qL(1+σ)(qH −qL )
, respectively.
[(qH +qL )+σ(qH −qL )](1−β)f
Case 1: pR ≥ (1+σ)(qH −qL )

31
 [(qH +qL )+σ(qH −qL )](1−β)f ′
When pR ≥ (1+σ)(qH −qL )
, the demand is dR = 1 − γS = 1 −
(1+σ)pR +(1−σ)(1−β)f
(1+σ)qH
, and the returns drR = 0 because of
the high quality. Thus,
the retailer pays an infinitely small premium to the insurance company, i.e.,
a = 0. Moreover, to ensure the demand is larger than 0, we have pR ≤
qH − (1−σ)(1−β)f
1+σ
. The retailer solves the following program to determine the
retail price
 (1 + σ)pR + (1 − σ)(1 − β)f 
max ΠR = pR dR = pR 1 − (A.5)
pR (1 + σ)qH
[(qH + qL ) + σ(qH − qL )](1 − β)f (1 − σ)(1 − β)f
s.t. ≤ pR ≤ qH − .
(1 + σ)(qH − qL ) 1+σ
∂ 2 ΠR
ΠR is a concave function of price pR since ∂p2R
= − q2H < 0. By ana-
lyzing the Lagrangian of ΠR , i.e., L = ΠR + λ1 ( (1−σ)(1−β)f 1+σ
− pR ) + λ2 pR −
[(qH +qL )+σ(qH −qL )](1−β)f (1) −(1−σ)(1−β)f
, we obtain the interior solution pR = (1+σ)qH2(1+σ)


(1+σ)(qH −qL )
2
(1) H −(1−σ)(1−β)f ] H (qH −qL )
(with profit ΠR = [(1+σ)q4(1+σ) 2q
H
) when f ≤ (1−β)[2(q(1+σ)q H +qL )+(1+σ)(qH −qL )]
;
(1) )+σ(qH −qL )](1−β)f (1)
and the corner solution pR = [(qH +qL(1+σ)(q H −qL )
(with profit ΠR =
[(qH +qL )+σ(qH −qL )][(1+σ)(qH −qL )−2(1−β)f ](1−β)f H (qH −qL )
(1+σ)2 (qH −qL )2
) when f ≥ (1−β)[2(q(1+σ)q H +qL )+(1+σ)(qH −qL )]
.
[(qH +qL )+σ(qH −qL )](1−β)f
Case 2: pR ≤ (1+σ)(qH −qL )
)+σ(qH −qL )](1−β)f ′
When pR ≤ [(qH +qL(1+σ)(q H −qL )
, the demand is dR = 1 − γ C = 1−
2pR
(qH +qL )+σ(qH −qL )
, and the volume of strategic customers shrinks to zero, i.e.,
the returns drR = 0. Thus, the optimization problem of the retailer can be
expressed as
2pR

max ΠR = pR 1 − (A.6)
pR (qH + qL ) + σ(qH − qL )
[(qH + qL ) + σ(qH − qL )](1 − β)f
s.t. pR ≤ .
(1 + σ)(qH − qL )
2
The objective is a concave function of price pR since ∂∂pΠ2R = − qH +qL +σ(q
4
H −qL )
<
R
0. Given the concavity of the profit function, we
solve the Lagrangian of
)+σ(qH −qL )](1−β)f
ΠR : L = ΠR + λ1 [(qH +qL(1+σ)(q H −qL )
− p R . We obtain the interior
(2) qH +qL +σ(qH −qL ) (1+σ)(qH −qL ) (2)
solution pR = 4
when f ≥ 4(1−β)
(with profit ΠR =
qH +qL +σ(qH −qL ) (2) )+σ(qH −qL )](1−β)f
8
); and the corner solution pR = [(qH +qL(1+σ)(q H −qL )
when
(1+σ)(qH −qL ) (2) [(qH +qL )+σ(qH −qL )][(1+σ)(qH −qL )−2(1−β)f ](1−β)f
f≤ 4(1−β)
(with profit ΠR = (1+σ)2 (qH −qL )2
).

32
 (1) (2)
Next, we compare ΠR and ΠR to find the optimal strategy. First, note
H −qL ) H (qH −qL )
that (1+σ)(q
4(1−β)
< (1−β)[2(q(1+σ)q
H +qL )+(1+σ)(qH −qL )]
by rearranging the inequality,
we find that 4qH ≥ 2(qH + qL ) + (1 + σ)(qH − qL ) always holds. As a
(1) (2) H (qH −qL )
result, we compare ΠR and ΠR regarding f ≥ (1−β)[2(q(1+σ)q H +qL )+(1+σ)(qH −qL )]
,
(1+σ)(qH −qL ) (1+σ)qH (qH −qL ) (1+σ)(qH −qL )
4(1−β)
≤f ≤ (1−β)[2(qH +qL )+(1+σ)(qH −qL )]
, and f ≤ 4(1−β)
.
(1+σ)qH (qH −qL )
(1) when f ≥ (1−β)[2(qH +qL )+(1+σ)(qH −qL )]
, we have

(1) [(qH + qL ) + σ(qH − qL )][(1 + σ)(qH − qL ) − 2(1 − β)f ](1 − β)f

ΠR =
(1 + σ)2 (qH − qL )2
(2) qH + qL + σ(qH − qL )
≤ΠR = .
8
(qH +qL )+σ(qH −qL )
Then we conclude that the optimal price is p∗R = 4
.
(1+σ)(qH −qL ) (1+σ)qH (qH −qL ) (1) [(1+σ)qH −(1−σ)(1−β)f ]2
(2) when 4(1−β)
≤ f ≤ (1−β)[2(qH +qL )+(1+σ)(qH −qL )] , ΠR = 4(1+σ)2 qH
(2) qH +qL +σ(qH −qL ) (2) (1)
and ΠR = 8
. By formulating their"difference ΠR − ΠR , #
q
(2) (1) H −qL ))
we have ΠR −ΠR ≥ 0 when f ≥ F h = 1+σ
(1−σ)(1−β)
qH − qH (qH +qL +σ(q
2
,
(2) (1)
and ΠR − ΠR ≤ 0 when f ≤ F h .
H −qL ) (1+σ)qH (qH −qL )
Next, We show F h ∈ [ (1+σ)(q
4(1−β)
, (1−β)[2(qH +qL )+(1+σ)(qH −qL )]
] by ver-
H −qL ) (1+σ)qH (qH −qL )
ifying (a) F h ≥ (1+σ)(q 4(1−β)
and (b) F h ≤ (1−β)[2(qH +qL )+(1+σ)(qH −qL )] ]
respectively.
H −qL )
(a) As for F h ≥ (1+σ)(q
4(1−β)
, we have [4qH − (1 − σ)(qH − qL )]2 ≥ 8[(1 +
2
σ)qH + (1 − σ)qH qL ] by rearranging the inequality, which is equivalent
to [(1 − σ)(qH − qL )]2 ≥ 0.
H (qH −qL )
(b) As for F h ≤ (1−β)[2(q(1+σ)q
H +qL )+(1+σ)(qH −qL )]
], it is equivalent to 8qH [qH +
qL + σ(qH − qL )] ≤ [2(qH + qL ) + (1 + σ)(qH − qL )]2 by rearranging the
inequality, which is equivalent to (1 − σ)2 (qH − qL ) ≥ 0.
H −qL ) H (qH −qL )
In conclusion, we have F h ∈ [ (1+σ)(q 4(1−β)
, (1−β)[2(q(1+σ)q
H +qL )+(1+σ)(qH −qL )]
].
As a result, we conclude that, in this interval, the optimal price is
H −qL ) −(1−σ)(1−β)f
p∗R = qH +qL +σ(q
4
when f ≥ F h , and p∗R = (1+σ)qH2(1+σ) when
f ≤ F h.
2
H −qL ) (1) H −(1−σ)(1−β)f ] (2)
(3) when f ≤ (1+σ)(q4(1−β)
, ΠR = [(1+σ)q4(1+σ) 2q
H
≥ ΠR =
[(qH +qL )+σ(qH −qL )][(1+σ)(qH −qL )−2(1−β)f ](1−β)f
(1+σ)2 (qH −qL )2
. Then we conclude that the
∗ (1+σ)qH −(1−σ)(1−β)f
optimal price is pR = 2(1+σ)
.

