Product Returns: Return on Profit

3. Consider returns in your inventory planning to optimize fulfillment and cash flow. Returned inventory lowers sales and reduces profits. The timing and management of returns can also impact fiscal sales and profits as they relate to order fulfillment and inventory turnover.

A simple example: You have demand for 1,000 units of a style. If 200 come back as returns (a 20 percent return rate), you end up with 800 units of net sales. Your inventory planner then faces a difficult choice: purchase 1,000 units to fulfill all demand and get 200 units of overstock or purchase 800 units to avoid overstocks but miss sales when returns don’t arrive in time to fulfill demand?

To optimize inventory and deliver peak fulfillment and cash flow, the inventory planner needs to apply the following best practices:

• Plan for both “total” and “reusable” returns by product. It’s likely that some of your returns can’t be resold, as products vary widely in their reusability rates. For example, personalized goods have a reusable rate around 0 percent while 95 percent of leather belts may be reusable.
• Include timing of returns in your weekly inventory planning. You should actually plan two curves. The first is a weekly demand curve — e.g., how you expect customer orders to arrive for the 1,000 units of demand.
  The second is a return curve, typically timed at two weeks to four weeks following order shipment to the customer. Together these two curves allow inventory planners to factor returned units into their buying decision. Returns can then be regarded as anticipated receipts. With a 20 percent return rate, customer returns could become the single largest inventory supplier to a business.
• Profile your products and adjust your target inventory levels by product to account for the timing differences of demand and return curves. If an item is only sold in one season, it’s mathematically impossible to fulfill every customer order unless you purposely buy too much inventory and accept the resulting overstock. Current best practices involve profiling your products into those that you aim to fulfill 100 percent of demand — essentially buying overstock to cover returns — and those where you’re willing to purchase below demand forecast and accept a degree of lost sales to avoid the resulting overstock.

Customer returns are unavoidable in retailing. But by understanding the underlying causes and better managing the areas you can control, you can leverage returns to increase overall sales and profits, improve cash flow, and make more customers happy.

Joe Palzkill is director of sales and marketing at Direct Tech. Reach Joe at jpalzkill@direct-tech.com.