Managing Product Returns for Competitive Advantage

Product returns have often been viewed by customers as a necessary evil, a painful process and, usually, unavoidable. For retailers, manufacturers and distributors, returns have often been seen as a nuisance, a cost center and an area of potential customer dissatisfaction. As long as products are being sold, there will always be some returns. And, for many sellers, the process of handling product returns has been mostly on an ad hoc basis. However, many successful organizations have realized that the returns process incurs significant costs(See “Returns by the Numbers.”) and that an effective product returns strategy, which is a major aspect ofreverse logistics (the term that encompasses returns as well as a number of other activities related to items moving “backwards” in the supply chain) can provide a number of benefits.1,2 (See “About the Research”) Product returns can be categorized into two groups: (1)controllable returns, which can be avoided or eliminated by actions taken by the company, and (2)uncontrollable returns, which companies can do little or nothing about in the short term.

Controllable Returns.

Controllable returns result from problems, difficulties or errors of the seller or customer and can be mostly eliminated with the proper strategies and programs by the company or its supply chain partners. Every controllable factor has a cause or causes that could be minimized or eliminated with better forward logistics processes, improved market forecasting, improved product handling or storage and so forth. Products returned because of damage can be eliminated through some combination of improved handling, better packaging, improved transportation and storage of the items as they are being distributed in the supply chain. In essence, this is eliminating problems before they happen.

To illustrate, Philips Consumer Electronics North America took preventive steps to reduce controllable returns by implementing a variety of policies and programs, including improving their products’ ease of use, enforcing company return policies and improving their service network. Specifically, the company established a dedicated product returns department and eliminated the implied corporate policy of “taking anything back, from anybody, anytime.”3

Sierra Trading Post Inc., a seller of outdoor and recreational footwear headquartered in Cheyenne, Wyoming, minimized product returns by hiring “a size and fit specialist for shoes and put a lot of effort into accurately presenting product colors in its catalogs, including describing the various shades within a single color range. [The company] regularly pulls together a group of employees to try on different shoes and then works their feedback about the footwear into the catalog copy, along with recommendations.”4 These strategies help to reduce customer returns that previously occurred due to wrong size ordered and colors not matching the catalog.

Because controllable product returns are caused by problems, difficulties or errors of the company or members of the supply chain, developing systems that take care of the symptoms, rather than root causes, will likely result in the problems continuing, or, at the very least, only being partially addressed. For example, if some products are returned due to manufacturing quality problems, having high-quality logistics systems in place will do nothing to reduce the level of those returns. Likewise, making it easier or even more difficult for customers to return items will not reduce the amount of defective products being returned; they will be returned no matter what return policies are in place.

Uncontrollable Returns.

Uncontrollable returns cannot be eliminated by the company in the short term and, thus, these returns are often inevitable. The logic behind developing returns processes, primarily for uncontrollable returns, is straightforward. In warehousing, companies do not build, lease or rent storage space to accommodate the maximum amount of product that might be demanded by customers. Because inventory carrying costs can be high, companies often try to minimize or eliminate inventory altogether through Just-in-Time programs. Warehouses are configured to handle the minimal amount of product necessary to satisfy customer demand, relying on high levels of inventory velocity or turnover. Therefore, the optimal amount of product returns would be the minimal amount that is possible; that is, only the uncontrollable returns.

As a basic strategy, then, companies should attempt to eliminate the root causes of controllable returns while simultaneously developing optimal processes for handling uncontrollable product returns. Improvements in product quality, elimination of “mispicks” and shipping errors and implementation of programs such asvendor-managed inventory andefficient consumer response will limit returns to only those that will come back regardless of what the company does or does not do in the short term.

In essence, an efficient process both reduces the number of returns and makes the returns process more efficient, so that of the fewer products returned, a higher percentage can go back into the distribution pipeline to be sold. For example, Road Runner Sports Inc. of San Diego, California, a multichannel retailer of running shoes and gear, focuses on both aspects. The company trains its salespeople to be advisors and counselors to the customer. They understand sport shoes and training regimens so they can recommend products best suited to the customer. As a result, Road Runner’s return rate on running shoes is 12%, considerably below the industry average of 15%–20%.5

However, when returns do occur, Road Runner adopted theSmartLabel from Newgistics, a provider of intelligent returns management solutions based in Austin, Texas. The SmartLabel is a prepaid, preaddressed, barcoded return label that a customer can remove from the purchase invoice, put on the package and drop it off in any United States Postal Service mailbox. This approach makes the returns process quick and easy for the customer, and Road Runner has found that almost 80% of their returns come via the SmartLabel approach.

