The Six Hidden Costs of Reverse Logistics

by Lee Norman and Warren Sumner, ClearOrbit

Reverse Logistics Magazine, Fall 2006

Companies make money selling things, not taking them back. But companies automating the reverse logistics process have discovered a nontraditional but relatively easy way to move dollars to the bottom line. For many companies, reverse logistics is the last frontier of waste in today's supply chain. Take a look at the "industrial equipment" sector, where return rates run 4-8%. The total revenue impacted by returns is $52-104 billion in just the U.S. alone. For computers and network equipment, the return rate is 8-20%. For an industry with total U.S. revenue of $486 billion, the revenue impacted by returns is an astounding $39-97 billion.

Unfortunately, many companies have not yet had the information or tools necessary to turn this untapped source of value into additional revenue gains or cost reductions for their companies. A big reason for this is that the costs of reverse logistics are "hidden" across the organization, and no one functional group has line item responsibility for managing those costs.

To help identify where poorly managed returns may be affecting your bottom line, let's take a look at six hidden costs of reverse logistics, the area of greatest concern being Hidden Labor Costs, in addition to Grey Market Items, Lack of Visibility, Inaccurate Forecasts, Credit Reconciliation, and Poor Response Time.

• Hidden Labor Costs. Just as sales fulfillment impacts all facets of an enterprise, handling returns does too. From customer relations all the way to Sarbanes Oxley compliance, there are layers of cost incurred if your returns process is not automated. A reverse logistics operation is automated if it uses enterprise returns management software (used internally and externally by channel partners) which offers rules-based, product-specific protocols for how to handle any returned items. Based on information linked to the product's SKU—which can be activated by scanning or RF guns—this class of software can best determine what return rules and parameters apply if its attributes are drawn from the authoritative inventory, warranty, policy, and accounting information housed in the company's central ERP. These enterprise returns management systems work best when linked directly to a customer-facing web interface (more on this below), thereby integrating every link in the returns process to the ERP, allowing visibility across every station in the value chain 24/7.

  Let's look at the common areas of hidden labor costs:

  Customer Relations: Costs are incurred when manually deciphering return policies on a one-off basis, determining a product's eligibility for return, determining the timing of credits back to the customer, and identifying what warranties apply (if one applies). Moreover, you risk the perception that your company is interested only in customers who buy and not those who return.

  • Hidden Labor Costs
  • Grey Market Items
  • Lack of Visibility
  • Inability to Forecast Accurately
  • Credit Reconciliation
  • Poor Response Time and Brand Toxicity

  Customer Service: Costs are incurred determining which warranty policies to enforce, which service contracts apply, what credit rules are in place, how a product should be coded when it is replaced with a new one, and for determining special needs (e.g. expedited return shipping). Further, handling return-related contacts is alone time consuming. On average, customers call up to four times to inquire about each return. The opportunity cost of not eliminating one to two of those contacts is too significant to ignore. Imagine eliminating 35% of your return-related contacts, thereby redirecting the newfound capacity to generating additional revenue.

  Finance: Financial reconciliation of the return is required, as is issuing credit to customers. Most onerous, so is the inventory reporting for Sarbanes Oxley (where forward and reverse activity can very possibly be logged across two different quarters). Add in the appraisal / write-down process and the charges incurred if a returned product is not covered by warranty but is returned anyway.

  Sales: In many cases, account sales reps spend much of their valuable time dealing with nagging returns issues instead of new sales activities with clients. By implementing a web-based self-service customer portal, a major consumer electronics company was able to free up 40% of their sales reps time that was formerly tied up in dealing with returns issues.

  Traffic and Shipping: Because you bear the costs of shipping of returned items, it will cost you more in labor to individually assign a shipping method for each returned item. There are carrier-control rates to consider, as well as damage incurred in-transit, one-off shipments, inability to track returned items and cost-effective aggregation and routing. Without the application of rules, these decisions are made and costs incurred on ad hoc basis. Certainly, the processes aren't monitored regularly via metric reporting.

  Receiving and Warehousing: Facility and labor planning takes employees' time. Mostly because organizations have few systems in place to adequately support any such planning. And remember your warehouse costs, especially when occupied for long periods of time with inventory whose fate is unclear until a returned inventory assessment and recovery program is put in place to extract its value.

  Asset Management: Repairing, replacing, liquidating, or recycling products is costly, if it is done product by product by an ill-informed or undereducated worker. Also, assets and subcomponents devalue rapidly in some markets (2-5% per month in some cases) and value is lost if disposition isn't timely. Value recovery of a product means appraising its residual market value before it goes to costly repair. A cell phone whose market value is $5 isn't worth fixing for $15. But what returns manager can know the difference without physically opening the return shipment? Using business rules, some items can be scrapped in the field rather than returned and processed, based on a serial number or part number that is easy for end users to obtain.



