Nothing but a Hound Dog

Good sales cover a world of evils. How many times have I repeated this truism while returning to my rental car after having visited one of many hot dot-coms or customer-direct operations that is currently on the upswing but has abdicated its responsibility to operate prudently and efficiently? Robust present or projected sales are the most addictive drug available in industry today.

I recall visiting a boating supply catalog company some years ago. The company needed operations and fulfillment planning support to determine the operating infrastructure that could affect its business plans in the next millennium. Being an avid sailboater myself, and a skipper, a navigator, and a qualified officer of the deck in the Navy, I have always sought to develop my afloat skills. As I sat in the conference room of this boating supplier with the company’s senior executives, I asked who among them was indeed a boater. The president looked at the senior vice president of merchandising, who then glanced at the VP of operations, who then shrugged at the president. All three then looked determinedly at me, and one said, “None of us are boaters.” After a moment, the senior VP of merchandising blurted, “I think Fred in re-buying has a boat.” The other two nodded in agreement, satisfied at their completion of the subject.

What more need they have considered?

Lip service Good sales. That is what we are all about, right? On the other hand, customer returns are the illegitimate stepchildren of the marriage between business growth and fulfillment operations. Ever more commonly during this past decade, growing companies have failed to conduct returns operations effectively. And yet we have all read stories of direct fulfillment operations that have retained customers because of their generous merchandise returns policies.

Lands’ End prided itself on having big-name, ground-breaking policies in the art of making the customer return. Key among its practices was making the customer comfortable with his or her ability to return any item that was not satisfactory with no questions asked.

Operations managers all over the globe resounded with objections over the problems with such a policy, decrying it with arguments based on the reasoning that returns handling costs far outweigh the efficient costs derived from the order-filling mechanism. There is much more to the picture than this piece of it, however.

While most companies today recognize the tremendous impact that a re-ordering customer has on sustained business, many still do not understand the critical elements of conducting a successful returns operation.

Making a minimal accommodation to actual customer returns processing is like posting signs around your house that say how much you love the family dog and ignoring that same dog for weeks while it sleeps in a 2-ft.-by-3-ft., flea-ridden pen out back.

Give them credit For the satisfaction of your customers and the health of your overall business you need to execute the customer returns process correctly. Put simply, the credit back to the customer is how a successful operation retains and grows its customer base.

A case in point is Musician’s Friend, a growing musical instrument catalog and e-business based in Medford, OR. It offers its customers a 45-day, no-questions-asked return policy. Given the target customer niche of starving musicians and fussy professional yuppies adding to their instrument collections to reclaim their youth, one might imagine that the returns rate could become abusive of such a liberal policy. But in fact, Musician’s Friend’s return rate is on a par with with the rest of the customer-direct industry, in which typical return rates range from a low of 3%-5% to a high of 15%.

Commodities tend to remain in the lower return ranges, and businesses such as office supplies have the lowest return rates, at around 4%, while fashion- and impulse-purchase-based businesses have a much higher return rate. In other words, it is consistently the product type or merchandise category that affects the returns rate the most, not necessarily the merchant’s returns policy.

The price of loyalty The catalog industry relies on the resale and compilation of customer listings, which are critical to making the catalog investment pay off. Typical catalog costs, including list acquisition costs, fully delivered, range from 45 cents to $1.00 per publishing customer delivered. Given an average response rate of 4%-8% for total catalogs mailed to a new list, this equates to an average margin impact per order of $7.00 or more for each customer obtained.

Contrast that with the value of loyalty from customers who retain a catalog repeat order profile. These are customers who cost much less to prompt an order – the typical repeat purchaser costs less than $1.50 from margin to prompt an order. Given an average customer-direct order of $47, this equates to a margin impact of 15% to obtain a new customer and 3% to service an existing customer, a potential 12% differential between the two types of orders. Extrapolated to the whole business, this level of margin is the difference between survival and Wall Street miracles.

