Product Returns: Return on Profit

As I write this we’re in the midst of the holiday peak — four more weeks of industrywide frenetic selling activity. But while the sales peak ends at Christmas for most direct retailers, the inventory returns peak is just starting.

This annual phenomenon invariably creates waves throughout companies. Naturally, it always physically hits warehouse operations and customer service departments the hardest, but end-of-season returns also impact financial results due to their effect on profits. Less concerned with the operational effect of peak returns, merchandisers and inventory planners must consciously account for returns throughout the year. This is especially true for soft goods, which typically have high return rates. A 10 percent to 20 percent return rate is common in menswear and footwear; women’s basic apparel typically features return rates of 20 percent to 30 percent; and returns on women’s fashion apparel can easily top 30 percent.

Why are these percentages significant? Consider that a return rate of 20 percent for a retailer with $50 million of top-line demand means $10 million in returned sales. Then add in the resulting reduction in gross margin dollars plus the cost of processing returns, and it’s clear that returns can strongly impact a company’s bottom line.

Thus it’s incumbent upon merchants and inventory planners to try to reduce returns — or at least plan around them as best they can. There are three main areas to focus on:

1. Understand the causes of ­returns wherever possible. To reduce returns you must understand the reasons behind them. If you’re not already doing so, put processes in place to record the reason for every return. Doing so will allow you to perform analysis and take corrective action. Invariably you’ll soon find these at the top of your list:

• “Customer changed mind.” There’s really little you can do to address fickleness. It will always be there.
• “Item not as expected.” Something in the product marketing — e.g., visual image or copy — caused the customer to expect something other than what they received. Reduce these types of returns through better communication. Adapt your marketing to match the customer’s perspective.
• “Doesn’t fit.” Customers come in all shapes and sizes, but you can reduce bad-fit returns by making your sizing rigorously consistent across all product lines and communicating your size specifications clearly and often. Over time consumers will come to understand the fit of your products and return rates will lessen.

2. Factor returns into your product assortment planning. While you can’t eliminate returns, you can at least compensate for them. If you’re able to shift your product mix to favor those with lower return rates, you’ll achieve higher net sales. The tables below show how the simple act of increasing demand within a lower return rate category will lower the total company return rate, helping to improve overall sales and profits. In the second example the same level of demand results in $900,000 worth of additional net sales through an overall reduction in returns.

While this is purposely simplified, the concept is true at all business levels: Growing business in lower return rate product categories results in lower overall returns.

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.