33
By summarizing, we show the optimal price p∗R for the high-quality retailer
in Table A.6.
Table A.6: The Optimal Pricing Strategy of the High-quality Retailer.

Condition p∗R
qH +qL +σ(qH −qL )
f ≥ Fh 4
(1+σ)qH −(1−σ)(1−β)f
f ≤ Fh 2(1+σ)

Case II: q = qL
′ ′
When q = qL , we first find the exact value of γC and γS .
[(qH +qL )−σ(qH −qL )](1−β)f ′ pR −(1−β)f ′
(1) When pR ≥ (1−σ)(qH −qL )
, we have γC = qL
, γS =
(1−σ)pR +(1+σ)(1−β)f
(1−σ)qH
′
≤ γC ;
[(qH +qL )−σ(qH −qL )](1−β)f ′ 2pR ′ pR −(1−β)f
(2) when pR ≤ (1−σ)(qH −qL )
, γC = (qH +qL )−σ(qH −qL )
, γS = qL
.
With the above facts, we first analyze the low-quality retailer’s strategy when
)−σ(qH −qL )](1−β)f )−σ(qH −qL )](1−β)f
pR ≥ [(qH +qL(1−σ)(qH −qL )
and pR ≤ [(qH +qL(1−σ)(qH −qL )
, respectively.
Then, we combine two cases to find the optimal price.
)−σ(qH −qL )](1−β)f
Case 1: pR ≥ [(qH +qL(1−σ)(q H −qL )
[(qH +qL )−σ(qH −qL )](1−β)f ′
When pR ≥ (1−σ)(qH −qL )
, the demand is dR = 1 − γS = 1 −
[(1−σ)pR +(1+σ)(1−β)f
(1−σ)qH
. But the strategic customers will return the low-quality
product, i.e., the return volume is drR = pR −(1−β)f − γS = pR −(1−β)f
′
qL qL
−
[(1−σ)pR +(1+σ)(1−β)f k ′ pR −(1−β)f
(1−σ)qH
, and the keeping volume is dR = 1 − γC = 1 − qL
.
Thus, the retailer pays a RFI premium related to its return rate, i.e., a =
(drR /dR ) βf . The retailer solves the following program to determine the retail
price.
pR − (1 − β)f
pR − (1 − β)f

max ΠR = pR 1 − − (t + βf )
pR qL qL
[(1 − σ)pR + (1 + σ)(1 − β)f

+ (t + βf ) (A.7)
(1 − σ)qH
[(qH + qL ) − σ(qH − qL )](1 − β)f
s.t. ≤ pR ≤ qL + (1 − β)f.
(1 − σ)(qH − qL )
where the constraint guarantees the demand is larger than 0.

34
 2
ΠR is a concave function of price pR since ∂∂pΠ2R = − q2L < 0. We de-
R
rive the optimal solution by analyzing the Lagrangian of ΠN ,
i.e., L =
)−σ(qH −qL )](1−β)f
ΠR + λ1 (qL + (1 − β)f − pR ) + λ2 pR − [(qH +qL(1−σ)(qH −qL )
. We ob-
− (qH −q2qL )(βf
(1) qL +(1−β)f +t)
tain the interior solution pR = 2 H
when f ≤ F l =
(1−σ)(qH −qL )[qH qL −t(qH −qL )] (1)
4(1−β)qH qL +(1−σ)(qH −qL )(qH −βqL )
(with ΠR =
(1−σ)[(qL −f −t)qH +qL (t+βf )]2 +4(1−β)f qH qL [(1−σ)qH +2(t+βf )]
4(1−σ)qH 2 q
L
); and the corner solution
(1) )−σ(qH −qL )](1−β)f (1)
pR = [(qH +qL(1−σ)(q H −qL )
when f ≥ F l (with profit ΠR =
[(1−σ)qH +(1+σ)qL ][(1−σ)(qH −qL )−2(1−β)f ](1−β)f
(1−σ)2 (qH −qL )2
).
[(qH +qL )−σ(qH −qL )](1−β)f
Case 2: pR ≤ (1−σ)(qH −qL )
[(qH +qL )−σ(qH −qL )](1−β)f
When pR ≤ (1−σ)(qH −qL )
, the volume of strategic customers shrinks
′ 2pR
to zero, thus the demand is dR = 1 − γC = 1 − (qH +qL )−σ(q H −qL )
, and the
return volume is drR = 0. Thus, the optimization problem of the retailer can
be expressed as
2pR

max ΠR = pR 1 − (A.8)
pR (qH + qL ) − σ(qH − qL )
[(qH + qL ) − σ(qH − qL )](1 − β)f
s.t. pR ≤ .
(1 − σ)(qH − qL )
2
The objective is a concave function of price pR since ∂∂pΠ2R = − qH +qL −σ(q
4
H −qL )
<
R
0. Given the concavity of the profit function, we
solve the Lagrangian of
[(qH +qL )−σ(qH −qL )](1−β)f
ΠR : L = ΠR + λ1 (1−σ)(qH −qL )
− pR . We obtain the interior
(2) qH +qL −σ(qH −qL ) (1−σ)(qH −qL ) (2)
solution pR = 4
when f ≥ 4(1−β)
(with profit ΠR =
qH +qL −σ(qH −qL ) (2) )−σ(qH −qL )](1−β)f
8
); and the corner solution pR = [(qH +qL(1−σ)(q H −qL )
when
H −qL )
(with profit ΠR = [(qH +qL )−σ(qH −qL(1−σ)
)][(1−σ)(qH −qL )−2(1−β)f ](1−β)f
(2)
f ≤ (1−σ)(q
4(1−β) 2 (q −q )2
H L
).
(1) (2)
Next, we compare ΠR and ΠR to find the optimal strategy.
H −qL )
First, note that (1−σ)(q
4(1−β)
≥ F l because we have −4(1 − β)(qH − qL )t ≥
(1−σ)(qH −qL )(qH −βqL ), which always holds, by rearranging the inequality.
(1) (2) H −qL )
As a result, we compare ΠR and ΠR regarding f ≥ (1−σ)(q 4(1−β)
, Fl ≤ f ≤
(1−σ)(qH −qL )
4(1−β)
, and f ≤ F l .
(1−σ)(qH −qL )
, ΠR = [(qH +qL )−σ(qH −qL(1−σ)
)][(1−σ)(qH −qL )−2(1−β)f ](1−β)f
(1)
(1) when f ≥ 4(1−β) 2 (q −q )2
H L
(2) qH +qL −σ(qH −qL )
≤ ΠR = 8
. Then we conclude that the optimal price is
∗ qH +qL −σ(qH −qL )
pR = 4
.

