You've rented a just-released movie, totally loved it and want to buy it for your collection. Should the company you rented it from apply the rental fee to your purchase?
Two researchers in the University of Oregon's Lundquist College of Business explored the issue. In a recently published paper, they used a mathematically rich analysis to develop a strategy that could tell companies when applying a rental fee to a subsequent purchase should be profitable. The math parsed out future value by analyzing a product's decay factor.
A movie with high decay has much less value on future viewings. Later rentals may not happen, so a streaming service or store may profit more by selling the movie with a partial or full credit for the rental, according to former UO doctoral student Monire Jalili and her thesis adviser Michael Pangburn.
"In our paper we make a set of assumptions to model rational consumer behavior," said Pangburn, the Ehrman V. Giustina Professor and head of the Department of Operations and Business Analytics. "Based on those assumptions, we proved mathematically that under a quite wide range of scenarios a firm would, indeed, increase their profitability by giving people back a substantial fraction or in some cases all of the rental amount for a subsequent purchase."
The study, published in the journal Production and Operations Management, began soon after Pangburn and Jalili, now an assistant professor of management at Bentley University in Massachusetts, observed heated online discussions by people arguing for rental refunds.
Initially, Pangburn and Jalili examined previously published work, but they found little information on what factors would make such a conversion profitable to companies.
Rent-to-buy and rental refunds are not unusual for some products, Pangburn said, with customers often debating whether to keep renting or buying something they like. For example, he noted, skis are often initially rented, with the rental fees applied to purchase after customers find a good fit and desirable performance with the rental.
For movies and electronic books, offering customers the option to apply rental fees towards purchases is currently the exception to the norm. As a case in point, Apple and Google now have no such policy. Amazon.com has been experimenting with such an option for rentals and sales of e-books.
"It will be interesting to see how these policies play out in the future," Pangburn said.
Beyond predicting the potential popularity, considering the decay factor aspect of a product such as a movie or e-book should be a vital component in the decision-making of a firm, the researchers found.
A comedy or psychological thriller will have a low decay factor if it will resonate every time, perhaps in new ways, on subsequent viewings with family and friends. A company would continue to profit from rental fees, Pangburn said.
A suspense movie or a documentary may provide an enjoyable experience worthy of repeating, but the film's big surprise may not be as breathtaking in later viewings. That means a high decay factor, meaning a diminishing incremental utility for the movie.
And that, Pangburn said, suggests higher income if a firm goes with incentives for rental-purchase conversions.
There is a caveat, the researchers wrote in their conclusion. The full-refund and no-refund heuristics perform relatively poor when uncertainty is high and the consumption effect is moderate.
"Theoretically we show this approach could work," Pangburn said. "Although not tested, we do see some validity to the theory in the practices of smaller sellers of products other than digital movies. They are doing exactly that. They are applying rental amount toward a purchase conversion."
