Sears: The Return On Returns

Diane Petro is returning an aqua blue sweater bought as a holiday gift for her 9-year-old granddaughter.

Wrong color. "She's very particular," Petro explains.

Two people stand in line ahead of Petro at this Sears store in Yorktown Heights, N.Y. But their transactions move slowly. By the time she gets to the counter, Petro already is annoyed.

The service agent, without looking up, takes Petro's white plastic bag and utters a single word: "Receipt?"

"It's in the bag," clips the grandmother, in response.

The agent processes the transaction, gives Petro her cash back and drops the sweater atop a pile of other returned merchandise. The agent's bored expression never changes. Petro walks out. The next customer steps up.

Processing returns like Petro's isn't a glamour job. Dealing with mad, complaining customers is often unpleasant and always underappreciated. The reason a retailer is in business, after all, is to sell products, not take them back. Historically, it's been a money pit for retailers, as the goods get sent back to suppliers (in hopes of getting refunds), destroyed or dropped in landfills.

But at Sears, returns aren't a lost cause. Sears makes money on them.

"Returns can actually be profitable. That sounds crazy, but it's true," says Dale Rogers, a professor of supply-chain management at the University of Nevada in Reno. "It has become an objective for a lot of enlightened firms."

Retailers joke that there's nothing slimmer than an emaciated fashion model-unless it's the industry's profit margins. Indeed, Sears' net profits from both retailing and financial services were just 1.8% of sales last year.

But here's why handling returns well can fatten profits: Not only can a company more systematically hound suppliers for credit due on returned goods, but stuff that at a disorganized retailer would be donated or thrown out-chalked up as a loss-can efficiently be sold in alternate outlets.

Getting there isn't easy. Before Sears rebuilt returns, it—like most retailers—had no companywide process. Every store did it differently and considered it a low priority. Returned products were stuck in a back room, then shipped to suppliers piecemeal every two months or so. Individual store managers were responsible for sending the goods to the right place and following procedures set up in supplier contracts.

One manufacturer might want returns sorted by type of product-pants, shirts, sweaters. Another might want them shipped back only when the pile hit a certain dollar value or number of units. Store managers had to know or find this information for Sears' 10,000 suppliers, do the right paperwork and chase after each supplier for appropriate credit on goods sent back.

Multiply this scene by the hundreds or thousands of stores that a major retailer may run—Sears has 2,900 outlets in the U.S.—and you have disorder that leads to financial disappointment. Breaking The Cycle

To escape that cycle, Sears in 1993 hired a service company for "reverse logistics"—the management of returned products as they swim back upstream along the supply chain. Pittsburgh-based Genco Distribution System provides three giant warehouses, plus most of the staff, to handle Sears' unwanted goods. Since 1999, Genco has processed at least 23 million returned items every year for Sears.

Genco also supplies most of the hardware and software, a key attraction for Sears. Most retailers pinch funding for reverse-logistics operations. They don't see the sense in investing because there is a tradition of accepting losses on returns as a cost of doing business.

"We're an after-the-fact industry here," says Clay Valstad, director of central return center operations at Sears in Hoffman Estates, Ill. "It's not our core business and it's not likely I'm going to get capital for information technology," Valstad says. "But it is the third-party's business and they are willing to make investment in software and research."

Genco's custom-built R-Log software, which runs on Sun Microsystems Unix servers, tracks several variables associated with each Sears item. That includes which store the product came from, the proprietary Sears item number, the stock-keeping unit (SKU) number and the price Sears paid for it. The SKU number identifies other attributes as well, such as the name of the supplier.

At Sears, most returns go back to suppliers. (For a more detailed look, see "How Sears Makes Money on Returns," p. 55.) Other potential paths include online auctions, discounters, discounters, resale next year, recycle, donate or destroy.

Those decisions are made at Genco-run return centers in Sacramento, Calif.; Columbus, Ohio; and Atlanta. Genco's R-Log compares data on incoming returns against a 60-gigabyte Oracle database that tells how to route the hundreds of thousands of products Sears sells, including clothing, appliances, electronics, tools, toys, car parts and home decor.

For example, apparel maker OshKosh B'Gosh wants all returned merchandise back, then gives Sears full credit for it. OshKosh doesn't allow Sears to sell its products to secondary markets. In contrast, private-label clothing made for Sears can often be sold overseas at a discount, with the label ripped out. And, products such as gardening supplies can be stored and resold the next year. Craftsman tools often go to online auctions.

In the past, individual Sears stores only casually approached the process. They lacked easy access to a central database of information to guide them and would often make errors in how and when they shipped items back. Tags would be missing, handwritten paperwork would have incorrect SKU numbers. Those mistakes cost them refunds.

"Our job is to maximize the value of that item as it goes back up the supply chain," says Curtis Greve, president of Genco's retail division. R-Log "tells people on the floor where to ship the product to get the biggest return for the customer," he says.