Of course not every catalog or customer-direct business will realize this magnitude of difference between orders generated by new and repeat customers. But as a catalog becomes more focused in its offerings and begins to develop a brand or sourcing name loyalty among customers, this difference becomes greater.

Compare the margin impact of the new versus the repeat customer. Typical operations cost a customer-direct business around 5%-20% of total sales. Returns operations generally comprise about 15% to 20% of total operations costs – a fairly expensive endeavor. For starters, the returns process involves piece-level receiving, with full disposition determination, and a resulting credit action. Add to this a full complement of stock handling, and you have the making of one of the most serious pain-in-the-butt activities that a distribution operation can muster.

Return to receiving Let us take a look at the impact of returns on total company business. If we assume that returns activities cost an operation 15% of total expenses and that total operations cost the business 12% of total revenue, this equates to a returns-versus-sales cost of 1.8%. Add this to the 3.2% or $1.50 that is required to generate a repeat purchase via a catalog. That makes a total of 5% of costs of operations versus sales to maintain the average repeat purchaser who has made a return. Compare this to the cost of 12% of sales that is required to obtain a new customer who has never made a return, and you see the value of appropriately planned returns policies and operations.

But given this logic, just how should you plan your returns process to maximize both its effectiveness and customer perceptions of its activities? First and foremost, the returns operation needs to be a receiving process. Typical returns arrive via parcel service deliveries or bulk mail center backhauls and require a set of dedicated receiving doors. You should match these doors to a receiving dock that facilitates a number of activities. Specifically, the receiving process should begin with sign-off of the delivery manifest or freight bill after initial staging and accounting have been completed.

Immediately thereafter, each parcel should be directed to a customer disposition and credit workstation where a customer credit should be executed on the ordering credit card. Companies that insist on handling batches of paperwork routed to various individuals prior to issuing a customer credit are inviting problems.

Next, the customer should be notified quickly, via e-mail or other correspondence, that she has received her credit. A customer is far more likely to make a repeat purchase when she perceives a credit readily available for the next purchase than if she discovers on her credit card statement that the cash was received back long ago.

Heart of darkness The cavernous world of customer returns tends to become darker and more obscure as one moves further into the distribution operation. Many businesses that have planned and executed the customer credit correctly then fail to follow through with the efficient procedures for disposition, handling, and inventory adjustments that should lie at the heart of a completed returns process.

Of course, industries with vendor return caps or high degrees of perishability or product dating have limited degrees of freedom with regard to their ability to restock or regain cost purchases on returned items. Once the Texas State Income Tax preparation software has been shipped for 1999, a return of that item does not afford the merchant much leeway. The key to execution of returns disposition lies in clarifying return-to-stock and return-to-vendor types of items. In the operations realm we can usually leave the critical issues involved in that decision process up to the merchandising and financial groups.

What a typical operations executive can contribute, however, is determination of the value that can be added back to an item that is returned. Key to this decision process is the cost of handling a returned item to begin with. The majority of customer-direct operations that I have toured are managed without a keen awareness of the full cost of returns handling. A good rule of thumb is to take the average four-wall fulfillment cost per order and multiply it by 2.5. In other words, if it costs me $1.50 to fill each order that goes out my door, then my typical handling cost for a returned item is $3.75. If my gross margin on the item returned is $5.25 or less (3.75 plus 1.50 on the next order fill) and I cannot achieve a cost purchase credit with the vendor, I may want to consider not handling the returned item at all, with the exception of those activities that improve the overall perception of customer service (such as the swift issuance of customer credit). Understanding this cost can open up the feasible set of exit strategies available. But exit strategies are another column topic.

Certainly, the challenge of customer returns is one commensurate with the overall challenge of order filling itself. No company revels in its perceived failures when things are going great on the outbound end of the business. However, the complexity of the decision process and handling requirements are no excuse for the state of ignorance and neglect that pervades the industry with regard to customer returns.