Service Operations

Returns and Warranties: Reverse Logistics need not be the Weak Link in the Value Chain – by Mark Kiteley

Some history on Warranties, Returns and Reverse Logistics

Back in the day, in the UK at least, banks used to close at 3.30 pm on a Friday and there were no such things as ATMs or Cash-Points. There was one, yes just one, retailer whose unique selling point was that if you didn’t like the product you purchased, you could bring it back for a refund. That retailer was Marks & Spencer (M&S).  You went to your wallet on a Friday at 4.00 pm and found it empty and you needed some cash for the weekend – remember plastic was almost unheard of. Unless you lived near an airport where there might be a Bureau de Change, which might cash a cheque for you, you were “stuffed”. No money for the whole weekend! Except of course you could go to your wardrobe and pull out your least favorite jumper or cardigan and first thing Saturday morning go to M&S and get a refund!

The returns and reverse logistics industry was then born and, fast forward a couple of decades later -driven also by the UK Distance Selling Regulations for on-line sales-, today, every retailer and “e-tailer” has to offer effectively a “no quibble guarantee”, a promise to take back a product -“no questions asked”. With retailers in many markets vying for market share, there was even a phase of competition on the basis of who could offer this guarantee the longest: 30 days, 90 days, 6 months, 1 year or more, effectively taking away from the purchaser the responsibility for his/her purchasing decision. And at the same time manufacturers, themselves under intense pressure to grab market share, started offering warranties extending to beyond the traditional six months or a year, to two years and beyond. And then retailers saw a market for this and begun to sell extended warranties for 5 years or more. The returns and warranty approaches effectively merged -warranties were subsumed into broader returns strategies.

This behaviour spread into technology, though in consumer electronics in the 90’s, a one year returns policy was realistically unsustainable, as technology was being refreshed at the rate of every 6 months! Nevertheless, companies kept on offering ever longer no quibble guarantees. And as sales volumes increased, returns volumes increased faster. Finally processes broke down and retailers began to return items back to manufacturers, saddling them with additional costs in what essentially was and is a low margin business.

Initially, manufacturers were overwhelmed into accepting all returns as warranty claims and didn’t differentiate between a faulty item and a “no quibbles return”. The KPI’s started going in the wrong direction! Service Directors were being hammered at their monthly ops meetings. Continuous quarrels between sales and service ensued. Standards such as ISO 9000 were supposed to help sort everything out, but in the end proved to be less robust in implementation than assumed. And all this while the returns kept piling up and then re-sold at a loss or dumped.

While all this was happening service delivery terms were also being extended or improved for customers. One of the first “door step swap” services in the late 1980’s was for the Kodak Diconix printer. The customer would call and say her printer wasn’t working. Kodak would send out a brand new printer, with firmware disk, ink jet, cable, power supply and a small paper tray. All they were getting back was the printer. Not only was the process expensive, the number of parts and items they were able to recover was very small.

To save costs on this returns process, my company designed a special flight case (bag) for Kodak, which had shaped holes in it for each of the accessories and the new unit.  We would dispatch the courier with a case that had the new printer and accessories together with the instruction “whatever the customer takes out she has to put one back.” The result was that the customer nearly always took a printer out but left everything else, hence saving replacing all those expensive accessories. This simple intervention dramatically reduced the cost of the returns process.

Another example is from the time supermarkets started selling PCs, when the Pentium IVs came out and RAM was expensive. My company bought the returned PCs from the manufacturer with a view to testing, repairing and reselling them.  The problem was that customers were stripping the processor and memory out of the computer before returning them. When I challenged the purchasing director of one of the supermarkets and asked: ”why don’t you put some sort of acceptance criteria in place and make sure the product you are giving the refund for is at least complete?” The reply I got was “Mark, a guy spends £10K a year or more on grocery products, why would I upset him over a £400 PC? We simply take the hit.”

At some point manufacturers started to come to grips with what was happening and to recognize returns (and warranties) not only as traditional quality and service problems, but as a cost of doing business (cost of sales) in their particular industry -with warranties effectively subsumed into returns policies and strategies. They started implementing tactics to mitigate the problem such as BOG – Bought-Out Guarantees*, which simply moves the problem (accepting all returns) from them to the resellers. Nevertheless the problems remain in the value chain.