35
 (1−σ)(qH −qL ) (1) [(qH +qL )−σ(qH −qL )][(1−σ)(qH −qL )−2(1−β)f ](1−β)f
(2) when F l ≤ f ≤ 4(1−β)
, ΠR = (1−σ)2 (qH −qL )2
(2) )−σ(qH −qL )](1−β)f
= ΠR . Then we conclude the optimal price is p∗R = [(qH +qL(1−σ)(q H −qL )
.
(1) (1−σ)[(qL −f −t)qH +qL (t+βf )]2 +4(1−β)f qH qL [(1−σ)qH +2(t+βf )]
(3) when f ≤ F l , ΠR = 4(1−σ)qH 2 q
L
(2) [(qH +qL )−σ(qH −qL )][(1−σ)(qH −qL )−2(1−β)f ](1−β)f
≥ ΠR = (1−σ)2 (qH −qL )2
. Then we conclude
∗ qL +(1−β)f (qH −qL )(βf +t)
that the optimal price is pR = 2
− 2qH
.

Table A.7: The Optimal Pricing Strategy of the Low-quality Retailer.

Condition p∗R
H −qL ) qH +qL −σ(qH −qL )
f ≥ (1−σ)(q
4(1−β) 4
H −qL ) [(qH +qL )−σ(qH −qL )](1−β)f
F l ≤ f ≤ (1−σ)(q
4(1−β) (1−σ)(qH −qL )
f ≤ Fl qL +(1−β)f
2
− (qH −q2qL )(βf
H
+t)

In summary, we show the optimal price p∗R for the low-quality retailer in
Table A.7. □

Proof of Proposition 1. We take the derivative of p∗R with the return

freight fee f and the signal efficiency σ, to show the monotonicity of p∗R .
(1) Property of p∗R for the high-quality retailer
H −qL )
(i) when f ≥ F h : we have p∗R = qH +qL +σ(q 4
. Obviously, it is
dp∗R qH −qL ∗
independent of f . dσ = 4 > 0, i.e., pR is increasing in σ.
−(1−σ)(1−β)f dp∗R
(ii) when f ≤ F h : we have p∗R = (1+σ)qH2(1+σ) . df = − (1−σ)(1−β)f
2(1+σ)
,
dp∗
thus we conclude that p∗R is decreasing in f . dσR = (1−β)f
(1+σ)2
, thus we con-
∗
clude that pR is increasing in σ.
In summary, we have p∗R is non-increasing in f and increasing in σ for
the high-quality retailer.
(2) Property of p∗R for the low-quality retailer.
H −qL )
(i) when f ≥ (1−σ)(q
4(1−β)
: we have p∗R = qH +qL −σ(q
4
H −qL )
. Obviously, it
dp∗
is independent of f . dσR = − qH −q 4
L
> 0, thus we conclude that p∗R is
decreasing in σ.
H −qL ) )−σ(qH −qL )](1−β)f
(ii) when F l ≤ f ≤ (1−σ)(q
4(1−β)
: we have p∗R = [(qH +qL(1−σ)(qH −qL )
,
dp∗R L )−σ(qH −qL )](1−β) dp∗R
and df
= [(qH +q(1−σ)(q H −qL )
> 0, i.e., p∗R is increasing in f . dσ
=
2qL (1−β)f
(1−σ)2 (qH −qL )
> 0, i.e., p∗R is increasing in σ.

36
 (iii) when f ≤ F l : we have p∗R = qL +(1−β)f
2
− (qH −q2qL )(βf
H
+t)
. Taking its
dp∗R
[(1−β)qH −β(qH −qL )](1−β)
derivative, we have df = 2qH
> 0. It is decreasing
in f when qH ≤ β , and increasing in f when qH ≥ 2β−1
qL 2β−1 qL
β
. As for the
∗
impact of σ, it is obvious that pR is independent of σ.
In summary, we conclude that, the retail price for the low-quality re-
tailer: (i) is decreasing in f when f ≤ F l , qqHL ≤ 2β−1 β
; (ii) is non-
decreasing in f otherwise.
The retail price for the low-quality retailer: (i) is increasing in σ when
H −qL )
F l ≤ f ≤ (1−σ)(q
4(1−β)
; (ii) is non-increasing in σ otherwise. □

Proof of Lemma 4. Note that there are no customer returns except for
∗
Case (3)-(iii) of Lemma 3. The return rate in Case (3)-(iii) is dr∗ R /dR , where
[qH qL −t(qH −qL )](qH −qL )
dr∗
R = 2q 2 qL
2(1−β)f
+ (1−σ)qH
+ (qH −β)qL )(qH −qL )
2q 2 qL
and d∗R = 1+ qL (βf
2q 2
+t)
−
H H H
(3+σ−4β)f +(1−σ)(qL −t)
2(1−σ)qH
.
∗
Next, we take the derivative of dr∗
R /dR to explore its monotonicity with
the return freight fee f and the signal efficiency σ.
∗
(1) The monotonicity of the return rate dr∗ R /dR in f
r∗ ∗
Taking the derivatives of dR and dR with respect to f respectively, we
ddr∗ dd∗R
have dfR = (1−σ)(qH −qL−2(1−σ)q
)(qH −βqL )+4(1−β)qH qL
2 q
L
< 0, df
= (1−σ)βq L −(3+σ−4β)qH
−2(1−σ)q 2
,
H H
dd∗
where dfR is larger than 0 when qqHL ≥ 3+σ−4β
β(1−σ)
, is smaller than 0 other-
wise.
∗
Taking the derivatives of dr∗
R /dR with f , we have
∗
d(dr∗ dd∗R r∗
 r∗ 
R /dR ) ddR ∗
= d − d /(d∗R )2 .
df df R df R
qL d(dr∗ /d∗ )
(a) when qH
≥ 3+σ−4β
β(1−σ)
, it is easy to find that Rdf R < 0;
ddr∗
(b) when qqHL ≤ 3+σ−4β
β(1−σ)
, we have dfR = − (1−σ)(qH −qL2(1−σ)q
)(qH −βqL )+4(1−β)qH qL
2
H qL
dd∗R (1−σ)βqL −(3+σ−4β)qH
< df = − 2(1−σ)qH2 < 0. This is because

(1 − σ)(qH − qL )(qH − βqL ) + 4(1 − β)qH qL (1 − σ)βqL − (3 + σ − 4β)qH

2
< 2
−2(1 − σ)qH qL −2(1 − σ)qH
⇔ 0 < β(qH + qL )2 + β(qH + qL )qL + (1 − β)qH 2

ddr∗ ddr∗ dd∗R r∗ d(dr∗ ∗

R /dR )
Thus, R
df R
d∗ < R
df R
dr∗ < df R
d , which implies df
< 0. Putting
d(dr∗ /d∗ )
two parts together, we have Rdf R < 0.

