Optimal pricing, return and modular design policy for build-to-order (BTO) products in a two parties supply chain system

A build-to-order (BTO) product is produced according to customers' requirements and specifications. Returning such a product is generally not allowed. However, if a return policy is offered, the producer may gain significant competitive advantages. The producer can gain the advantage of the return policy if the product design is highly modular. Modularity in design implies that the product is made up of a number of modules and expresses the degree to which the product can be disassembled into components, which keep their full initial value. When a BTO product with modular design is returned, it is easily disassembled into a number of components, which are used to build new BTO products. A firm applying a return policy to BTO products refunds to the customer a value for the returned product. This amount is critically related to the level of modularity. Mukhopadhyay & Setoputro (2005, Optimal return policy and modular design for build-to-order products. J. Oper: Manage., 23, 496-506) developed a profit maximization model to jointly determine optimal return policy and modularity level for BTO products in a two parties (producer buyer) supply chain system, using selling price as a given exogenous parameter. In this paper, the above model is extended by considering the selling price of the BTO product as an additional decision variable. From the resulting three-dimensional constrained maximization problem, closed-form optimal solutions for the decision variables are obtained under certain conditions imposed on the model's parameters. A comparative static and numerical analysis of optimal selling price, refund and modularity level is also conducted.