If consumers were given a choice between buying a brand new MP3 player or a cheaper, refurbished one, which would they choose? Professor Anton Ovchinnikov, who teaches Decision Analysis courses at the University of Virginia Darden School of Business, has designed a new model to help companies determine which consumers would choose the refurbished model. He describes it in his study, “Revenue and Cost Management for Remanufactured Products,” which appears in the Production and Operations Management Journal.
Consumer behavior and associated demand cannibalization play a central role in a company’s decision to add remanufacturing to its business operations. According to Ovchinnikov, standard methodologies that rely on consumers’ willingness to pay (WTP) do not accurately determine how many consumers would switch from buying new products to used products. Ovchinnikov used surveys and consumer focus groups to show that a segment of consumers would prefer to stick with the new and more expensive product.
“For example, in one of the studies we found that at a 40 percent discount, 82 percent of subjects found the product’s price below their WTP. A traditional WTP-based approach would suggest that 82 percent of customers would switch to the remanufactured product,” Ovchinnikov says. “However, 39 percent of those respondents doubted product quality because of the low price and in the end only 43 percent made the switch.”
On a graph, Ovchinnikov represents this behavior as an inverted-U. His study shows that the company incorporating the inverted U-shape consumer behavior into their remanufacturing strategy remanufactures under broader conditions, charges a much lower price, typically remanufactures more units and has incremental profits from remanufacturing twice as high as the company that uses WTP alone.
“To profit from remanufacturing, companies need to carefully balance cannibalization of the new product’s sales with new demand that remanufactured products can attract from price sensitive consumers and overlay the two factors with the cost structure that is specific to a remanufacturing operation,” Ovchinnikov says.
Companies also need to weigh the number of remanufacturable used products that a company receives against the number of remanufactured products it wants to sell.
“The more used products (called cores) the company acquires, the cheaper it is to remanufacture a given number of units. A certain fraction of returns typically correspond to so-called ``false returns” for which no refurbishing is needed at all; the remaining units require some work and parts and are therefore more expensive.”
Ovchinnikov shows that companies may want to strategically capitalize on that dependency and collect more cores than they intend to remanufacture. Doing so could also further a company’s sustainability goals.
“The company incorporating the inverted-U model generally acquires more cores and remanufactures more units,” Ovchinnikov says. “This suggests that a better understanding of consumer behavior also has the potential to benefit the environment by diverting more items from the waste stream.”
In the future, Ovchinnikov will look at other aspects of remanufacturing electronics.
“It could be interesting to consider the introduction of remanufactured products as a mechanism to create/change product lines. For example, a $139 remanufactured version of a $399 smartphone could be cannibalizing not only the sales of this costlier device, but also the sales of the “regular” phones priced around $139. It could be that consumers who purchase refurbished smartphones are more likely to spend more on voice or data plans. Thus cannibalizing regular phone sales could in fact be profitable overall,” Ovchinnikov adds.
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