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Creating Value Through Reverse Logistics

by Diane A. Mollenkopf and Howard Weathersby

Are you interested in producing a better return on your assets and creating shareholder value while keeping ahead of environmental legislation? Learn how getting products back and pushing them up through the supply chain to be reused, sold or properly disposed of creates value.

It’s time for an attitude change. Stop thinking of reverse logistics as just a necessary evil, or a cost of doing business, something that doesn’t really jibe with your firm’s real logistics activities. In light of increasingly strict regulatory measures (emanating particularly from Europe) that limit landfill disposal and extend producer responsibility into postconsumption product life stages, it’s time to start managing your firm’s reverse logistics processes. In doing so, you may find some surprising benefits as well.

Traditional supply chain management focuses on delivering value to end-customers through integrated management of various processes such as procurement, order fulfillment, demand management and customer relationship management, to name just a few. Organizations are increasingly including reverse logistics in their process-management focus. As a process, reverse logistics refers to the set of activities related to getting goods (products, materials, packaging) back from point of use to points further up the supply chain where they can be reused, refurbished, resold, or disposed of properly. These activities, as defined by Rogers and Tibben-Lembke (1999) include gatekeeping (managing the insertion of goods into the reverse supply chain), collecting, sorting and grading returns, developing a network of logistics providers to transport and process returned goods, refurbishment and/or remanufacturing of selected goods, resale or reuse, and ultimately proper disposal.

You could be missing a real opportunity if reverse logistics were only viewed as a cost-minimization exercise. Opportunities to recapture and create value in the supply chain should also be explored. Using a Return on Assets (ROA) approach is one way to assess value creation through the returns process. ROA is a key indicator of a firm’s profitability, and also a key contributor to shareholder value. Effective returns management can contribute to improved ROA in several ways. First, reclaiming products/parts that can be reutilized in the forward supply chain can dramatically reduce a firm’s cost of goods sold.
Even if refurbishment or remanufacturing is required, revenues can ultimately be gained from essentially ‘free’ inputs where a refund is not required.The firm has already paid for the raw materials once, and doesn’t have to re-procure or totally transform them again in order to gain additional revenue. Appliance and electronic goods manufacturers are prime examples of organizations that are taking advantage of this type of non-traditional supply. Firms that lease their products, such as office equipment and computer manufacturers, also focus on asset recovery initiatives to reclaim their end-of-lease products. Many of these products (or at least their parts) still have useful life that can be offered to other customers at very little up-front cost.

Second, operating expenses can be reduced through effective and innovative returns management programs. In addition to minimizing costs relative to returns processing, customer service costs can be reduced if the return process is streamlined from a customer’s perspective. Additionally, capturing information about the reasons for returns being made can be leveraged to further improve the product, thus reducing future returns. Effective returns management and processing can also reduce a firm’s environmental compliance or waste disposal costs.

Third, assets in the form of obsolete inventories can be reduced if returns are managed efficiently. This means getting merchandise returns from dealers in a timely manner so that alternative uses can be made of the inventory before the only option is to write it off, and then dispose of the product.Managing the timing of returns is especially critical for seasonal or short life-cycle products. Merchandise returned at the end of a season has little potential for alternative use. Making earlier decisions about stock disposition in the field can provide many opportunities to reuse inventory before it becomes obsolete.This means implementing channel-cleaning policies with dealers and retailers to manage not only the quantity of returned products,but also the timing.

The ROA Approach
Profitability analysis is an important means of assessing logistics activities and proposed changes to a firm’s logistical systems. Profitability analysis goes beyond total cost analysis by incorporating the revenue impact of logistical activities. For example, an improved level of service may bring about increased revenue as your customers respond to your higher levels of service. Such changes must be built into logistical system analysis. Additionally, the impact of assets such as inventory levels, accounts receivable and fixed logistical assets should be incorporated into a comprehensive profitability analysis approach.

A critical measure of strategic success is Return on Investment, which can typically be measured by Return on Net Worth (RONW), or by Return on Assets (ROA). RONW measures the profitability of the funds that owners have invested in the business, and is most likely of interest to shareholders and investors. ROA provides a more operational perspective by providing a view of how well managers utilize operational assets to generate profits. Thus, ROA becomes a key managerial tool for logistics profitability analysis.

The Strategic Profit Model provides the framework for ROA analysis by incorporating revenues and expenses to generate net profit margin, as well as an inclusion of assets to measure asset turnover. Net profit margin measures the proportion of each sales dollar that is kept as profit, while asset turnover measures the efficiency with which assets are used to generate sales. Together, they form the basis for ROA. Figure 1 provides the general framework for understanding how logistical decisions can impact net profit margin, asset turnover, and ultimately, ROA.