• Grey Market Items. Even if a warranty program is controlled by serial numbers or SKUs, manual lookups are costly, and grey market contamination is a risk. Grey market contamination is a risk on many levels, not the least of which is warranty processing or the cost of determining that a product is not even eligible for warranty service. Controlling both asset history and required disposition systematically at the SKU or product category level helps to minimize this risk. For example, assets designated as scrap may reappear for warranty service. Manual operations are not able to quickly ascertain this, and costly work is performed against an asset that has been deemed to have no residual value. The key to avoiding this cost is to establish a rigorously enforced returns authorization process that grants you the power to deny any unacceptable return and offers you advanced knowledge of what's coming at you.

• Lack of visibility. Customers want visibility to the status of their return requests. If they don't have it, they'll call. Or email. Repeatedly. Merchandising would like to know what inventory is on hand, immediately. Are they short on the latest hand-held device…do they need to order more or is a sufficient supply in-transit as a return? Design would like to know if a product line is experiencing high return rates due to a single component failure. Marketing wants information about the instructions on the new phone system that is so confusing that customers think the phones don't work. A well-run returns operation can derive more efficient use of capital by capturing, synthesizing and publishing intelligence about your returns population to the relevant functional areas in your organization.

• Inability to forecast accurately. Detailed historical information about returns may be trapped in local Excel spreadsheets and static databases. Sales staff is often asked to provide forecasts for reserves, but they can see across the various stations and links in the supply chain to make those predictions accurate. Operations is unable to accurately predict whether additional (temporary) resources are needed to process a large influx of returns. They may be paying overtime to ensure internal cycle times are met, or up-staff too far in advance and have to send employees home early, if they have no returns to process.

• Credit reconciliation. Large customers often calculate their own credits – and take a debit on next payment, which is a very labor-intensive problem to resolve in the accounting office. And that's not the only reconciliation problem. Return requests are approved, but not valued or matched against receipts. This prevents accurate accruals, claims recoupment or effective vendor management. Manually processing this information is a method made obsolete 30 years ago. It can be automated and integrated, and the cost eliminated.

• Poor response time and brand toxicity. Manual return request processing and validation cause delays in approving or rejecting return requests. This frustrates customers and communicates lack of concern, which tarnishes your brand and drives up call and email volume. It also ties up their "open-to-buy" dollars and prevents more sales. So do delays in validation, cycle count discrepancies in receiving, and many other "simple" problems. Customers expect you to stand by your products during the entire lifecycle. They demand that your returns processes work as well as your sales process. Do you have this same expectation and a path to implement enterprise reverse logistics to solve it?

Reducing Hidden Costs by Automating the Reverse Logistics Process

A few approaches to reverse logistics have been tried and shown to be inefficient. For some companies, it seemed like a good idea to ship a product with a pre-printed return label. This process guarantees only one thing: The returned inventory will be shipped to the proper address because it is printed on the label. Beyond that, the data management process hasn't advanced much because these labels declare neither the quantity of goods, or if the return shipment is a mixed lot. Nor do they control the timing of the return of those goods.

Other companies have tried call centers. Fair enough, as you typically get the data right (or nearly right) with an agent, and you can even take time to sort through the various mix-matched SKUs in the shipment. But manual, human intervention in a returns process (as with any supply chain task) is costly because it is time consuming. According to Gartner: If you were to automate your reverse logistics with a web interface that demanded an RMA and compliant label before any return – it would save 35-50% over a live call center. If you were to set up an entirely web-based RMA system that linked directly to your ERP, your company could save 50-80% over pre-printed return labels.

Clearly, automating front-end RMA approval and labeling processes, as well as rule-based receiving, disposition and settlement, is the path insightful companies are taking for managing reverse logistics. C-level officers are eager to reduce costs, and the return-on-investment for an "enterprise returns management" (ERM) system can be achieved in a remarkably short time, given the margins and the money now left on the table. Set up a web-based RMA system, link it to your ERP, and train your customers to respect and adhere to your rigorous returns process, as enforced by web services. This need not alienate your customers, nor be perceived as inflexible. Returns can be made remarkably easy, given the flexibility built into powerful ERPs for manipulating highly granular data, the wide availability of "distance printing" of customized "returns compliant" labels, and the availability of sophisticated web services that can access and distribute data from a central ERP…and update that ERP with awareness of inventory that is heading back to the warehouse, and better yet, what to do with it once it arrives.

Leading companies today are recognizing the damage that hidden costs of reverse logistics are having on their profitability. Increased profits and excellence in the returns management process is found once companies focus on reverse logistics. With a logistics team "thinking in reverse" and the process automated at the industrial level, an effective reverse logistics operation offers a significant opportunity to recover returned goods and dollars that can dramatically impact the bottom-line of a company of any size and structure.

About the Authors: Lee Norman is senior manager of Enterprise Returns Management for ClearOrbit.

ClearOrbit provides real-time supply chain execution (SCE) and reverse logistics software solutions. Founded in 1994, ClearOrbit serves more than 275 leading manufacturing and distribution companies including Cisco Systems, Motorola and Texas Instruments. ClearOrbit.com.

Reverse Logistics Magazine, Fall 2006