Tuesday, February 27, 2007

Lifetime money back guarantee

A consumer walks into a store, purchases a digital still camera, walks out of the store. After two years of heavy use, the camera fails. Consumer walks back into the store and returns the camera stating that the camera doesn't meet his demand. The store gives money back to the consumer without asking a question.
The store is offering lifetime money back guarantee, no questions asked.

This is what Costco used to be. Today, they announced a change in their return policy citing losses due to abuse by customers.

I was not even aware of this return policy of Costco. I heard about this last month when somebody started gloating about how he returned his camera after two years of use. I was appalled by the fact that someone could even think of doing this. I was always under the impression that Costco had a 30 day money back guarantee.

At first, I was shocked to hear this. But, this got me thinking.
Why would a company offer such a return policy?
What makes a sensible return policy?
Should stores even have a return policy?

One thing we need to realize is that stores in most countries do not even offer a money back guarantee. It is only in some developed countries that we see such offers. This is mainly to spur impulse buying. You step into the store and you see a stunning boombox on the display shelf. Remember, you didn't walk into the store to buy a boombox. You wanted to buy milk. But, you fall in love with this boombox and think "If I decide that I shouldn't have bought it (for whatever reason), I can return it within 30 days", and you buy it on the spot (thanks to credit cards)! You take it home, set it up and after 20 days of use, you are used to the boombox (even if you didn't like it at first) and decide to keep it. Who wants to locate the receipt, and pack the thing into the box, and haul it back all the way to the store, and give an explanation to the store clerk to return it?.

That is exactly what the seller intended!

So, the 30 day guarantee works for the seller. And, in some cases allow the buyer too (the DVD player you bought fails to play VCDs, and you take it back after a few days). I can live with this.

Now, let us look at warranties.

Notice the bathtub curve above. The curve represents the failure rate of products over time. Statistically, products have a high failure rate early in their life (also called 'infant mortality' period), and then the rate falls and stays flat for most of the product's life. At the end of its life, the failure rate increases again due to ageing and failure of the components.

Initially manufacturers started running their products until the infant mortality period passed, and then the product was sold. A motor used to be run in a simulated environment until it passes this period. If any motor fails, it would be fixed and run again. So, the manufacturer was taking the burden of clearing this first phase.

Then, somebody had a bright idea and decided that instead of the manufacturer running the product through its IM phase, why not ask the customers to use it and if the product fails during this phase, gladly fix it for the customer.

Thus, warranties were born.

You take the risk for the manufacturer, and the manufacturer gives you an incentive (fixing free of charge) for sharing the risk. The bathtub curve varies for every product. Thus, one product comes with a 1 year warranty while another could be offered a 2 year warranty.

Where does Costco get its unlimited return policy? They initially came up with the idea to entice customers to buy from them. This worked real well. People bought from Costco since it offered an extra sense of security. What if my DVD player breaks down on day 32 or day 366? I will have to struggle with the manufacturer and get it fixed. But, with the Costco policy, I can just return it and get my money back. Awesome.

This works only if all the customers are honest. Looks like that has not been so. Especially with electronics, which become obsolete the moment you bring it home and take it out of its box. In a way, Costco asked for it when it announced its 'no questions asked' return policy.

I even heard stories of how some people returned empty TV dinner boxes stating that they didn't like the taste. How disgusting. Consumers need to understand how businesses work and start taking responsibility for their decisions, and understand the risks that come with buying a product. Understand that every product has a definite life. The TV that you buy today is not going to work for ever. Maybe, manufacturers should start printing an expected life for every product, like they do for some electric bulbs.

So, is this move going to hurt Costco?

I don't think so. I, for one, never went to Costco because of their return policy (I didn't even know of it until recently). Remember that Costco still stands apart from the competitors by offering 60 or 90 day money back guarantee, and a 2 year extended warranty for free. That is a great deal. People who used to misuse the policy may stop doing so. So, Costco wins in this situation. People who relied on the added security may think twice, but Costco needs to market their additional warranty in order to lure this crowd. Others who didn't care for the return policy, will continue to not care and continue to shop at Costco.

So, all in all, Costco wins with this move.