Dramatically Increased Product Return Rates Are Challenging Retailers

Steve Katz:

Hi everybody, and thanks for taking time out of your busy schedule to listen in on our Hilco Global Smarter Perspective Podcasts. As return listeners know by now, I’m your host, Steve Katz, and if this is your first time with us, well then welcome. We’re glad that you could tune in. Today we’re going to be talking about a development in the retail market, which is creating operational complexity and threatening margins for both operators and brands. And we’re all familiar with it, as consumers who have at least to some degree modified our buying habits in recent years, particularly coming out of the pandemic. And that topic is the growing number of product returns that are taking place, why this has occurred, and how those in the market can and are responding. And with us for that conversation is a very distinguished group of co-managing directors from turnaround and restructuring firm, Getzler Henrich, a Hilco global company, including Mark Sampson, Michael Apple, and Glenn McMahon. Gentlemen welcome to the podcast.

Mark:

Thank you for having us.

Steve Katz:

Yeah, glad to have you on. So,

Mark, let’s just jump right in with you. What kind of challenges are you guys seeing right now in retail specifically pertaining to this return situation?

Mark:

Well, of course, retail’s under huge pressure cause they’re trying to grow the revenue grow margin. And also the biggest headwind, of course, is inflation that we haven’t seen in 40 years. And with that is the returns situation. Cause there was approximately a million dollar, a million, sorry, a trillion of online sales last year, of which there were more than 200 billion in returns. Just of note, of the 200 billion, about 10% were fraudulent. But the market is sort of accepting that high rate of returns is normal, which I can’t accept. The percentage of returns on an annualized basis is running at approximately 25%.

This is according to McKinsey and other authorities. So the question is that is 20 or 25% acceptable? And in our opinion, we believe that it’s absolutely not. The US consumer is probably the most educated consumer in the world and has been given a free pass on returning goods. Now, I’m not saying that return of goods, it’s not a normal part of the practice, but if a company’s gross margin is approximately 75 to 80% and they disciplined in their return policy, then it doesn’t matter as the customer’s paying for the return and the restock stocking fee. But I’m shocked that most companies do not know the dollar amount of the returns and they don’t know the true cost.

Steve Katz:

Yeah, that is surprising. So what is that true cost?

Mark:

Well, I’m, I’m going to keep it simple. So let’s just use a middle market company that’s doing a hundred million dollar online revenue and it’s selling approximately a million units at a hundred dollars per unit. These are the costs that go into it to pick and pack that unit, it’s two dollars. To ship that product out is 12 dollars. A credit card transaction fee is another three dollars. The credit card refund transaction fee is three dollars. To restock that product is four dollars. To ship that product back is costing the company 12 dollars. You add that all up, it’s 36 dollars out of a hundred dollars.

That’s not to, I’ve got to mention the digital marketing cost, which is about 20 dollars, the acquisition cost. So when you add this all up together, you’ve got approximately 55 to 60 dollars of the cost to return that product on an item that you’re selling for a hundred dollars and it probably costs you 40 dollars. So you’re totally under the water and this is costing approximately on the hundred million dollar company, they’re getting 25 million dollars of returns and you call, it’s about a 10 million dollar straight to the bottom line for these returns.

Steve Katz:

Yeah. So that is obviously significant, much higher than I would’ve thought. And again, surprising that some of that data is not understood or known. What’s the fix? I mean, how do you solve for that problem given what’s going on, given how things have shifted and returns have become so prevalent?

Mark:

Well, to be clear, they’re always going to be returned. It’s a cost of them doing business and the big players need to lead the way. And you’re finding that a lot of people have, are not now giving free returns. But the way to fix it is you got to have a threshold on free shipping. So if you take the client that I’ve just spoken about, or online if you’re talking about a hundred million company, online business and their average unit cost is a hundred dollars and they’re giving free shipping, raise the threshold to somewhere between 175 and 200 dollars and educate your customer that it costs 15 to 20 dollars to restock. And it’s amazing how many CEOs do not actually know the true cost, but that is the fix. Raise, the shipping threshold and a lot of the small market guys are doing that now.

Steve Katz:

Okay, Mark, thanks. Let’s turn Michael to you, this is probably the next question that’s on most people’s minds, which is why do some retailers seem to have markedly lower rates of returns than others right now. What are they doing right? Are they approaching it from the perspective that Mark just suggested, or what are they doing correctly?

Michael:

Well, I think when you look at returns, what you have to do as you ought to have to look at returns by category, and some might argue that some categories have endemically higher return rates cause of the category themselves. If you look at shoes, shoes has the highest rate of return because of the sizing issue and the fact that different manufacturers have different lasts and different sizings. Then if you look at home goods where people are pretty much buying what they see or they’re electronics and they have serial numbers and they do research, or if you look at basic branded apparel like socks and underwear where customers are basically, they know their size and they’re restocking, you’ll see different return rates between those categories. But regardless of that fact, it’s really how a retailer manages their business from sourcing to point of sale to managing the return process that can have a major impact on the return rate.

