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Service Cancellation and Competitive Refund Policy

Department of Marketing, Hong Kong University of Science and Technology, Clear Water Bay, Kowloon, Hong Kong, China
mkguo{at}ust.hk

Although previous research demonstrates the profitability of partial refund policies in a monopoly setting, there is a certain lack of ubiquity in practice about these refunds in competitive service markets. This raises the question of how a partial refund policy may work and whether it is even sustainable in a competitive environment. This study investigates how competition may influence the profitability and the equilibrium choice of refund policies. It is shown that partial refunds may endogenously change the nature of strategic interaction between service providers from local monopolies into a competition regime, which moderates the gains from exploiting the efficiency-enhancing effect of partial refunds. A whole range of pure-strategy equilibria can be obtained as a result of the interplay between the efficiency-improving and the competition-intensifying effects. When the capacity is small (large) such that the efficiency-improving (the competition-intensifying) effect is dominant, both firms in equilibrium follow identical partial (zero) refund policies. Moreover, interestingly, the symmetric firms may end up in an asymmetric equilibrium in which one firm follows a partial refund policy and the other adopts a zero refund policy.

Key Words: advance selling; cancellations; capacity constraint; competition; contingent contracts; refunds; reservations; services; uncertainty; yield management
History: Received: February 13, 2008; accepted: August 12, 2008.