*Through a “Bought-Out Guarantee” a manufacturer provides a negotiated rebate to a reseller. In return the reseller is then responsible for handling and making good all customer warranty claims. If managed correctly BOG may significantly reduce costs, goods movements as well as the environmental impact of reverse logistics.

Cost of returns and reverse logistics

How can manufacturers minimize the costs of returns, warranties and reverse logistics? There are essentially three cost categories to examine: direct costs, the “cost of defense”, and then the “hidden costs”.

If the return process is straightforward (customer unhappy with purchase for whatever reason –> returns product –> product goes back to a Distribution Centre (DC) –> product sorted into a return to manufacturer or, if BOG, –> sent to processing house for asset recovery), then the costs are also fairly straightforward.

The reseller bears the cost of the transaction with the customer, shipping back to a DC, sift and sorting and shipping back to the manufacturer or onwards to a processing facility for asset recovery. All calculable and some of those costs can perhaps be minimized through back hauling. However, for some large items, such as white goods, or 65” LED TV’s, the first transaction will have to be with the customer at her home address. Marshalling these returns and sending them onwards is not insignificant: 120 washing machines on a trailer is a cost of at least £4 per machine for each shipment.

There may be additional costs like, storage space whilst waiting for a load to come together for onward shipping.  Or, if the reseller is simply selling off all returns, some costs associated with that transaction – marketing on an auction site and other sales costs need to be borne as well.

The manufacturer has a similar set of costs: receiving goods from the reseller, sift and sort and onward transport costs to asset recovery houses, or marketing and sales costs if they too are selling off. There are also hybrid arrangements between manufacturers and resellers, where, for example, the manufacturer has to collect directly from retail stores. Some of these retail stores, the smaller independents which perhaps belong to a central purchasing group, only have storage space for one or two items, so the manufacturer is committed to a round robin of several hundred stores, nationwide on a weekly or fortnightly basis. This is particularly burdensome on the large white goods / brown goods sector.

Bear in mind that for every touchpoint there will be a system – or even paper- transaction and these will have to be audited and accounted for. There will also be the parallel transaction between the reseller and the customer and/or the manufacturer and reseller of actually undoing the original sales transaction – cash back to the customer and the dreaded debit note from reseller to manufacturer or credit note the other way.

There will also be the “exception costs” – where a disgruntled customer threatens to tell the Trading Standards authority if something isn’t done even though the product may be out of warranty. The retailer or even the manufacturer then executes a one off transaction simply to avoid the bad publicity.

And finally there is the cost of waste disposal. Because not everything coming back will be recoverable, there will be some wastage that needs to be properly disposed of and whilst we might think that everything has a value, almost certainly the cost of disposal outweighs the value of that which needs to be disposed.

“Costs of defense” are an attempt to avoid the motions of the reverse supply chain and can also be quite high. Sometimes there are two layers of defense, a simple call center to authorize a transaction or prevent one, and/or a technical support center, again to diagnose and rectify problems before a reverse transaction is made.

“Hidden” or opportunity costs occur because many resellers and manufacturers outsource the functions of the reverse logistics chain, whether it is an outsourced call centre, a 3PL organisation, or asset recovery company. Costs or, more importantly, losses occur and are crystalized through the selling/remarketing processes and of course these outsourced functions all have overheads and their own profits to generate.  It is very easy for a mountain of costs to build up, forcing manufacturers and resellers to ask themselves three challenging questions:

  • Can I reduce the sheer volume of that which is in my reverse supply chain?
  • Am I managing these outsourced functions for utmost efficiency or have I just let them get ahead of me?
  • Could I bring any part of the reverse supply chain back in house to reduce the costs/losses?

Tactics for Winning in Reverse Logistics

  1. Maximise Recovery

From studies and my own experience, there is no fault with 50% of all product returned. For technology products generally, by cannibalizing and mixing faulty product with good, it is possible for 75% of returned product to be made re-salable. In reality, one unit of damaged or faulty product can actually “fund”, in spare part terms, 3 “new” items, so a final yield of re-salable product might reach 87.5%. But at what cost and is it worth it? Lines must be drawn up with value thresholds as to what should be processed and what should be scrapped or, for example, exported to countries with lower labor rates for recovery (something which is closely monitored in those countries as well as the UK’s Customs and Excise to ensure that there is no “dumping”).

Graded product can be resold for anything between 50% and 75% of a current retail price, dependent on the processing house putting warranty with the item. There are many other parameters forcing this price point, like age of product, original packaging, actual condition of product and the price point of a new item on the day.

