Bottom Line: Product returns are typically seen as a necessary headache and a cost drain. But companies can use their return policies to enhance customer loyalty and increase profits.
When customers send back a product they’ve bought, managers usually view the transaction in a purely negative light. After all, researchers have estimated that manufacturers and retailers spend more than US$100 billion each year on return-related logistics, an average revenue drain of nearly 4 percent per year. And that number is probably conservative, because even if some returned products can be resold through subsidiary outlets that specialize in unloading used items, the loss in profit on the original sale can be substantial.
Nevertheless, major retailers such as Zappos have implemented liberal return policies that make it very easy for customers to return merchandise. Such policies can have the effect of inviting consumers to take a chance on products they might otherwise hesitate to buy. And these permissive return policies may be advantageous — firms may be able to build loyalty with consumers through their interactions regarding returned products, attracting more positive word of mouth and repeat purchases as a result.
So can firms actually use return policies to improve their business? According to a new study by J. Andrew Petersen of the University of North Carolina at Chapel Hill and V. Kumar of Georgia State University, the answer is a resounding yes. Breaking with tradition and realigning corporate resources in favor of leniency toward customer returns not only benefits firms in the near term but can significantly increase their profits over the long term.
The authors began by surveying managers from retailers operating in three different industries and found that the number of returns they received was relatively high. For example, one apparel catalog reported that 70 percent of its regular customers had returned a product; the numbers were similarly eye-popping for a high-tech business-to-business firm (64 percent) and a general merchandise outlet (75 percent).
Clearly, the returns these companies had to deal with weren’t outliers to be endured on occasion, but a necessary part of doing business. However, the firms seemed slow to catch on to returns’ significance. In the second stage of the study, Petersen and Kumar surveyed 56 retailers and found that less than half of them considered product returns to be a fundamental part of their marketing appeals to consumers or their allocation of corporate resources.
The central phase of the study focused on 26,000 customers of a large retailer that sells apparel, footwear, and accessories through both an online store and a mail-order catalog. The company has a generous return policy, giving customers their money back for any reason if they want to return a product. Nevertheless, the firm bases its marketing outreach purely on purchase behavior: How recently and frequently customers shop at the store, and how much they spend.
The authors divided the customers into five groups: a control cohort that received no catalogs or e-mails; a subset that was targeted through the firm’s current strategy; two benchmark groups that received various blends of marketing approaches and return policies; and a faction that was targeted according to the authors’ proposed model — a customer lifetime value (CLV) metric that balanced a consideration of customers’ perceived risk against the return-related costs incurred by the company.
Over a six-month period, Petersen and Kumar tracked the number of emails sent and catalogs mailed to customers in each group. They also analyzed the purchase record and return behavior of every customer. Three years later, the authors compared the CLV — essentially, an estimate of how much each customer contributed to the firm’s coffers — to the actual profit each customer produced for the company.
The authors found that the firm was able to boost profits in both the short and long run when using their model. Profits shot up by more than 45 percent per customer, on average, over the six-month window, and by 29 percent at the end of the three-year span for consumers in the researchers’ proposed algorithm.
Here is how the numbers compare: After three years, the firm earned about $1.22 million from the control group; $1.25 million from the subset targeted by the company’s strategy; and $1.42 million and $1.53 million from the benchmark groups. Meanwhile, customers targeted via the authors’ proposed structure brought in $1.83 million, a gain of about $300,000 over the next-best resource allocation framework, or more than $58 per customer.
“This finding suggests that understanding the dynamics between product return behavior and purchase behavior over time enables firms to distinguish customers who are likely to increase purchase behavior at a faster rate relative to product return behavior rather than focus only on the net profit from purchase behavior — all at a lower marketing cost,” the authors write.
Still, many firms have gone the other way, introducing fees, deadlines, or other rules to discourage customers from returning products. Unfortunately for those companies, because stringent return policies tend to raise the risks for customers, they decrease consumers’ willingness to buy a product — not a huge problem if only a small number of consumers consider making returns, but a significant one in light of the authors’ findings that a high percentage of customers often send back their purchases.
Stringent return policies tend to decrease consumers’ willingness to buy a product.
In short, firms that ignore or downplay the area of customer returns are missing a huge opportunity to bond with customers and enhance their profitability. The trajectory of a customer’s value to the firm changes drastically when companies embrace product returns as well as purchases in their calculation of consumers’ long-term value.
And the findings have implications far beyond just retail firms. The profitability framework proposed and tested in the study should also be applicable to companies that primarily sell services. A previous study by Petersen and Kumar found that product returns and service-related complaints have comparable effects on customers’ future attitudes and behavior — their willingness to refer the company to friends, for example. Managers in the service sector who want to build a similar framework should substitute the costs incurred due to customer grievances for the outlay associated with product returns. In this way they can more precisely capture the complexity of the firm–customer relationship, the authors write.
Source: “Perceived Risk, Product Returns, and Optimal Resource Allocation: Evidence from a Field Experiment,” by J. Andrew Petersen (University of North Carolina at Chapel Hill) and V. Kumar (Georgia State University), Journal of Marketing Research, Apr. 2015, vol. 52, no. 2