Also, a better returns process will help the company salvage a higher percentage of products that can be refurbished or remanufactured, and a higher percentage of the parts or components that can be salvaged for resale. For example, some manufacturers of engines and pumps take back items that are defective, being replaced or returned for warranty work. Components are often replaced and the items returned to service or resold as refurbished parts. Some of the bearings and other parts that are replaced are fully serviceable but do not meet company specifications. However, the specifications for these items are higher than for the same parts used in other applications by other manufacturers. Thus, they can be sold to otheroriginal equipment manufacturers for use in their products. Previously, these parts would have been sold for scrap, but the prices obtained by selling them to OEMs are significantly higher, resulting in higher levels of profits for the seller.

Product returns management can also significantly reduce costs by improved operational efficiencies, better disposition strategies for salables, higher recovery rates for unsalables and a variety of other strategies. Effective returns processing often produces multiple benefits. A good example is Altec Electronica Chihuahua, a Mexican producer of electronic products such as radios, amplifiers and servo motors for power-train systems. The company continually experienced significant damage to the fragile electronics replacement parts as they moved to customers. In addition, it was under pressure to reduce purchasing, storage and disposal costs for the huge volume of packaging materials used in the logistics process. The answer for Altec was to use returnable packaging made of reusable polyethylene with cross-linked foam inserts. Each returnable container accommodated 120 parts. The new packaging not only eliminated damage, it also reduced the use of disposable films, covers and cardboard boxes. The net benefits were significant: elimination of lost and damaged parts, increased availability of storage space, reduced freight cost, improved stackability and handling and elimination of the disposal process for used packaging materials. By eliminating the problems causing returns, the company saved $5 million in a single year.6

The Product Returns Process

For the most part, the returns process is what occurs after retail customers have returned an item to a store or have sent it back to a catalog or Internet company. The process comprises five stages — receive, sort and stage, process, analyze, and support — which are common to almost all companies irrespective of industry or product type. (See “Stages in the Product Returns Process.”)

Stage 1 — Receive.

During the initial stage of the process, product returns are received at some centralized location, usually a warehouse or distribution center. In many cases, a first step in this process is to provide areturn acknowledgment. In the bookselling business, for example, returns from retailers are huge, and this part of the business must be handled effectively and with as little cost impact as possible. As a result, many large publishers have automated their returns processing to achieve cost and service goals.

Generally, returned items may include a wide assortment and variety of products, returned via a variety of carriers and in a seemingly infinite number of packages, either on full pallets or in individual containers — a far different procedure than when the items were originally shipped out to customers. The way that items are returned and received greatly influences how products are sorted and staged in the next step of the returns process. For example, one electronics manufacturer fast-tracks returns that are full pallets through the system so that they are available for sale more quickly, typically in less than 24 hours.

Some companies are finding that it is cost effective to “jump-start” the returns process at this stage, that is, to make a disposition decision about a returned item as early in the returns process as possible. Much like the theory of postponement for forward logistics processes, the concept ofprepostponement can be applied to returns. Postponement refers to waiting until the last possible moment to provide value-added services to a product. For instance, Sauder Woodworking Co., headquartered in Archbold, Ohio, sells ready-to-assemble furniture. Since costs are based on product value, which increases as value is added to the product, postponing value-adding activities can result in lower costs. Conversely, in reverse distribution, processing returned items nearer the point-of-sale, that is, early in the returns process, saves both time and money. The thought behind this approach is that returns are evaluated as soon as possible when they are received to assess their recoverable value. The advantage is that processing expenses can be avoided for items that are truly worthless and incurred only for those items with significant value (that is, those items that can essentially be put right back into the normal distribution channel).

Stage 2 — Sort and Stage.

Once items are received, products are sorted for further staging in the returns process. This sort could be based on how the items have been returned (for example, pallets, cartons, packets); the type of return (which could be identified from the address on the item; the color of the label, or some other kind of easily identifiable feature); or size or number of the item being returned. Combinations of these options are also possible, with subsorts taking place. Typically, the standard for this sort-and-stage activity combined with the receipt activity is three days or less, with most companies having one-to-two day standards.

Stage 3 — Process.

In this stage, returned items are subsorted into items, based on their stock-keeping unit number, which can be returned to stock/inventory; while vendor returns (if applicable) are sorted according to the specific vendor name. It is at this point that customer credits can be given, although most companies do not issue credits until later in the process, usually in Stages 4 or 5.

Items move from the sort-and-stage area to the processing station(s). Persons at these stations can process the items in order of their receipt, according to the type of product, by customer type or location, according to the physical size of the items or some combination of these and other factors.