37
 ∗
(2) The monotonicity of the return rate dr∗R /dR in σ
∗ ddr∗
Taking the derivatives of dr∗
R , dR with respect to σ, we have
R
dσ
=
∗
ddR 2(1−β)f
dσ
= − (1−σ)2q
H
< 0.
∗
Taking the derivatives of dr∗
R /dR with respect to σ, we have

∗
d(dr∗ dd∗R r∗
 r∗ 
R /dR ) ddR ∗
= dR − dR /(d∗R )2 < 0.
dσ dσ dσ

Proof of Proposition 2. Note that there are no customer returns except

for Case
(3)-(iii) of low-quality retailer in Lemma 3. For Case (3)-(iii), a∗ =
∗
dr∗
R /dR βf , we take its derivative with respect to f and σ to find the
monotonicity.
(1) The monotonicity of the
RFI premium a∗ in f
Note that a∗ = dr∗ ∗
R /dR βf , take the derivative with respect to f , we
have
da∗ dd∗R r∗
 r∗ 
ddR ∗
r∗ ∗
= βdR /dR + βf dR − dR /(d∗R )2
df df df
dd∗R r∗
  r∗ 
β r∗ ∗ ddR ∗
= ∗ 2 · dR dR + f d − d (A.9)
(dR ) df R df R
β
As for the second equality (A.9), the first part 2 is always larger
(d∗R) 
∗ ddr∗ ∗ dd∗R r∗
than 0. For the second part, note that dr∗
R Rd > 0 but R
df R
d − d
df R

< 0 , thus  the second part isgreater than 0 iff f < F̂ , where F̂ satisfies
∗ ddr∗ ∗ dd∗R r∗
dr∗
R Rd + F̂ R
df R
d − d
df R
= 0.
(2) The monotonicity of the RFI premium a∗ in σ
d(dr∗ ∗ d(dr∗ ∗
da∗ R /dR ) R /dR )
dσ
= dσ
βf , this derivative is determined by dσ
, thus the
property degenerates to the proof of part (2) in Lemma 4, i.e., a∗ is
decreasing in σ.

38
Proof of Proposition 3. We explore the impacts of the return freight fee
f and the signal efficiency σ on Π∗R regarding q = qH and q = qL , respectively.
Case I: q = qH
(i) when f ≥ F h : we have Π∗R = (1+σ)qH +(1−σ)(1−q
8
L)
. it is obvious that Π∗R is
dΠ∗
independent of f . Taking its derivative with σ , we have dσR = qH −q 8
L
> 0,
∗
thus we conclude that ΠR is increasing in σ.
2
H −(1−σ)(1−β)f ]
(ii) when f ≤ F h : we have Π∗R = [(1+σ)q4(1+σ) 2q
H
. Taking its deriva-
tive, we have
dΠ∗R [(1 + σ)qH − (1 − σ)(1 − β)f ](1 − σ)(1 − β)
=− <0
df 2(1 + σ)2 qH
dΠ∗R [(1 + σ)qH − (1 − σ)(1 − β)f ]σ(1 − β)
= >0
dσ (1 + σ)3 qH
In summary, we have Π∗R is non-increasing in f , and increasing in σ for
the high-quality retailer.
Case II: q = qL
As for the low-quality retailer, i.e., q = qL , we have the following results.
H −qL )
(i) when f ≥ (1−σ)(q
4(1−β)
: we have Π∗R = (1−σ)qH +(1+σ)q
8
L
. it is obvious
dΠ∗R
that Π∗R is independent of f ; Taking its derivative with σ , we have dσ
=
− qH −q
8
L
< 0, thus we conclude that Π∗R is decreasing in σ.
H −qL )
(ii) when F l ≤ f ≤ (1−σ)(q
4(1−β)
: we have
[(qH + qL ) − σ(qH − qL )][(1 − σ)(qH − qL ) − 2(1 − β)f ](1 − β)f
Π∗R =
(1 − σ)2 (qH − qL )2
Taking its derivative, we have
dΠ∗R [(1 − σ)qH + (1 + σ)qL ][(1 − σ)(qH − qL ) − 4(1 − β)2 f ]
= > 0,
df (1 − σ)2 (qH − qL )2
dΠ∗R 2(1 − β)f [(qH − qL )qL − (1 − β)f (qH + 3qL ) − σ(qH − qL )(qL − (1 − β)f )]
= .
dσ (1 + σ)3 (qH − qL )3
dΠ∗R dΠ∗
As for the second equation dσ
, we have dσR ≥ 0 when σ ≤ (qH −q L )qL −(1−β)f (qH +3qL )
(qH −qL )(qL −(1−β)f )
,
dΠ∗ (qH −qL )qL −(1−β)f (qH +3qL )
and dσR ≤ 0 when σ ≥ (qH −qL )(qL −(1−β)f )
. In summary, Π∗R is firstly
increasing in σ then decreasing in σ.
(iii) when f ≤ F l : we have
(1 − σ)[(qL − f − t)qH + qL (t + βf )]2 + 4(1 − β)f qH qL [(1 − σ)qH + 2(t + βf )]
Π∗R = 2
4(1 − σ)qH qL

39
Taking its derivative, we have

dΠ∗R β[(qL − t − f )qH + qL (t + βf )] (1 − β)[(1 − σ)qH + 2(t + 2βf )]

= 2
+ > 0,
df 2qH (1 − σ)qH
dΠ∗R 2(1 − β)f (t + βf )
= > 0.
dσ qH
In summary, we conclude that the low-quality retailer’s profit is non-decreasing
H −qL )
in f . As for the impact of σ, when f ≥ (1−σ)(q
4(1−β)
, Π∗R is decreasing in σ;
H −qL )
when F l ≤ f ≤ (1−σ)(q4(1−β)
, σ has an inverse U-shaped impact on Π∗R ; when
f ≤ F l , Π∗R is increasing in σ. □

Proof of Proposition 4. To explore when the retailer can employ the markup
price with the adoption of RFI, we compare p∗R and p∗N with quality q =
{qH , qL } respectively.
Case I: q = qH
First, we compare p∗R and p∗N to find the condition when the high-quality
retailer (q = qH ) employs the markup price with adoption of RFI, i.e., p∗R ≥
p∗N . To achieve this goal, we first show two algebra facts. Given these facts,
we argue that, regarding the thresholds of the optimal pricing strategies,
p∗R ≥ p∗N .
Firstly, from the view of algebra, we have:
(1+σ)qH +(1−σ)qL
(1) 4
≥ qH +q
4
L
always holds.
(2) qH
2
− (1−σ)(1−β)f
2(1+σ)
≥ qH2−f always holds.
Regarding the thresholds of the optimal pricing strategies with/ without
the RFI, the retailer always charges a higher price by adopting the RFI
service because

n (1 + σ)q + (1 − σ)q q (1 − σ)(1 − β)f ] o

H L H
max , − = p∗R
4 2 2(1 + σ)
nq + q q − f o
H L H
≥ max , = p∗N .
4 2
Case II: q = qL
Next, we compare p∗R and p∗N regarding different return freight fees, to find

