The world seems to be paying a lot of attention to supply chains recently, and a lot of the focus has been on delivering products to the customer, with various inefficiencies and delays along the way. The focus has been primarily on what some refer to as the forward supply chain, from raw material to the customer.
I think it's essential to use this opportunity to also look at the other side of the supply chain. Some people like to call it reverse logistics, circular supply chain, or closed-loop supply chain. This process starts when a customer returns the product and ends when the product is either back on the shelf or at another final destination.
One of the most disconcerting realizations is that many of the products that firms work so hard to bring to the US, by introducing mandatory overtime at the ports, for example, will be returned soon after they are purchased. How many of them? Across all e-commerce, that would account for approximately 30%. For apparel specifically, the number is closer to 50%.
If your initial reaction is: “So what? They are probably sold to another customer,” then maybe I can help you realize that this is likely not the case. And I would like to start with The Atlantic which had an interesting article on the topic a couple of weeks ago:
“We can dispense now with a common myth of modern shopping: The stuff you return probably isn’t restocked and sent back out to another hopeful owner. Many retailers don’t allow any opened product to be resold as new. Brick-and-mortar stores have sometimes skirted that policy; products that are returned directly to the place where they were sold can be deemed close enough to new and sold again.”
To deeply understand the amount of waste we are creating by the return process, Marketplace purchased a dozen products from Amazon and returned them, hiding a GPS tracker inside each one:
“Many returns took a circuitous route, often covering several hundred — sometimes even thousands — of kilometers to reach their final destination. Marketplace returned toy blocks that traveled over 950 kilometers [590 miles] before reaching a new customer in Quebec. And a printer clocked over 1,000 kilometers [620 miles] while circling around southern Ontario.”
The article reports that of the 12 items returned, only 4 had been resold to new customers when the story was published. The rest were still in transit, months after they had been returned. Some were even found in landfills, even though they were absolutely new.
There is nothing here that is unique to Amazon. ReturnGo, a firm I have been working with that helps retailers improve their return process, estimates that 25% of returned products are discarded.
If you have recently initiated an Amazon return, you will have noticed that the firm no longer requires the product to be packed and labeled. After a return is approved, a QR code is sent out, which you can then use to drop your return off at any designated UPS or Whole Foods location. In some cases, they might even suggest that you just give the product away and still get refunded.
The Economics of Returns
Why are firms so wasteful in dealing with returns?
One reason has to do with health and safety regulations: Reselling certain products is considered unsanitary (e.g., undergarments, swimwear, or beauty products).
A second, and more prevalent reason is reverse logistics. Unlike the forward supply chain which enjoys economies of scale in every stage, reverse logistics is very costly and inefficient. Products are returned at random times and in small batches (of one or two). They are shipped back to different places (based on product type), sorted in various locations, and in different ways, and finally stored until a decision is made on whether to sell them again or not. The reverse process is time-consuming and has no value for anyone involved in any of the stages. When people cannot identify the value in a process, they tend to bother less in making it more efficient.
Industry experts estimate the cost of returning a product (including the different steps and overhead) at $15 per product. For a $100 item, this can easily eliminate any margins the firm had. Also, based on the experiment carried out by Marketplace, most of the returned items end up in landfills or circling around indefinitely.
Returns are both extremely costly and very wasteful, both in terms of non-value-added work needed to process them and their effect on the environment.
So, if this is the case, why do firms offer such generous return policies?
The obvious answer is: To keep their customers.
Returns in e-commerce are much more prevalent than in brick-and-mortar shopping, where approximately 8-9% of the products are returned. We have probably forgotten the early days of e-commerce, but while books and CDs made quick inroads, people were reluctant to buy clothing and shoes online, given the genuine concerns on size and fit. Zappos was the first to disrupt this industry by allowing for very generous returns.
And almost all other retailers were quick to follow.
The problem was that customers were also quick to change their purchasing behavior.
Shoppers are ordering multiple items with the knowledge that they’ll easily be able to return some, whether online or in-store. In a recent survey, 51% of online shoppers avoid retailers with strict return policies, while in the same survey, nearly 55% of respondents made online purchases knowing they were likely to return at least some of the items purchased.
The New Equilibrium
Customers order products they know they are probably going to return. Firms incur significant costs from handling these returns, but the fear of losing customers does not allow them to change this behavior. Customers have no incentive to change their behavior because they don’t want to lose convenience (even though they claim they care about sustainability and the environment).
What are the implications of this new equilibrium? The prices of the products will probably reflect the fact that they are likely to be returned, and will incorporate that cost. And to the extent that the different channels (brick-and-mortar vs online) offer similar pricing: one pays in real estate what the other pays in shipping and returns. The costs remain, the structure shifts.
Other long-term implications, primarily in places where demand is quite elastic (making customers sensitive to price changes), have to do with firms reducing the quality of their products. If a product is likely to be returned, why invest in its longevity. And indeed, one of the most successful retailers is Shein where items are extremely cheap and seem to be of low quality. But in order to stay up-to-date with the latest Instagram fashion trends, having access to a variety of styles is more important than investing in a good-quality product.
Is this the equilibrium we want as consumers? Do we bear some responsibility for it?
I am not talking about extreme cases such as pure fraud, where customers just mislead the firm by buying products upfront to use and return (rather than rent) or return a cheaper version of the product they purchased. I am also not talking about returns of faulty or damaged products. I am talking about pure consumerism where people don’t think much about the ramifications of buying and returning and don’t realize the externalities they pose. It’s hard to identify exactly what portion of returns are of this type, but the survey above quotes 50%. In my opinion, even 20% would be too high.
A recurring theme of this newsletter is consumer irresponsibility and the inability to recognize the long-term effects of this behavior. We want firms to be sustainable, but we impose on their wasteful behavior. We want small retailers to exist and thrive, but we buy and return items just as we would with a larger firm. It is important to allow firms to build economies of scale around returns so they may offer better service; both in terms of reverse logistics and fraud detection.
Possible Solutions for Smaller Retailers
Several ventures are trying to help firms manage their return process. I mentioned ReturnGo, a venture that uses an analytics-driven solution to help firms make return decisions informed by logistical costs and customer lifetime value.
Another solution is mixing online and offline retail.
Inviting customers to “have some skin in the game” may increase the alignment. For example, 44% of respondents still prefer to return in-store, which can help firms reduce the cost of shipping. The same survey showed that 57% of customers would still shop from the same merchant even if they had to pay shipping costs to make a return.
And finally, now that COVID is less intimidating, we can use brick-and-mortar not only as a return center but as it was originally intended: a place to try and find the best suitable products in person. David Bell, Santiago Gallino, and Toni Moreno studied data from Warby Parker and the effect of introducing showrooms (physical locations where customers can view and try products). They show that these showrooms improve overall operational efficiency by increasing conversion in decreasing returns, among many other benefits.
Running an omnichannel operation requires some scale. But the advantages can be pretty significant, as the trend of favorable and flexible returns is not going to go away.
The current supply chain crisis is exposing more and more inefficiencies. I would expect more returns than usual after the holidays. Why? Given the uncertainty revolving around shipping dates and availability, people are probably ordering more than anticipated. Therefore, it is safe to assume that more products are going to be returned, and reckoning is going to come after the holidays.
So, during your early holiday shopping, ask yourself whether you are buying for keeps or are likely to return. That way, each one of us can consider the impact of our actions. I am also curious if you have seen interesting ways in which firms handle these issues.