Handling a mixture of items evens out the workflow and makes it easier to develop piece-handling metrics and standards. In one consumer-products company, returns are placed on a conveyor belt after receipt, then move to processing stations where diverters direct items to each station so that each processing line has an equal number of return items in their queue. Having the appropriate information on the return label on the product allows for items from the same customer to be diverted to the same conveyor line for simultaneous processing.

At this stage, the paperwork that accompanied the return is separated from the item and these documents are then physically sent to the administrative area for comparison with the electronic records should discrepancies occur.

Stage 4 — Analyze.

It is at this stage that employees must be the most highly trained, since this is where the most important disposition decisions are made. Because the value of the returned item varies depending on the product disposition strategy employed, individuals involved in this stage must be very knowledgeable about the products, repairing or refurbishing opportunities, allowable versus nonallowable returns and the financial benefits associated with each disposition option. For example, items that can be repackaged for resale will return greater financial reward than items that must be refurbished or remanufactured prior to sale. Repackaged or refurbished items always result in higher revenues than items being sold as scrap or salvage.

A final step in this stage, and one that needs to be planned in advance, is marketing of products that have been repackaged, repaired, refurbished or remanufactured. Many remanufactured or refurbished products are sold in secondary markets for additional revenue, often to a market segment unwilling or unable to purchase a new product. This might include using repaired products as spare parts. The markets for these products must be treated just as any market — with an understanding of customer needs, price elasticity and proper channels of distribution. Effective marketing strategies for repackaged, repaired, refurbished and remanufactured products often determine whether a company will make a profit in their returns process.

Stage 5 — Support.

At this point, the disposition of each returned item has been determined. Items are distributed according to where they should go. Back-to-stock or back-to-store items are returned to inventory. If repair, refurbishment or repackaging are required, appropriate diagnostics, repairs and assembly and disassembly operations are performed in order to get the items into a salable condition. Relative to costs, the degree of repair or refurbishing that occurs should be correlated with the potential value of the product once it has been “improved.” Because recovery rates for repaired or refurbished products are high, exceeding other disposition options, performing repair and refurbishment efficiently at low cost is important to a company’s return on investment. Likewise, getting items into a salable condition quickly also reduces inventory carrying costs. From a service perspective, these salable items are made ready for resale to customers sooner, thus improving service levels. This would be especially important if there is high demand for the items and regular inventories have been depleted.

Items that are going to be returned to vendors must be handled quickly, inasmuch as vendor return windows can be very short, especially when the time to get the items back from customers or stores is taken into consideration. The speed of the returns process also has important cash-flow implications. Speedy processing of returns will reduce the amount of cash tied up in returns inventory, thereby increasing the profitability of the process.

In some instances, processed items will be resold in outlet stores, serve as replacements for warranty repairs or sold to wholesalers, off-price retailers or offshore buyers. Returned items can be donated to local, regional and national charities or relief organizations. If the items are not salable to some type of customer, they will likely be sold to a salvage or scrap dealer who will purchase the items for the value of their components.

Transforming Product Returns into a Profit Center

Too often, companies are more than happy just to minimize the costs of managing and administering the cost of product returns. However, product returns management can become a profit center if managed and administered properly. Turning product returns into a profit center requires that in addition to cost savings, companies improve the recovery value of returns and, if possible, obtain revenues from various reverse logistics activities.

More efficient product returns programs can reduce variable costs, resulting in improved margins. Companies often find that they can reduce processing costs by up to 50%, sometimes more, if their existing processes are inefficient. Because much of the product returns process is manual, especially in the processing of customer credits and in the evaluation of product returns for disposition, the elimination of labor inefficiencies or the improvement of labor productivity can reap significant cost benefits.7

Strategically and operationally, however, how can reverse logistics be a profit center? The following illustrate some of the major ways that efficient returns management can reduce costs, improve revenues and enhance profitability as a result.

Improved customer service and customer knowledge.

Effective product returns management usually results in customer credits being issued more quickly and reduces the number of reconciliation problems, so customers are more satisfied and revenues are increased (customer satisfaction has been proven to have a positive impact on profitability). Additionally, customers are more likely to engage in repeat purchasing with the same company.

In addition, returns are an excellent source of information on the buying expectations and habits of customers. Few companies are prepared to gather such data, but L.L. Bean Inc., an apparel company based in Freeport, Maine, and Nordstrom Inc., a major department store chain based in Seattle, Washington, are companies that do gather information via returns and find that the data have helped them increase their sales volume. By tailoring follow-up marketing programs after a return, the companies are able to stimulate additional purchases by the customer.

Effective inventory management and product dispositioning.