40
the conditions when the retailer with q = qL charges a high price under the
RFI case, i.e., p∗R ≥ p∗N .
H −qL )
When f ≥ max{ qH −q 4
L
, (1−σ)(q
4(1−β)
}, i.e., p∗R = (1−σ)qH +(1+σ)q
4
L
and p∗N =
qH +qL
4
where (1−σ)qH +(1+σ)q
, 4
L
≤ qH +q
4
L
. That is, the pricing strategy under
the RFI case is always below the strategy under the case without RFI.
)(qH −qL )
When f ≤ min{F l , f l }, we have p∗R = qL +(1−β)f
2
− (t+βf2qH
≤ qL2+f −
t(qH −qL )
2qH
= p∗N .
(1−σ)(qH −qL )
When min{F l , f l } ≤ f ≤ max{ qH −q
4
L
, 4(1−β)
}, we compare p∗R and
H −qL )
p∗N conditional on the size of qH −q
4
L
, (1−σ)(q
4(1−β)
, F l , f l . Before that, we
H −qL )
firstly explore the size of qH −q
4
L
, (1−σ)(q
4(1−β)
, F l , f l . We have the following
5 Cases depending on the value of σ.

Table A.8: Threshold Comparison.

Case Condition Size

(1−σ)(qH −qL )
Case 1 ≥ qH −q L
≥ Fl ≥ fl
σ≤β 4(1−β)
(1−σ)(qH −qL )
4
qH −qL
Case 2 4(1−β)
≥ Fl ≥ 4 ≥ fl
(5qH −qL )β qH −qL (1−σ)(qH −qL )
Case 3 β<σ≤ 4qH +(qH −qL )β 4
≥ 4(1−β)
≥ Fl ≥ fl
(5qH −qL )β 4(1−β)f qH −qL H −qL )
Case 4 4qH +(qH −qL )β
< σ ≤ 1 − qH −qL l 4
≥ (1−σ)(q
4(1−β)
≥ fl ≥ Fl
4(1−β)f qH −qL (1−σ)(q H −qL )
Case 5 σ > 1 − qH −qL l 4
≥ fl ≥ 4(1−β)
≥ Fl

Next, we discuss the comparison of pricing strategy regarding different

cases in Table A.8.
Case 1
Given the relationship under Case 1, we compare p∗R and p∗N depending
on f .
qH −qL (1−σ)(qH −qL ) [(1−σ)qH +(1+σ)qL ](1−β)f
(i) when 4
≤ f≤ 4(1−β)
, we have p∗R = (1−σ)(qH −qL )
<
(1−σ)qH +(1+σ)qL qH +qL
4
≤ 4
= p∗N .
Note that the first inequality is from
the property of pR we discussed in Proposition 1, that p∗R is continuous
∗

and non-decreasing in f ;
(ii) when F l ≤ f ≤ qH −q
4
L
, we have p∗R = [(1−σ)q(1−σ)(q
H +(1+σ)qL ](1−β)f
H −qL )
and p∗N =
(qH +qL )f H −qL )β
(qH −qL )
. p∗R ≥ p∗N holds when σ ≥ 2qL(q+(q
H +qL )β
H −qL )β
, where β ≤ 4qH(5q+(qH −qL )β
(qH +qL )β ∗ ∗
≤ 2qL +(qH −qL )β . Hence, we conclude that pR ≤ pN in this interval;

41
 qL +(1−β)f (t+βf )(qH −qL )
(iii) when f l ≤ f ≤ F l , we have p∗R = 2
− 2qH
and p∗N =
(qH +qL )f qH qL −t(qH −qL )
(qH −qL )
. p∗R ≥ p∗N is equivalent to f ≤ q +q β(qH −qL ) = fA
2qH [ qH −qL + 2qH
− 1−β
2
]
H L
by rearranging this inequality. However, we can show that fA ≤ f l .
Hence, under Case 1, we have p∗R ≤ p∗N .

Case 2
Given the relationship under Case 2, we compare p∗R and p∗N depending
on f .
H −qL )
(i) when F l ≤ f ≤ (1−σ)(q4(1−β)
, we have p∗R = [(1−σ)q(1−σ)(q
H +(1+σ)qL ](1−β)f
H −qL )
and
∗ qH +qL
pN = 4 . Referring to the same argument in Case 1-(i), we conclude
that p∗R ≤ p∗N in this interval;
(ii) when qH −q 4
L
≤ f ≤ F l , we have p∗R ≤ p∗N due to same argument in Case
1-(ii);
)(qH −qL )
(iii) when f l ≤ f ≤ qH −q 4
L
, we have p∗R = qL +(1−β)f
2
− (t+βf2q H
and
p∗N = (q(qHH+qL )f
−qL )
. Referring to the same argument in Case 1-(iii), we
conclude that, under case 2, we have p∗R ≤ p∗N .

Case 3
Given the relationship under Case 3, we compare p∗R and p∗N depending
on f .
(1−σ)(qH −qL )
(i) when 4(1−β)
≤ f ≤ qH −q 4
L
, we have p∗R = (1−σ)qH +(1+σ)q
4
L
and
∗ (qH +qL )f ∗ ∗ qH −qL qH −qL
pN = (qH −qL ) . pR ≥ pN is equivalent to f ≤ 4 [1 − σ qH +qL ]. Since
qH −qL H −qL )
4
[1 − σ qqHH −q L
+qL
] ≥ (1−σ)(q
4(1−β)
when σ ≥ 2qL(q+(q
H +qL )β
H −qL )β
, we conclude
∗ ∗
pR ≤ pN in this case;
H −qL )
(ii) when F l ≤ f ≤ (1−σ)(q 4(1−β)
, we have p∗R = [(1−σ)q(1−σ)(q
H +(1+σ)qL ](1−β)f
H −qL )
and
∗ (qH +qL )f
pN = (qH −qL ) . Referring to the same argument in Case 1-(ii), we
conclude that p∗R ≤ p∗N in this interval;
)(qH −qL )
(iii) when f l ≤ f ≤ F l , we have p∗R = qL +(1−β)f 2
− (t+βf2q H
and p∗N =
(qH +qL )f
(qH −qL )
. Referring to the same argument in Case 1-(iii), we conclude
that, under Case 3, we have p∗R ≤ p∗N .

Case 4
Given the relationship under Case 4, we compare p∗R and p∗N depending
on f .