And if you really look at return rates, it really all starts with the product itself. Well-constructed products with a high price value perception that fit consistently can go a long way to reducing returns because basically if the consumer has trust in the retailer and the representation of the fit, they’re not going to order more sizes just to get the right fit. They’ll have a strong trust in that the size that they’re ordering will fit. So I thought it would be interesting to present the case history of an apparel retailer to illustrate this point.

Steve Katz:

Great.

Michael:

So Mark talked about the McKinsey data on apparel returns and this company, and it shows that apparel retail total returns run around 20%, but online apparel retail runs in 25% of sales in returns. This specialty apparel retailer in 2022 achieved return rates, half of what the McKinsey survey averages were and both in online and in the bricks and mortar channel.

Steve Katz:

And so why is that?

Michael:

Well, that’s the question, right? That’s the question. And how do some retailers do it? And other retailers are swimming in returns and really it starts with the product itself as apparel merchants. In this particular case, the company has been maniacally focused on making sure that the product fits their target customer. They had research on the customer, they had experience in terms of how that customer’s sizing respect. So they also, instead of just what we call grading a product down or up in a formula mathematically, they basically inspect each size individually. So an eight might be a little different than a 10 than a 14. And so they really had that down pack. And so because of that fact their customer right, trusted that the size garment she either ordered online or tried on in-store was consistent and was consistent throughout old product categories. Whether it was a dress, a sweater, jeans or fashion tops for apparel customers’ fit continues to be the most important driver of purchase and repeat purchases And poor fit is, has always been, and continues to be the most important reason for customers returning product.

Now if you look at the company’s bricks and mortar channel, the company focuses on the experience and focuses on the fitting room experience with dedicated sales associates. So the key in apparel really if you want to build a sale is to get the customer into the fitting room and the result is a better experience. And the fact that when she purchases the item, she knows that the garment fits her. So getting her into the fitting room is critical so that she buys something that she has tried on and she knows that fits. Another aspect where product is critical is differentiated assortments that the customer cannot find elsewhere. So if she’s buying a fashion item in short supply and not a commodity item, if it fits, it won’t come back because she knows that she won’t be able to find it elsewhere. And another portion of this too in that regard is a scarcity.

If you look at people like Zara who basically flown in fashion items all the time, they know customers know that when they see an item online or in-store, that if they don’t buy it immediately it’ll be gone. So they will purchase it right away. In addition, in this particular apparel retailer, it’s not Zara. There’s a dedicated focus by the sales associates on reducing the return rate by what they call arranging the exchange in-store. So a customer buys a product and they decided they want to return it, whether they may not like it or it doesn’t fit, or the quality’s not great or they just bought too much. When they come in, the stores trained sales associates who understand how to convert the return into an exchange and even grow the total sale through and on sales and completing the outfit with accessories. So sometimes how you handle return either online or in-store, can really end up engaging the customer, making the customer feel better about the brand and resulting in a larger sale.

So in e-commerce, there are also some additional factors such as to get customers comfortable. And one of them would be product reviews. If the company has high ratings on their products, these ratings which come from other customers, not from the company, give her comfort in choosing the size and item that works for her without having to buy multiple sizes of the same item. And then the other, another thing online, which is important is being able to give customers sizing information size charts that help her figure out whether or not the sizing is correct for her. Whether that she has to go up a size or whether it’s accurate to what she thinks her size is or whether she’s got to buy a size larger. Another aspect that’s really helpful is some stores, both online and stores have style consultants who can talk or text the customer through the purchase journey so that by the time they purchase the item and they push that button and purchase that they have a strong trust that this item is going to be right for her.

Now the last aspect of how you reduce returns is something that people are starting to talk about is charging for returns. Charging for returns, especially when you look at the cost of returns. That gives the customer pause in order to make sure that she buys the right product in her right size. Now, while this might be a negative for some customers, if you have a differentiated product that she cannot find elsewhere and she has trust in the fit and quality, this overcomes the prospect of having to pay for returns because basically, she’s going to say, I know that what I get is going to work and I’m not worrying about having to pay for returns because I’m not going to return it.

Steve Katz:

Yeah, I mean excellent points. And I think the use of the case is really compelling here. Certainly helped drive it home for me, especially I do some shopping online. I started to see more of those sizing charts being incorporated into the sales process online, which does give, I think would give anybody a little more comfort. And then the idea of charging for returns, Yeah. I mean, it’s definitely going to discourage the returns. And again, as you said, if you have the confidence in what you’re buying in the first place, I don’t think that really becomes too much of a deterrent. So great, thanks for sharing that case as an example, and I think it crystallizes things. So let’s turn now to Glenn last, but not least in this triad of experts that we have here today. Glenn, if you could just address a couple of things I think we haven’t covered yet, it’d be great.