In using the ROA approach to better understand the impact of reverse logistics decisions, Figure 2 illustrates that the impact of reverse logistics goes beyond cost reductions. In fact, the impact can be broadly described in terms of:

  • Cost reductions that come through reduced cost of goods sold and operating expenses;
  • Improved asset turnover through better inventory management; and
  • Increased revenues in both the short and long terms through additional sales and full-price maintenance due to newer stock being offered.

Fourth, return products are often an overlooked source of additional revenue. Recovered product may be re-sold through existing or new channels,depending on the characteristics of the target markets. For example, remanufactured computer products are often resold to consumers that represent a different target market than the OEM’s primary customers. Original customers might include large corporations purchasing computer equipment in large volume. Secondtime- around customers may be small businesses or consumers who wish to purchase a certain computing power, but are unwilling or unable to pay premium prices for new equipment. In the case of multi-use packaging such as 55- gallon drums or intermediate bulk containers (IBCs), the cost of goods sold is essentially the collection freight and the reconditioning cost.Those reconditioned products often sell at a price point approaching new containers, and actually have a higher gross margin. Not exploring these potential new markets can really shortchange a firm’s revenue opportunities.

Fifth, another source of additional revenue comes through better inventory management. Better inventory management and channel cleaning initiatives can help prevent markdowns, and thus help retain higher margins on sold products.

Sixth,the market positioning power of effective returns management programs should be considered. As customers and consumers become increasingly conscious of the environmental impact of the corporations they deal with, being able to honestly promote reverse logistics activities can help a firm gain repeat business and increase customer loyalty. Many firms are finding that significant brand equity can accrue by being an environmentally responsible corporate citizen.

In the returnable packaging arena,opportunities to create value can come about by switching from expendable to returnable containers.This not only avoids the disposal cost for expendable packaging,but returnable containers may be able to provide additional protection to products,thus reducing product damage, along with the related lost sales and expenses to correct the damaged product. Of course, returnable packaging may not always be cost-justifiable, so a total cost approach to analyzing the expendable versus returnable container option should always be taken. This may also involve reviewing and re-engineering packaging materials to ensure recyclable material is being used.There can be significant value added in the form of market perception, particularly in examples like the chemical industry’s “Responsible Care” program where members have significant measurable commitments to “Reduce, Reuse,Recycle”.

On a somewhat larger scale than switching a corrugate box for a plastic tote, is the whole issue of mobile assets. These are usually more expensive types of containers, such as beer kegs that must be returned from a restaurant or pub back to the brewery. Such containers represent a significant investment for a firm, and the movement of these assets should be carefully managed, so as to minimize shrinkage and damage to the containers, as well as to minimize cycle time as the containers rotate through the closed loop system. Managing cycle time is especially important so as to maximize asset utilization,and minimize the total number of containers needed to keep the system running smoothly.A brewery cannot afford to run out of kegs.But it’s equally important that it should not underestimate the financial consequences of having too many kegs in the system.The chemical railcar industry provides another example of mobile asset management. Somewhat unique in the rail industry, chemical companies tend to own or lease their own railcars due to the specialized nature of the cars.Thus, railcars are essentially bulk chemical product containers that rotate through a system from factory to customer and back again.Poor management of these assets has led chemical companies to invest in more railcars than necessary,while the utilization rate on each railcar remains very low, because they sit idle on rail sidings or at customer plants for far too long. At approximately (US)$70,000 per car, the investment level is high, while the returns on these investments remain unnecessarily low.Thus effective asset utilization becomes an important means of improving a firm’s ROA, and ultimately its value to shareholders.

In summmary, effective reverse logistics management can add significantly to a firm’s profitability and ultimatel, to shareholder value.As environmental legislation continues to become increasingly strict, firms can either take the minimalist approach by doing only what is legally necessary, or they can seek out opportunities presented by the environmental legislation. Contrary to conventional wisdom, environmentally responsible logistics practices can be highly profitable for firms.The key is to take a systems approach to better understand the total costs and benefits of your reverse logistics system. The ROA approach provides a systematic means to understanding the cost/benefit tradeoffs. Remember, however, that to capture potential benefits, your firm must shift its focus from viewing returns as an unwanted but necessary evil and instead look for opportunities to transform returns into additional revenue, profit and market “perception capital”.

References Rogers, Dale S. and Ronald S.Tibben-Lembke (1999), Going Backwards: Reverse Logistics Trends and Practices. Reno: Reverse Logistics Executive Council.