42
 (1−σ)(qH −qL ) qH −qL (1−σ)qH +(1+σ)qL
(i) when 4(1−β)
≤ f ≤ 4
, we have p∗R = 4
and
(qH +qL )f q −q q −q
p∗N = (qH −qL )
. p∗R ≥ p∗N is equivalent to f ≤ H 4 L [1 − σ qHH +qLL ].
Referring to the discussion in case 3-(i), we conclude that p∗R ≥ p∗N
H −qL ) H −qL )
when σ ≥ 2qL(q+(q H +qL )β
H −qL )β
and (1−σ)(q
4(1−β)
≤ f ≤ (1−σ)(q
4(1−β)
;
(1−σ)(qH −qL ) ∗ [(1−σ)qH +(1+σ)qL ](1−β)f
(ii) when f l ≤ f ≤ 4(1−β)
, we have pR = (1−σ)(qH −qL )
and
∗ (qH +qL )f ∗ ∗ (qH −qL )β
pN = (qH −qL ) . pR ≥ pN holds when σ ≥ 2qL +(qH −qL )β based on the
argument in Case 1-(ii);
[(1−σ)qH +(1+σ)qL ](1−β)f
(iii) when F l ≤ f ≤ f l , we have p∗R = (1−σ)(qH −qL )
and p∗N =
qL +f
2
− t(qH2q−qL)
. p∗R ≥ p∗N is equivalent to f ≥ qH qL −t(qH −qL )
(1−β)(q +q ) σ(1−β) =
H 2qH [ (1−σ)(qH −qL ) − 1−σ
− 12 ]
H L
(qH −qL )β
fB . Since fB ≤ f¯l when σ ≥ 2qL +(qH −qL )β
. Then we conclude that
(qH −qL )β
p∗R ≥ p∗N holds when fB ≤ f ≤ f¯l and σ ≥ 2qL +(qH −qL )β
.
Case 5
Given the relationship under Case 5, we compare p∗R and p∗N depending
on f .
(i) when f l ≤ f ≤ qH −q
4
L
, we have p∗R = (1−σ)qH +(1+σ)q
4
L
and p∗N = (qH +qL )f
(qH −qL )
.
p∗R ≥ p∗N is equivalent to f ≤ qH −q
4
L −qL
[1 − σ qqHH +qL
];
(1−σ)(qH −qL )
(ii) when 4(1−β)
≤ f ≤ f l , we have p∗R = (1−σ)qH +(1+σ)q
4
L
and p∗N =
qL +f
2
− t(qH2q−q
H
L)
. p∗R ≥ p∗N is equivalent to f ≤ (qH −qL )[(1−σ)q
2qH
H +2t]
;
(1−σ)(qH −qL ) [(1−σ)q +(1+σ)q ](1−β)f
(iii) when F l ≤ f ≤ 4(1−β)
, we have p∗R = H L
(1−σ)(qH −qL )
and
∗ qL +f t(qH −qL ) ∗ ∗
pN = 2 − 2qH . pR ≥ pN is equivalent to f ≥ fB .
By summarizing all the above cases, we show the conditions of p∗R ≥ p∗N
H −qL )
When min{F l , f l } ≤ f ≤ max{ qH −q
4
L
, (1−σ)(q
4(1−β)
}, in Table A.9.

Proof of Proposition 5. We analyze the RFI adoption strategy of the re-

tailer with quality q = {qH , qL } respectively. As for the retailer with quality
q, specifically, it would like to adopt the RFI strategy iff Π∗R ≥ Π∗N . There-
fore, in the sequel, we aim to find the conditions by comparing Π∗R and Π∗N .
Case I: q = qH
First, we compare Π∗R and Π∗N to find when the retailer with q = qH prefers

43
 (1−σ)(qH −qL )
Table A.9: Condition of p∗R ≥ p∗N When min{F l , f l } ≤ f ≤ max{ qH −q
4
L
, 4(1−β) }

Condition
H −qL ) σ(qH −qL )
(1) (qH +qL )β max{f l , (1−σ)(q
4(1−β) } ≤ f ≤ qH −q4
L
[1 − (qH +qL ) ]
σ≥ 2qL +(qH −qL )β (1−β)(q −q )
(2) fB ≤ f ≤ min{f¯l , H
4(1−σ)
L
}
(qH +qL )β 4(1−β)f l (1−σ)(qH −qL )
(3) 2qL +(qH −qL )β ≤ σ ≤1− qH −qL f l ≤ f ≤ max{f l , 4(1−β) }
4(1−β)f (1−σ)(qH −qL ) +2t](qH −qL )
(4) σ ≥ 1 − qH −qL l 4(1−β) ≤ f ≤ min{f l , [(1−σ)qH 2qH
}

the RFI service, i.e., Π∗R ≥ Π∗N . Similar to the proof of pR ∗ ≥ pN ∗ , we first
show two algebra facts. Given these facts, we argue that Π∗R ≥ Π∗N always
holds regarding the thresholds of the optimal pricing strategies with/without
RFI.
Firstly, we have the following two algebra facts.
(1+σ)qH +(1−σ)qL qH +qL
(1) 8
≥ 8
.
 (1−σ) 2
[(1+σ)qH −(1−σ)(1−β)f ]2 q −(1−β)f
(1+σ) H (qH −f )2
(2) 4(1−σ)2 qH
= 4qH
≥ 4qH
.
Given these facts, we find that the retailer always obtains a higher profit
by adopting the RFI service because

(1 + σ)qH + (1 − σ)qL [(1 + σ)qH − (1 − σ)(1 − β)f ]2

Π∗R = max{ , }
8 4(1 − σ)2 qH
qH + qL (qH − f )2
≥ max{ , } = Π∗N .
8 4qH
Case II: q = qL
Next, we compare Π∗R and Π∗N to find the conditions when the retailer
with q = qL prefers the RFI service under the RFI case, i.e., Π∗R ≥ Π∗N .
H −qL )
(1) When f ≥ max{ qH −q
4
L
, (1−σ)(q
4(1−β)
}, we have
(
Π∗R = (1−σ)qH +(1+σ)q
8
L
,
∗ qH +qL
ΠN = 8 .

(1−σ)qH +(1+σ)qL qH +qL

However, Π∗R = 8
≤ 8
= Π∗N . That is, the retailer never
adopts RFI.

44
 (2) When f ≤ min{F l , f l }, we have
(1−σ)[(qL −f −t)qH +qL (t+βf )]2 +4(1−β)f qH qL [(1−σ)qH +2(t+βf )]
(
Π∗R = 4(1−σ)qH 2 q
L
,
2
[qH (qL −f −t)+tqL ] +4qH qL (qH +2t)f
Π∗N = 4qL qH2 .

Recall that Π∗R (σ) is an increasing function of σ, and we have Π∗R (σ = 0) ≤

Π∗N , Π∗R (σ = 1) = +∞ > Π∗N . Then, there must exists a threshold σ h≥ σ̂
such that Π∗R ≥ Π∗N , where σ̂ satisfies Π∗R (σ̂) = Π∗N , i.e., σ̂ = q1H 1 −
i
2(1−β)(t+βf )
4qH (βqH +2t)−[2(qL −t−f )qH +qL (2t+βf )]β
.
(1−σ)(qH −qL )
(3) When min{F l , f l } ≤ f ≤ max{ qH −q
4
L
, 4(1−β)
}, we compare Π∗R
(1−σ)(qH −qL )
and Π∗N conditional on the size of qH −q
4
L
, 4(1−β)
, F l , f l (as is shown in
Table A.8).
Case 1. Given the relationship under Case 1, we compare Π∗R and Π∗N
depending on f .
qH −qL (1−σ)(qH −qL )
(i) when 4
≤f ≤ 4(1−β)
, we have
(
[(1−σ)qH +(1+σ)qL ][(1−σ)(qH −qL )−2(1−β)f ](1−β)f
Π∗R = (1−σ)2 (qH −qL )2
,
qH +qL
Π∗N = 8
.