When done effectively, more value is created from the disposition of returned merchandise (there are many options available for dispositioning returns, and the options have different cost and revenue implications). A good example of prepostpone-ment, discussed earlier, is Logitech International SA, which dispositions returns as early in the return cycle as possible, putting product back on the shelf or into an alternative channel rapidly, thereby speeding cash flow and minimizing storage cost. Logitech, based in Switzerland, is a $1.4 billion producer of joysticks, computer mice and keyboards. Returns for Logitech often represent 10% or more of outbound shipments. Because of the fast pace of technology in this business, inventory has to be moved quickly to avoid severe price erosion. Logitech follows a process ofprogressive dispositioning, where the goal is to rapidly and continuously disposition (repair, refurbish, liquidate, recycle and scrap) returned inventory as early in the cycle as possible. One way they accomplish this goal is to use an online site that dispositions excess inventory through various channels, such as intranet auctions. On balance, a key financial goal of the returns process is to lose as little as possible on a return. To accomplish this goal, the focus in designing the system is to minimize the loss of product value, because each step in the returns process and each handling of the item incur costs that subtract from the product’s value.8

It is important to keep in mind that efficiency (low cost) in returns processing is not always the best strategy. Speed is the critical variable in many cases, and managers need to remember that cost-efficient supply chains are not necessarily fast supply chains. The longer it takes to retrieve and process a returned product, the lower the likelihood of economically viable reuse options. Logitech provides a good example of the need to focus on speed rather than cost. For items with short life cycles (for example, fresh produce, some pharmaceuticals) the more efficient the returns process, the more product is “saved” from destruction or markdowns.

Efficient product returns as a marketable asset.

Good product returns and reverse logistics operations can be marketed to other companies (revenues can be achieved from selling off the process to other companies or using the competency as a competitive weapon against other companies marketing to the same customers).

Charging the various functions — sales, marketing, manufacturing, transportation and warehousing — for return goods processing will help each of them focus their attention on increasing quality, making normal, not outrageous claims to potential customers, handling products more carefully, pricing correctly and so on. Proper control of product return costs, as well as receiving revenues from vendors, suppliers and even customers, can result in profits from returns management.

One highly publicized effort, now considered to be a classic example of product return efficiencies, was that of Estée Lauder Companies Inc., a major cosmetics company based in New York. The company used to dump $60 million of their product returns from retailers into landfills each year. Then they invested $1.3 million in scanners, business intelligence tools and a data warehouse and, in the first year after installing the new systems and processes, the costs were recouped due to several factors: (1) 150% increase in redistribution of its returns, (2) $475,000 saved in reduced labor costs, (3) reduction from 37% to 27% of returned products being destroyed, (4) reduced production and inventory levels resulting from an increased ability to place products back into the market more quickly, and (5) better data on why products were being returned in the first place.9

Personnel and Training.

A general rule of thumb is that the companies that perform the best job of processing returns are those with full-time managers responsible for the activity. Additionally, the best companies provide both formal and informal training of employees in product returns processing. Standard operating procedures manuals are provided to new and continuing employees responsible for processing returns. Each of these procedures is discussed in depth through explanations of each step in the process; review of the equipment that will be used in the processing activity; and explanations, with diagrams, of computer inputs required at each stage of the returns process. In addition to written policies and procedures, new employees are mentored for some period of time by more experienced personnel.

Good Communications.

An effective and efficient returns process cannot work without well-conceived communications processes, both personal and electronic, which facilitate the smooth and rapid transmission of information. When one looks at the processes involved in returns — open, inspect, repair, remanufacture, scrap, etc. — it is obvious that these steps require communications with various internal and external departments, customers, vendors, liquidators and, in the case of hazardous materials disposal, various governmental bodies. For Internet sales, communication is especially important, because customers will demand rapid processing of credits to their credit card accounts.

Use of Third Parties.

Processing product returns requires more than part-time effort and minimal resources. Using third parties can sometimes be a better choice when the company lacks the expertise, if it has limited funds or experience or where the amount of products returned to the company are low. Specifically, there are several reasons that justify a company’s decision to outsource product returns processes. First, if the third party can perform the product returns process more quickly and accurately than the company, outsourcing can be a good choice. Second, if a company experiences few product returns and they do not have dedicated personnel or procedures for dealing with product returns, going outside to a third party for product returns services is a viable option. Finally, because third parties are often specialists in processing product returns, they can often provide higher levels of efficiency and effectiveness, resulting in lower costs and higher revenues from better disposition of returned items.

ALTHOUGH THE NATURE OF PRODUCT RETURNSvaries significantly from company to company due to type of industry, product, market and other factors, top management at most successful companies recognizes that full-time administration of the product returns process is a priority because it can result in cost savings, revenue enhancements, service level improvements and, in some instances, sustainable competitive advantage. Most of these successful companies implement the policies, procedures and practices presented here and subject them to continuous measurement, evaluation and improvement.