Customer Returns: 1 % returns = 10 % sales

Liberal customer return policies drive sales, no doubts. However, how nice is nice enough? Where is the line between generating extra sales and losing money? Here is a a simple framework to evaluate impact of your return policies on well-being of your business.

Your return costs = product cost + shipping + marketing
  • Product costs: half of your vendors don`t accept returns, others charge 15 % restocking fee. Rough estimate - you lose 57.5 % of COGS or ~ 30 % of retail value of returned products.
  • Shipping: typical return policy is customer paying two way shipping. Underestimated shipping costs in your system and other issues result in ~5 % of retail value lost.
  • Marketing: you`ve spent money on key words or search comparison engines to get this customer. 10 % of retail value lost.
Total: 1 % returns costs you 0.45 % of sales.

Yes, there is a tradeoff - liberal return policy means higher sales. Let`s calculate how much extra sales do you need to off-set 1 % increase in returns.

On $10 million sales 1 % returns increase means $45,000 lost in costs. At 4.5 % margin to off-set this loss you need $1 million extra sales. Are you getting this much because of a nicer policy?

A rule of thumb - you need 10 % sales increase to offset 1 % increase in returns.

Simple, isn`t it?

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3 Comments:

Anonymous Anonymous said...

Ok, Think I'm missing something.

Assuming we previously had no returns:
$10 million in sales times 1% = $100,000 x45% = $45,000 in cost.

$163,000 in additional sales times 27.5% profit margin =approx $45,000

December 26, 2008 at 9:33 AM  
Blogger Maxim Mironov said...

Thank you for the comment. Your application of the logic is correct. The key is your Net Margin.

In my example I used 4.5 % net (reasonable margin for a dropship company). If you have 27.5 % Net - you are in a great business and 1 % of returns costs you ~1.6 % of sales.

An argument to use Net margin (instead of Gross profit margin): Marketing. You`ve spent money on attracting the customer and if he/ she returns the item - this money is lost.

In some sense we can use controllable gross margin (gross minus marketing) with appropriate allocation of % of "fixed" G&A and other costs but this makes calculation pretty complex.

In the situation when most of the retailers have no way of measuring impact of different return policies - plugging in your Net Margin into the formula is the easiest way to get an educated guess.

December 26, 2008 at 9:53 AM  
Anonymous Anonymous said...

Got it - Thanks!

There are drop-ship companies that only net 4.5% and still survive?

Very informative site. I have bookmarked for future use. Thanks again.

December 26, 2008 at 12:03 PM  

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