Recall that Π∗R is increasing in f , thus in this interval, we have

 (1 − σ)(q − q )  (1 − σ)q + (1 + σ)q
H L H L
max Π∗R (f ) = Π∗R =
4(1 − β) 8
qH + q L
≤ = Π∗N ,
8
i.e., Π∗R ≤ Π∗N in this interval.
(ii) when F l ≤ f ≤ qH −q4
L
, we have
( ][(1−σ)(qH −qL )−2(1−β)f ](1−β)f
Π∗R = [(1−σ)qH +(1+σ)qL(1−σ) 2 (q −q )2
H L
,
(qH +qL )f (qH −qL −2f )
Π∗N = (qH −qL )2
.

We explore properties of the function Π∗R − Π∗N as follows. Firstly, we

denote G(f ) = Π∗R − Π∗N , which is regarded as a function of f , then
∂ 2 G(f ) 4[(1−(1−β)2 /(1−σ)2 )(qH +qL )+(1−β)2 /(1−σ)2 σ(qH −qL )]
∂f 2 = (qH −qL )2
> 0 (this inequal-
ity always holds because σ ≤ β), i.e., we conclude that G(f ) is a convex

45
 function of f when f < qH −q4
L
. Besides, when f = 0, we have G(0) = 0;
L −(qH +qL )
qH −qL qH −qL
when f = 4 , we have G( 4 ) < (1−σ)qH +(1+σ)q 8
≤ 0. The
qH −qL ∗ ∗
above facts implies that for F l ≤ f ≤ 4 , ΠR − ΠN < 0. As a result,
Π∗R < Π∗N in this interval;
(iii) when f l ≤ f ≤ F l , we have

(1−σ)[(qL −f −t)qH +qL (t+βf )]2 +4(1−β)f qH qL [(1−σ)qH +2(t+βf )]

(
Π∗R = 4(1−σ)qH 2 q
L
,
(qH +qL )f (qH −qL −2f )
Π∗N = (qH −qL )2
.

Note that Π∗R is increasing in σ in this interval. Similar to the analysis

in case (2), we have Π∗R − Π∗N ≥ 0 when h σ ≥ σ̃, where σ̃ satisfies
q (q +qL )f (qH −qL −2f )
Π∗R − Π∗N = 0, i.e., σ̃ = 1 − 2(t+βf )(1−β)f
H H
(qH −qL )2
+ (1 − β)f −
2
i
[(qL −f −t)qH +qL (t+βf )]
4q 2 qL
. Thus, we conclude that Π∗R ≥ Π∗N when σ ≥ σ̃.
H

Case 2. Given the relationship under Case 2, we compare Π∗R and Π∗N
depending on f .
(1−σ)(qH −qL )
(i) when F l ≤ f ≤ 4(1−β)
, we have
(
[(1−σ)qH +(1+σ)qL ][(1−σ)(qH −qL )−2(1−β)f ](1−β)f
Π∗R = (1−σ)2 (qH −qL )2
,
qH +qL
Π∗N = 8
.

(ii) when qH −q
4
L
≤ f ≤ F l , we have
)]2 +4(1−β)f qH qL [(1−σ)qH +2(t+βf )]
(
Π∗R = (1−σ)[(qL −f −t)qH +qL (t+βf
4(1−σ)q 2 qL
,
H
qH +qL
Π∗N = 8
.

As for the above two sub-cases, we refer to the same argument in Case
1-(i), and conclude that Π∗R ≤ Π∗N ;
(iii) when f l ≤ f ≤ qH −q
4
L
, we have

(1−σ)[(qL −f −t)qH +qL (t+βf )]2 +4(1−β)f qH qL [(1−σ)qH +2(t+βf )]

(
Π∗R = 4(1−σ)qH 2 q
L
,
(qH +qL )f (qH −qL −2f )
Π∗N = (qH −qL )2
.

Referring to the same argument in Case 1-(iii), we conclude that Π∗R ≥

Π∗N when σ ≥ σ̃.

46
Case 3
Given the relationship under Case 3, we compare Π∗R and Π∗N depending
on f .
(
(1−σ)(qH −qL ) qH −qL Π∗R = (1−σ)qH +(1+σ)q
8
L
,
(i) when 4(1−β)
≤ f ≤ 4 , we have ∗ (qH +qL )f (qH −qL −2f )
ΠN = (qH −qL )2
.
∗ ∗
By arranging ΠR − ΠN ≥ 0, we have
(1 − σ)qH + (1 + σ)qL (qH + qL )f (qH − qL − 2f )
− ≥0
8 (qH − qL )2
 q   q 
qH −qL qH −qL qH −qL qH −qL
It is equivalent to f ≤ 4 1 − σ qH +qL . 4 1 − σ qH +qL ≥
q
(1−σ)(qH −qL ) (σ−β)
4(1−β)
when σ ≥ σ̄, where σ̄ solves (1−β)
= σ qH −qL . As a result,
 q qH +qL 
we conclude that Π∗R ≥ Π∗N when f ≤ qH −q 4
L
1 − σ qqHH −q L
+qL
and σ ≥ σ̄;
H −qL )
(ii) when F l ≤ f ≤ (1−σ)(q
4(1−β)
, we have
( ][(1−σ)(qH −qL )−2(1−β)f ](1−β)f
Π∗R = [(1−σ)qH +(1+σ)qL(1−σ) 2 (q −q )2
H L
,
(qH +qL )f (qH −qL −2f )
Π∗N = (qH −qL )2
.
By solving Π∗R − Π∗N ≥ 0, we obtain
[(1 − β)((1 − σ)qH + (1 + σ)qL ) − (1 − σ)(qH + qL )](1 − σ)(qH − qL )
≥2[(1 − β)2 ((1 − σ)qH + (1 + σ)qL ) − (1 − σ)2 (qH + qL )]f. (A.10)
β(qH +qL )
(i) When σ ≥ 2qL +β(qH −qL )
, both the LHS and RHS of formula (A.10)
[(1−β)((1−σ)qH +(1+σ)qL )−(1−σ)(qH +qL )](1−σ)(qH −qL )
are positive. Hence, (A.10) holds when f ≤ fS = 2[(1−β)2 ((1−σ)qH 2
√+(1+σ)qL )−(1−σ) (qH +qL )]
q +3q +β(2−β)(q −q )− (1−β)2 ((qH +3qL )2 −β(2−β)(qH −q
(ii) When σ1 ≤ σ ≤ 2qLβ(q H +qL )
+β(qH −qL )
, where σ1 = H L H L
2qH +2qL
the RHS remains positive but the LHS becomes negative. Hence,
(A.10) cannot hold. (iii) When β ≤ σ ≤ σ1 , both the LHS and RHS of
(A.10) are negative. Then, (A.10) holds when f ≥ fS .
β(qH +qL )
In summary, Π∗R − Π∗N ≥ 0 when σ ≥ 2qL +β(q H −q−L)
, f ≤ fS and
β ≤ σ ≤ σ 1 , f ≥ fS .
(iii) when f l ≤ f ≤ F l , we have
)]2 +4(1−β)f qH qL [(1−σ)qH +2(t+βf )]
Π∗R = (1−σ)[(qL −f −t)qH +qL (t+βf
(
4(1−σ)q 2 qL
,
H
(qH +qL )f (qH −qL −2f )
Π∗N = (qH −qL )2
.