R-Log also feeds data to Sears' internal PeopleSoft accounting and analysis systems. As merchandise arrives at a return center, credit notations are made electronically to the accounts of the individual store that sent it. Such prompt return crediting frees up funds for new buying by Sears merchandisers.

Sears fingers problem products and suppliers by running reports to see which manufacturers are slow to bestow proper credit or where the highest return rates are coming from. Buyers at Sears use that data when negotiating with a given company. Centralizing The Process

Discounters and other kinds of secondary buyers prefer to buy in big lots rather than a few items at a time. Before, Sears stores often would end up destroying or discarding some merchandise because amassing enough of it to sell on an alternative market took too long. Sears lost income this way.

But managing returns from three warehouses, rather than 2,900 individual back rooms, means that bulk collects quickly and other markets are a practical and frequent option.

Store labor is one of the biggest areas for savings, Greve says. At retail companies where each store handles reverse logistics, managers and clerks typically spend a total of 40 to 80 hours per week on returns work at each store. Most of that time is spent sorting merchandise and following up with suppliers.

By centralizing and outsourcing the process, in-store people simply take back the products from customers, pile them on a single pallet unsorted, then call Genco to pick up the goods when the pile gets big. Labor can be cut to 15 or 20 hours per week, per store, Greve says.

A recent financial analysis Genco did for a regional discount chain showed a positive cash flow in reverse logistics in as little as one year. The discounter averages 4 million returned items per year and spends about 50 hours per week handling them in each of its 104 stores. Genco's services would cost about $3 million per year, plus an initial $323,000 on capital equipment, such as scanners and bar-code readers.

By Genco's estimates, centralizing and outsourcing returns can cut in-store labor to about 10 hours per week per store. Product shipments would be simpler, with pallets of all different manufacturers' merchandise being sent every two weeks to Genco return centers. Annual benefits-increased manufacturer credits, fewer labor hours on the chore, more cost-effective shipping-are pegged at $4 million per year.

Still, problems arise. One is philosophical: Although every retail executive knows that returns can cost significant money, getting funding for a reverse logistics operation can be tough. The process is antithetical to the mission of a retailer to move products out the door, so why spend money on it?

Doing the initial database upload is also tricky. Genco, for example, had to spend several weeks with Valstad's eight-member staff and other Sears managers to understand and record all the different returns requirements of Sears' suppliers.

Plus, the database has to maintain data on items Sears no longer even sells. Though there is usually a 30-day return limit, customers commonly return products months or even years later. Sears won't turn away a customer with a gripe. "It still says 'satisfaction guaranteed' above the door," Valstad says. Genco keeps two years' worth of Sears data on file.

For example, as part of a $1 billion restructuring plan to jack up profits, Sears is cutting slow-selling products, including bicycles and custom window treatments. Genco will keep pertinent data at least until the end of 2004.

Sears also works with other reverse logistics companies. Hangerman, in Grand Rapids, Mich., for example, repacks and sells 100 million plastic garment hangers per year for Sears, and Sears gets a cut. Damaged hangers go to plastic recyclers, also income for Sears.

Valstad won't say how much Sears takes in from its various reverse logistics programs, or how much the company spends with Genco. But he says the venture is profitable. "In addition to recovering significant dollars in vendor credits or through recycling, we are able to recover all of the costs of running our reverse logistics program," he says.

As for Diane Petro's granddaughter in New York, she saw a new pair of jeans under her tree. How Sears Makes Money On Returns

For some retailers, returns are written off as a cost of doing business. But Sears has created a process that actually generates income and is able to press suppliers for proper credit due on returned products. Sears and logistics partner Genco have also built a carefully maintained database to help decide how to handle each return, in order to wring the most money from it. 1. Customer returns product to a Sears service desk. Service agent scans tags into point-of-sale system, gives customer refund. 2. Returns placed on a pallet in back room. When stack reaches about seven feet, store manager calls Genco for pick up. 3. Items brought to one of three return centers run by Genco for Sears are scanned and tagged. Genco electronically credits each store for the merchandise. Items are then sorted by manufacturer and type of item. 4. Depending on the contract with the supplier, Sears handles returns different ways. REFUND: Supplier takes item back and issues Sears full or partial credit. RESALE: Sears sells item to online auctions or to discounters. It may even store some items such as gardening gear for resale the following year. DESTROY: Underwear or bathing suits often get heaved. DONATE: Some items make their way to charity. Sears Base Case Headquarters: 3333 Beverly Road, Hoffman Estates, IL 60179

Phone: (847) 286-2500

Businesses: Department stores (about 86% of revenue), financial services

Chief Information Officer: Garry Kelly

Financials in 2001: $41.1 billion in sales; $735 million net profit

Challenge: Revitalize its 867 full-line department stores by discontinuing poor-selling products, improving customer "experience" and cutting costs

BASELINE GOALS BY 2004: Increase annual profit by $1 billion Increase earnings-per-share by 50%, to at least $3.36 Eliminate 5,950 jobs, out of work force of 310,000

Copyright © 2004 Ziff Davis Media Inc. All Rights Reserved. Originally appearing in Baseline.