Returns Management: Happy Returns!

Returned goods are the hangover retailers endure following their blistering holiday sales runs. Customers dissatisfied with gifts they've received or purchases they've made will begin returning those items to retailers in droves as the sales surge winds down.

You're probably experiencing this annual phenomenon right now, as "return season" tends to peak in the weeks following the holidays. If so, you're seeing firsthand how the sheer volume of activity strains your customer service and warehouse operations. As you wrap up month- and year-end financial reports, you'll also see the impact that product returns have on your bottom line.

To illustrate, let's imagine a business with $100 million in top-line demand or gross sales. If that business experiences a return rate of 20 percent on its products sold (a fairly common percentage for apparel retailers), that means $20 million is going back out the door due to returns, resulting in $80 million in net sales. Add in the additional cost of processing all those returns, and it's clear that profits are going to take quite a hit.

By now, most merchandisers and inventory planners recognize the need to account for returns in their assortment planning, both throughout the year and particularly in preparation for the holiday peak and its aftermath. The question most struggle with: How? In particular, my sympathies go out to inventory planners. If you consider returns as a product supplier, it's your single largest supplier, but you have absolutely no control over the delivery quantity or timing. And yet you're still responsible for having the right amount of inventory on hand. Easier said than done.

Let's look at some of the factors at work here as well strategies you can implement to gain control of this crucial aspect of inventory planning. The examples are intentionally simplistic, as the idea here is to understand the principles and institute best practices in your inventory planning.

1. Know thy products. Different product types have different return rates. Soft goods, for example, have notoriously high return rates — typically 10 percent to 20 percent in footwear and menswear, 20 percent to 30 percent in women's basic apparel, and well above 30 percent in women's fashion apparel.

Products also vary based on their reusability once returned. For instance, you may have little chance of turning around and reselling personalized goods or intimate apparel, yet virtually your entire stock of leather belts might be able to be resold.

Industrywide, returns seem to peak approximately two weeks to four weeks following the sale of an item. This is good to know with respect to seasonal offerings. Knowing the likely return rate, reusability rate and timing of return for each product type can help you maximize the accuracy of your financial forecasts and inventory scheduling up front.

2. Listen to your customers. You must understand the motivations behind returns in any effort to try and reduce them. You'll find that it pays to document the reason for every return. Doing so allows you to quantify and share this information with other departments within your business — and with vendors if necessary — to take corrective action.

Oft-cited reasons for returned products are "damaged," "doesn't fit," "item not as expected" and "changed mind." While there's not much you can do to prevent a customer's change of heart, communication with packing and shipping, product developers, and vendors can minimize damage and help ensure a consistent fit within your product lines. With rigorous enforcement over time, customers will respond by returning fewer items.

By the same token, working with creative resources can enhance the accuracy of photos and descriptions in your marketing sales channels. Whenever and wherever possible, target your marketing message to match your customers' perspective. Something as simple as showing front, back and side images of a product can directly reduce returns.

3. Adjust your overall inventory planning to actively account for returns. While you can't eliminate returns, you can at least compensate for them. If you shift your product mix to favor those with lower return rates, you'll achieve higher net sales. Obviously you shouldn't change your overall product positioning, but you can be smart about paying attention to details.

Again, using the 20 percent returns benchmark, the chart shown below shows how increasing demand within a lower return rate category will lower the total return rate, helping to improve overall net sales (and therefore, profits). Example one is the status quo; example two illustrates how a simple reduction in the return rate provides a significant boost in net sales.

4. Plan for returns to optimize fulfillment and cash flow. Returned inventory lowers sales and reduces profits. As noted, the timing and reusability of product returns can also impact sales and profits as they relate to order fulfillment and inventory turnover. These factors add an extra dimension to your already complex demand planning.

Consider the following example: You have demand for 1,000 units over a three-month period. With a 20 percent return rate, you have 800 units of net sales, but some of the returns arrive too late to fulfill customer orders. So which is the better approach for your business: Purchase 1,000 units to fulfill all demand (thus accepting 200 units of overstock), or purchase 800 units to avoid overstocks but miss sales (and perhaps displease customers) when returns don't arrive in time to fulfill demand? The answer typically lies somewhere between the two.

No one said managing returns is easy. However, you can limit the financial impact of product returns with a few simple adjustments to your inventory planning. Follow these three steps:

• Plan for both "total" and "reusable" returns by product. Remember that some of your returns can't be resold.
• Create two separate curves in your weekly inventory planning to identify the timing of returns: one, a standard demand forecast that anticipates ordering activity and, two, a return curve for reusable items timed at two weeks to four weeks following order shipment. This second curve allows you to factor returns into your purchasing as well as treat them as anticipated receipts.
• Profile your products and adjust target inventories to cover the differences in your weekly demand and return curves. Identify the products for which you intend to fulfill 100 percent of demand (buying overstock to cover anticipated returns) and those for which you'll purchase below demand forecast (and accept lost sales) to avoid the resulting overstock.

Customer returns are unavoidable for retail businesses, but that's not to say that you don't have any control over them. With a few adjustments in your inventory planning, returns can provide an opportunity to strengthen overall sales and profits, improve cash flow, and make more customers happy.

Joe Palzkill is the vice president of sales and business development at Direct Tech, a multichannel marketing consulting firm. Joe can be reached at jpalzkill@direct-tech.com.