Research by Gilvan Souza
Product returns are a serious financial concern that costs
U.S. firms more than $100 billion annually. In an effort to
keep consumers happy, most major retailers have liberal product
return policies. While some products are returned because the
products are defective, a large percentage of returns are false
failure returns: returns that have no functional or cosmetic
defect. Hewlett-Packard has found that false failure returns
account for 80 percent of inkjet printers returned to the manufacturer.
Most of this cost is born by the manufacturer, which must
transport the returns back to a factory, test to be certain
the product isn’t really defective, possibly refurbish, repackage,
and then remarket the product, which cannot then be sold for
its full original price. There is also a loss in value for the
time a returned product spends in the reverse supply chain,
which can be up to several months for some companies. For a
company like Hewlett-Packard, all this adds up to 25 percent
of the retail price of returned products like inkjet printers.
In his paper “Supply Chain Coordination for False Failure
Returns,” Gilvan Souza, associate professor of operations management,
with co-authors Mark Ferguson, Georgia Institute of Technology,
and V. Daniel R. Guide, Jr., Pennsylvania State University,
looked at the problem of false failure returns as a function
of supply chain coordination. Souza proposes a target rebate
contract that pays the retailer a specific dollar amount per
each unit of false failure returns below a certain amount.
Because the manufacturer enjoys most of the benefits from
reducing the number of false failure returns, the manufacturer
must share some of these benefits with the retailer to achieve
a coordinated solution. Souza and his co-authors developed a
model to determine how best to motivate retailers to expend
the optimal amount of effort to reduce false failure returns,
and found that a target rebate would result in maximized profit
for both retailers and manufacturers. The authors used real
data from Hewlett-Packard and Bosch, a German manufacturer of
power tools, in developing their model. Both companies are highly
brand-name conscious and have a policy that a product returned
for any reason must be returned to the company’s product return
There are a number of reasons why consumers return a product
that is not defective. The consumer may find it difficult to
install the product, not because it doesn’t work properly, but
because the consumer did not understand the product’s features.
Sometimes the product may not perform to the consumer’s expectations,
not because the product is defective, but because the consumer
just didn’t know enough about what she was purchasing to choose
the right product for her needs. Complex or complicated products,
such as HP’s printers or Bosch’s power tools, are particularly
prone to this problem.
If sales staff spent more time with customers, explaining
complex products features or helping consumers better match
the product to their needs, some of the problems that cause
false failure returns would be alleviated. But that involves
effort on the part of the retailer, and because retailers aren’t
bearing any of the cost of returned goods, they have no incentive
to put any additional effort into decreasing the number of returns.
Rewarding retailers with cash is effective because it reduces
the overall processing cost for false failure returns while
providing the retailer with a higher level of net sales as well.
It acts as in incentive for retailers to change their behavior
to be closer to the actions of a coordinated supply chain.
Souza found that the average magnitude of profit improvement
per expected return as a result of the retailer’s increased
effort is 31 percent for the retailer, 17 percent for the manufacturer,
and 24 percent for the supply chain itself. “Fifteen or 20 years
ago, there wasn’t much discussion of strategic coordination
issues among supply chain managers. Supply chain coordination
is being thought about in a more strategic way, and managers
are seeing the benefits of providing incentives for others in
their supply chain to make decisions that are good for the system
as a whole,” says Souza.
Future research in this area may focus on generalizing these
results to other settings and industries, says Souza. “Supply
Chain Coordination for False Failure Returns” was published
in the Manufacturing & Service Operations Management journal.
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