Refunds are widely observed in almost all privately provided services and also to some degree in retail industries. Refunds are heavily used by travel-related service providers. Most noticeably, refunds are heavily used by airlines where cheaper tickets allow for a very small refund (if any) on cancellations and no-shows, whereas full-fare tickets are either fully refundable or are subject to low cancellation penalty rates.

In Chapter 7, we analyze service providers who face consumers who value advance reservation systems because they enable them to guarantee that the service will be available at the contracted delivery time. However, the drawback of the advance reservation system, to both consumers and service providers, is that consumers may either cancel their reservations or simply may not show up at the time when the contracted service is scheduled to be delivered. This will leave some capacity unused, thereby resulting in a loss to service providers. Clearly, this loss can be minimized if service providers do not provide any refund to consumers who either cancel or do not show up.

In this chapter, we show how service providers can enhance their profit and extract higher surplus from consumers by offering refunds to consumers who either cancel their reservations or simply do not show up. For most parts of this chapter, we will not distinguish between a cancellation and a no-show. However, for the sake of completeness, the following definition clarifies the difference between these two terms.