So for starters, maybe you can talk about the impact of returns on the environment from a sustainability perspective, because I know that’s top -of-line for many businesses and many consumers as well. And then if you could talk also about alternative solutions that are available to brands and retailers for minimizing and reducing returns that maybe we haven’t touched on so far?

Glenn:

Great, Steve. Thanks. Be happy to. So yeah, the fashion industry is second only to the oil and gas industry and pollution, which is pretty remarkable. Each year the fashion industry produces 13 million dollars of waste and the average consumer throws away 70 pounds of clothing per year. Most of that clothing ends up in a landfill and an estimated 95% of the waste created by the fashion industry could be recycled, reused, or resold. The biggest culprits, as Michael pointed out I think earlier in the conversation, are the marketplaces like Amazon and Shein, fast-fashion like Zara, and H and M.

But these guys have figured out a way to reduce their cost for returns and their policy is keep it, don’t return it, and they’ll send you a replacement. So that works for these low-cost manufacturers where it’s actually more expensive per Mark’s great illustration of the cost. So they have figured out that if the garment, actually the first cost for them is three dollars and they’ve already, and they’re selling it to you for nine, they can’t afford to take it back, restock it. So it’s easier for you, just it’s easier for them and more economically sound for them just to tell you to keep it and they’ll send you a replacement. But middle market brands and retailers on the high end cannot afford the same approach. So what the luxury brands have done and middle market brands are following suit, taking a page out of the automotive, the luxury automotive playbook.

I think everybody’s familiar with Mercedes-Benz and BMW-certified pre-owned. So we’re seeing this trend really pick up in the retail business, which is really interesting actually in electronics and the home goods as well. It’s not just apparel. So it really runs a gamut because they have a, it’s important for them to address the sustainability issue and it’s important for the consumer that’s buying the product from these brands. They are now either taking back the merchandise, they’re refurbishing it, they’re recycling it, they’re repairing it, and they’re selling it either in a resale concept like Patagonia is called rework. Gucci has done the same type of thing where they’re actually selling it. So similar to a Mercedes-Benz where you walk into a Mercedes dealership and you may be looking at that new G Wagon, but the price tag of 200 thousand dollars is a little frightening. But you can buy a certified pre-owned one for about half that price.

It’s been authenticated by the brand, it’s been repaired and the maintenance has been done by the brand. So you’ll know that you’re buying high quality and we’re starting to see this trend happen in fashion as well. So to Mark’s point, I think returns are never going to go away, but brands and retailers that are adopting this resale or the secondary market restore, restoring the product, refurbishing it, I think this is a trend that we’re going to continue to see. And it’s a great alternative to minimize some of the costs associated with returns.

Steve Katz:

Fantastic, very interesting. Specifically the restoring piece of it. I think some of us have seen some of that taking place also in terms of you go to Amazon, you go elsewhere and you see refurbished or restored items as a slight discount.

Glenn:

Right.

Steve Katz:

So that’s how we’re seeing it now. Yeah.

Glenn:

Yeah, and I think it’s interesting because Patagonia was one of the pioneers in this space, and of course, they’ve been an environmentally conscious brand for a long time or purpose driven brand. And what they found initially was by taking these goods back from their very loyal customers that own a lot of Patagonia have bought it for years, if it can be refurbished, then it’s a great entree into the brand for a new customer because these refurbished items tend to be at a lower price. So it’s a great new customer acquisition tool to get somebody into the brand. They would buy something, have a great experience with the brand on a refurbished product and eventually trade up to full price. So I think it makes a lot of sense. It is a true definition of this circular economy.

Steve Katz:

Yep. That seems to be the way things are going. All right.

Glenn:

Yeah, well yeah, it’s being driven by the younger generation. Gen Z is definitely, this is important for them. And they also love the concept of thrifting or discovery. It’s sort of, so it really checks off a lot of boxes. And as they continue to drive more and more of the purchase decisions in the households, I think we’ll see more of this continue.

Steve Katz:

Great. Really, really interesting stuff. Guys, Glenn, Mark, and Michael, super insights so relevant and timely. I think all of us are aware of what’s been happening and this is a great way to take a look at it and bring some of it to light with some possible solutions. So I wish we had more time to dig in deeper, but let’s provide the listeners with a single point of contact they could reach out to. Who wants to step up for that?

Michael:

I’m happy to do so and feel free to contact me, Michael Appel. My email address is mlmappel@getzlerhenrick.com and my direct cell is 917-789-3615.

Steve Katz:

Okay, great. Michael, thanks for volunteering for that. And listeners, certainly if your a business or a business in your portfolio is struggling with the types of issues pertaining to returns that we talked about here today, I would encourage you to reach out to Michael and the team for a discussion. And as always, we hope that this podcast provided you with at least one key takeaway that you can put to good use in your business or share with a colleague or client to help make them that much more successful moving forward. And lastly, please remember that you can check out more great podcasts and articles featuring timely insights from Hilco experts at hilcoglobal.com/smarter-perspectives. Guys, thanks again for joining us and until next time, for Hilco Global, I’m Steve Katz.