RL Magazine
Increase Profits using the Reverse Logistics Cost Equation
By Paul Rupnow

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The challenge of every Reverse Logistics Professional is to increase your corporate profits by improving the handling of your returns. Returns processing is made up of many people, processes and costs, so it can be a considerable challenge to assess where to focus your energies to ensure you can achieve the biggest return for time or money invested.

One way to tackle this challenge is to view your reverse logistics from a financial perspective. It is also helpful to arrange your returns processing into a framework to perform ongoing analysis, prioritize your decisions and benchmark your performance.

An excellent tool to help you perform this analysis and identify your profit opportunities is the Reverse Logistics Cost Equation.

The Reverse Logistics Cost Equation

The Reverse Logistics Cost Equation is an assembly of the key cost components or categories related to the creation, handling, processing and final disposition of a return item. The equation is as follows:

The Reverse Logistics Cost Equation: Processing Costs + Logistics Costs + Credits/Replacements Cost + Asset Depreciation Total Reverse Logistics Costs

It is very important to note that a reduction in any one of these Reverse Logistics Cost Equation components goes straight to your corporate bottom line profit.

Reverse Logistics Cost Components

A closer look at each component is as follows:

Processing Costs: are all costs incurred to process and handle your returns. For example, your returns process may start with the authorization of the return by a call center representative, followed by the receipt of the returned item at your warehouse and then the repair or refurbishment of the returned item.

Logistics Costs: are all costs related to moving and handling the retuning units as well as the cost related to the shipping of any replacement units. This may include freight costs for pickup and for shipping. It may also include warehouse handling and storage costs not already captured as a processing cost above.

Credits/Replacement Costs: most products that are returned require the issuance of a credit or the exchange with the same or a similar replacement product.

Asset Depreciation: most returned products have some value, whether it can be re-stocked, refurbished or even sold as scrap. Often these items have a higher recovery value than you may think. It is very important to consider the financial value that may be lost over time if these returned products are held too long and not dispositioned quickly.

Impact of a reduction in the Reverse Logistics Cost Equation Components

As mentioned earlier, a reduction in any one of these Reverse Logistics Cost Equation components goes straight to your corporate bottom line profit. So what happens to your corporate profits when you make small improvements to each of these cost components? Cost Component Potential Savings Range $ (very small) to $$$$$ (very large) Processing Costs $ - $$ Logistics Costs $ - $$$ Credits/Replacements Cost $$$ - $$$$$ Asset Depreciation $$ - $$$$$

Small improvements to processing often result in some financial savings that increases corporate profits. For instance, it may cost you $30/unit to process a warranty return. If you are able to improve the process and save 10% of your processing costs, you will send $3/unit to your corporate bottom line profitability.

Small improvements in the area of credits/replacement or the area of asset depreciation can often result in much larger profit impact. The reason for this is often driven from the impact of your cost per unit. If we look at the example of one of your retailers returning one of your electronics items due to a product defect. The cost to issue a credit to the retailer is equal to the amount you sold that unit to the retailer for, let’s say $80 as an example. The impact of this return is an immediate reduction in your corporate profit of the full $80 for this unit. Hopefully, you will be able to recover some value from this returned unit, but the immediate impact to profit can not be overlooked. Nor can the immediate gain you could achieve by somehow reducing the credits issued to the retailer by one unit. In this case, the impact of issuing an $80 credit for a unit is certainly much greater than the $3/unit you achieved above with the small improvement in per unit processing cost.

Similarly, large opportunities are often available in the area of asset depreciation. The number of channels to dispose of returned goods (in any condition) has grown significantly over the past few years. The profit impact of this opportunity can be very significant. For instance an electronic manufacturer recently learned that they could dispose of returned items collecting dust in their warehouse at 80% of retail value. The per unit selling price was above their original manufactured cost, but since these were returned units their book value was already written off to zero, so the gross profit margin was 100%. The profit impact of returned asset depreciation is essential to monitor, because time can rapidly reduce the value of idle returned goods and their potential positive impact of corporate profits.

Inter-Relationship between the Reverse Logistics Cost Equation Components

When performing your analysis of potential profit improvements in each area of the Reverse Logistics Cost Equation, you must also keep in mind the inter-relationship or effect that one equation component can have on the others. The best example of this is processing costs.

Processing Costs $ CAN DRIVE -> Logistics Costs $$$ Credits/Replacements Cost $$$$$ Asset Depreciation $$$$$

A small change in one part of the equation, such as processing, can drive very large changes in the other parts of the equation. For example an improved verification process when returned goods are received may involve an investment in technology or software and training. This change in processing costs may drive a large reduction in the number of unauthorized credits you have been issuing customers for goods that may have never actually been returned properly. So a small investment in processing technology drove a large change in bottom line profits since fewer credits are now issued.

A small change in processing costs can also often achieve a significant increase in profits through a reduction in Asset Depreciation. By speeding the turn around time of a rapidly depreciating product line, there is often an opportunity to significantly increase the profit recovered by selling the “newer” goods for a higher price to the secondary markets. This rapid turn around time can be achieved through a small change in processing costs, such as an investment in better IT systems that enable visibility and alerts to ensure the goods are flowing through the system at a much faster pace.

The Reverse Logistics Cost Equation can be a powerful tool for you to analyze your operations and determine where to spend your limited time and financial resources.

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