This is the final posting of this series focused on Omni-Channel / E-Commerce profitability. The focus of this posting is on the impact of product returns.
We have defined the four components of the Total Cost To Serve (TCTS) for Omni-Channel / E-Commerce orders to be:
- The cost to purchase or manufacture the products, often referred to as the product’s Standard cost
- The costs to position inventory to be ready for order fulfillment activities
- The costs to actually fulfill the Omni-Channel consumer order, and
- The cost of product returns
After defining these costs, we offered the straight forward profitability equation of:
Omni-Channel Order Profit = Net Revenue – (A+B+C+D)
Today, we are going to specifically focus on the cost category D above.
The problem
When consumers buy a product sight unseen, there is often a level of uncertainty about whether the product will be what they actually want. Retailers often offer free returns for customer satisfaction, an offer that consumers use to their fullest advantage. But how does that affect the overall profitability for the retailer? Seem simple? The answer is often not so obvious.
Let’s start with the revenue part of the equation. A returned product turns a positive into a negative because the actual revenue received for the transaction has been returned to the consumer. The loss associated with the order also has to account for all of the costs associated with the returns process. These returned product costs can be more significant than most people realize. Let’s break down product return costs in more detail.
Original Order Fulfillment Costs (sunk costs) – since the product(s) are being returned, the original order fulfillment costs are now not being covered by the revenues associated with the order. Therefore, these are now sunk costs that need to be absorbed.
Inventory Carrying Costs – the length of time that a consumers holds the product can have a significant impact on inventory carrying costs. When an initial order is filled, the typical inventory replenishment process applies which can mean that new replacement inventories have been ordered. Therefore, in reality the seller of the product now has working capital tied up in inventory sitting at the consumer’s location, inventory in-transit as it is being shipped back to the seller’s receiving locations as well as new replenishment inventory. This can significantly increase the levels of working capital tied up in product inventories. Forecasting returns can help but most companies end up replenishing inventory to ensure there are no lost sales, given their lack of confidence in their data.
Return Transportation Costs – this category of cost is dependent upon whether the consumer pays the shipping fee to return the product. If not, then return transportation costs can add significant increases to profit losses.
Secondary Handling Costs – assuming the returned product is placed back into storage or on the shelf, there are costs associated with the receiving, inspecting and put-a-way activities for the returned product.
Disposal Costs – if the product is not going to be placed back in general inventory and it is to be discarded or destroyed, then there may be a disposition cost associated with the returned product.
All of these costs are demonstrated in the visual below and can have a significant impact on the profitability of an Omni-Channel / E-Commerce channel.
The solution
So how do retailers selling in the Omni-Channel / E-Commerce tackle this issue? The solution starts by again recognizing the wisdom in the adage “one size does not fit all”. Treating all customer product returns the same way is simply a formula for failure.
The solution starts by segmenting Omni-Channel / E-Commerce customers by understanding their overall net profit contributions over time. This requires having specific and accurate facts regarding exact profit performance for Omni-Channel / E-Commerce customers including the frequency and impact of their product returns.
This form of segmentation enables the creation of tailored product return policies that help manage the negative impact on profitability. Informed policies regarding how products are returned, if there are shipping fees, if charges apply for returned products or if there are defined time windows for products to be returned.
Of course this may drive some customers to shop with another retailer. But that may not be such a bad thing from a competitive advantage perspective!
I would love to hear your thoughts.
All the best,
Richard