47
 Referring to the same argument in Case 1-(iii), we conclude that Π∗R ≥
Π∗N when σ ≥ σ̃.
Case 4
Given the relationship under Case 4, we compare Π∗R and Π∗N depending
on f .
(
(1−σ)(qH −qL ) qH −qL Π∗R = (1−σ)qH +(1+σ)q
8
L
,
(i) when ≤ f ≤ , we have −q −2f
4(1−β) 4
Π∗N = H L(qH −qHL )2 L ) .
(q +q )f (q

Referring to the same h argument

q iniCase 3-(i), we conclude that Π∗R ≥
qH −qL −qL
Π∗N when f ≤ 4
1 − σ qqHH +q L
and σ ≥ σ̄;
H −qL )
(ii) when f l ≤ f ≤ (1−σ)(q
4(1−β)
, we have
( [(1−σ)qH +(1+σ)qL ][(1−σ)(qH −qL )−2(1−β)f ](1−β)f
Π∗R = (1−σ)2 (qH −qL )2
,
(qH +qL )f (qH −qL −2f )
Π∗N = (qH −qL )2
.
By solving Π∗R −Π∗N ≥ 0, we again obtain (A.10). Referring to the anal-
β(qH +qL )
ysis in case 3-(ii), we have Π∗R − Π∗N ≥ 0 when σ ≥ 2qL +β(q H −q−L)
, f≤
fS and β ≤ σ ≤ σ1 , f ≥ fS .
(iii) when F l ≤ f ≤ f l , we have
][(1−σ)(qH −qL )−2(1−β)f ](1−β)f
Π∗R = [(1−σ)qH +(1+σ)qL(1−σ)
(
2 (q −q )2
H L
,
[qH (qL −f −t)+tqL ]2 +4qH qL (qH +2t)f
Π∗N = 4qL qH2 .
By the continuity and increasing property of Π∗R and Π∗N . It is sufficient
H −qL −2f )
to compare Π∗R with max Π∗N (f¯l ) = (qH +qL(q)fH(q
−qL )2
. That is, the
comparison degenerates to case 4-(ii). Then, guarantees that Π∗R ≥
H −qL )β
Π∗N holds when (a) σ ∈ [ 4qH(5q+(qH −qL )β
, β(2 − β)], f ≥ fS ; (b) σ ∈
4(1−β)f l
[ 2qLβ(qH +qL )
+β(qH −qL )
,1 − qH −qL
], f ≤ fS .
Case 5
Given the relationship under Case 5, we compare Π∗R and Π∗N depending
on f .
(
qH −qL Π∗R = (1−σ)qH +(1+σ)q
8
L
,
(i) when f l ≤ f ≤ 4 , we have ∗ (qH +qL )f (qH −qL −2f )
ΠN = (qH −qL )2
.
Referring to the same argument in Case 3-(i), we conclude that Π∗R ≥
h q i h 4f l
i2
Π∗N when f ≤ qH −q
4
L
1 − σ qH −qL
qH +qL
, σ ≤ qH +qL
qH −qL
1 − qH −qL
;

48
 (
H −qL )
Π∗R = (1−σ)qH +(1+σ)q L
,
(ii) when (1−σ)(q
4(1−β)
≤ f ≤ f l
, we have ∗ [q H (qL −f
8
−t)+tq L ] 2 +4q q (q +2t)f
H L H
ΠN = 4qL qH 2 .
∗
Note that ΠN (f ) is continuous and is strictly increasing in f in this
H −qL −2f )
interval, i.e., max Π∗N (f ) = ΠN (fl ) = min (qH +qL(q)fH(q −qL )2
, which is
h 4f
i 2
always less than Π∗R when σ ≥ qqHH +q L
−qL
1 − qH −ql L , as Case 5-(i) shows.
Otherwise, Π∗R ≥ Π∗N only holds when f ≤ fˆ (fˆ satisfies Π∗R = Π∗N (fˆ)),
because Π∗N is increasing in f . In summary, we have Π∗R ≥ Π∗N holds
h 4f l
i2 h 4f l
i2
when σ ≤ qH +qL
qH −qL
1− qH −qL
or when σ ≥ qH +qL
qH −qL
1− qH −qL
, f ≤ fˆ;
(1−σ)(qH −qL )
(iii) when F l ≤ f ≤ 4(1−β)
, we have
[(1−σ)qH +(1+σ)qL ][(1−σ)(qH −qL )−2(1−β)f ](1−β)f
(
Π∗R = (1−σ)2 (qH −qL )2
,
[qH (qL −f −t)+tqL ]2 +4qH qL (qH +2t)f
Π∗N = 4qL qH2 .

Similar to the argument in Case 5-(ii), the continuity and increasing

property of Π∗R and Π∗N guarantees that Π∗R ≥ Π∗N holds when σ ≥
h 4f l
i2 h 4f l
i2
qH +qL qH +qL
qH −qL
1 − qH −qL ; otherwise, if σ < qH −qL 1 − qH −qL , we compare
through numerical study.
By summarizing Case 1- Case 5, we have the following results when
H −qL )
min{F l , f l } ≤ f ≤ max qH −q4
L
, (1−σ)(q
4(1−β)
. Π∗R ≥ Π∗N holds if one of
the following conditions are satisfied.
 qH −qL (1−σ)(qH −qL )
Table A.10: Condition of Π∗R ≥ Π∗N When min{F l , f l } ≤ f ≤ max 4 , 4(1−β)

Condition
(5qH −qL )β
(1) σ̃ ≤ σ ≤ 4qH +(qH −qL )β
f l ≤ f ≤ min{F l , (qH −q
4
L)
}
q
4(1−β)f (1−σ)(qH −qL ) qH −qL H −qL )
(2) σ̄ ≤ σ ≤ 1 − qH −qL l 4(1−β)
≤f ≤ 4
[1 − σ(q qH +qL
]
(1−σ)(qH −qL )
(3) β ≤ σ ≤ σ1 max{F̄l , fS } ≤ f ≤ 4(1−β)
(qH +qL )β 4(1−β)f
(4) 2qH +(qH −qL )β
≤ σ ≤ 1 − qH −qL l f l ≤ f ≤ fS
4(1−β)f 4f (1−σ)(qH −qL )
(5) 1 − qH −qL l ≤ σ ≤ qqHH +q L
−qL
[1 − qH −ql L ]2 4(1−β)
≤ f ≤ fˆ
q
4f H −qL )
(6) σ ≥ qqHH +qL
−qL
[1 − qH −ql L ]2 qH −qL
F̄l ≤ f ≤ 4 [1 − σ(q qH −qL
]

49
 □

50
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