Selling off of raw returns can give a financial recovery in the range of anything between 5p to 35p on the retail pound, again dependent on a number of variables, like where the product sits in the technology spectrum, the quantity, the age of the return and “how raw is raw”!

What strategy a reseller or manufacturer should employ depends on what strategy they are adopting in accepting returns from their customers. Over the years I have seen retailers having their own outlets for graded stock, only to close them down when they thought it might impact their brand image. Some have persevered, whilst others have tried to set up an outlet incognito. A further tactic is profit sharing with a processing house. Occasionally, there is brand conflict and “own brand” product has to be either de-branded or exported to obtain financial recovery. Some manufacturers send returns back to their central depots or even back to the original factories for “re-manufacture” and then resell “new” products to a secondary market; And this tactic can work for as long as the product remains current.

  1. Prevention

Preventing returns is a matter of how strong the relationship is with customers, how desirable the product is and how much respect a reseller might gain from imposing preventative measures. For example, it would be interesting to know if general retailers and supermarkets get more returns either by value or volume than specific product retailers. We know from recent research that 60% of all women’s apparel on-line purchases are returned, but is that statistic valid for an up market retailer compared to a high volume budget retailer?

Clearly in the terms and conditions, the reseller must state what parameters can cause a return and so discourage the return without being unreasonable. For example, the customer has to get a returns authorization number, the item must have all its accessories and/or original packaging or the customer must pay for the cost of return. All of these can be requested in such a way as to sound reasonable but in fact become such a hassle to the customer that dependent on the retail price of the product, she ends up not bothering to send the item back. And analysis of the information obtained during use of the preventive mechanisms can also inform the terms and conditions a company may want to impose to prevent a return. In fact, the customer can now do part of the asset recovery herself and re-sell her unwanted purchase, which had nothing wrong with it, on e-Bay or similar sites. Of course, better selling techniques or approaches may also reduce returns: the purchaser must have confidence in the item she is interested in, so an on-line retailer may well have a bricks and mortar outlet where the product can be tested, tried on, felt, smelled or tasted. So do manufacturers need to finance/subsidize retail outlets or even have their own brick and mortar outlets (more like touch and feel centers) – so that the purchaser is better informed and doesn’t send product back?

Another tactic is for the manufacturer or retailer not to give an automatic refund for a product but to agree to repair and return the product. Again this must be stated in the T&C’s up front, but it is amazing how many faulty items all of a sudden work again when you tell the customer that is what you are going to do.

Manufacturers can also have “no returns” agreements with resellers. They then only accept back faulty product. Non faulty, incomplete product is returned to the reseller or only partial credit is granted. These terms will have to be agreed at the point of sale of course and the policing methodology acknowledged, agreed and applied consistently for it to work. I have seen at least one major CE manufacturer apply such a system to its products and achieve a much lower rate of returns as a consequence.

Conclusion

Will the returns problem ever go away? I don’t think so. I think we are too far down the path culturally in our buying habits and in terms of the competitive environment for this to happen. The good news is retailers and manufacturers don’t go under from the problem. The bad news is they need to understand and manage the problem with both imagination and determination so that it doesn’t become a drain in their profitability. And there are three things that are important:

  • Accept that returns are demanded by the market (society) and so here to stay. Hence reverse logistics is an important part of the business model and needs to be professionalized to minimize margin loss.
  • By examining closely their processes and the value chain, companies can optimize reverse logistics costs and maximize recovery of assets.
  • By understanding consumer habits and behaviors, returns volumes can be significantly reduced, without being unreasonable and loosing customer loyalty and market share.

 

Mark Kiteley is a Si2 Partners Expert in Reverse Logistics and Asset Recovery. He started his own 4th party repair company in 1979 concentrating on the rapidly growing IT industry of the time. The company was sold in 1992 and through a number of other businesses in which Mark served as investor or director he has continually evolved, designed and developed systems within the service and the reverse supply chain industry extending the thinking from electronics and the broader tech industry through to furniture, home-wares, hardware, clothing and others. 
Mark is a qualified company director and is currently discretely disposing of assets for clients, designing and implementing prevention and recovery programs or applying his wider business expertise in Non-Executive Director roles.

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Service in Industry or its owner

 

Further articles on this and other topics can be found in the Si2 Partners Resources Page and the Si2 Knowledge Center

 

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