How Philips Reduced Returns

From the November/December 2003 issue of Supply Chain Management Review

TONY SCIARROTTA -- Supply Chain Management Review, 11/1/2003

The answer to reducing the cost of returns does not always lie in improving your reverse logistics operations. At Philips Consumer Electronics, the returns management department has focused on how it can stop returns before they even enter the reverse supply chain. By taking preventative steps such as improving a product’s ease of use, enforcing company policies, and revitalizing the service network, Philips has cut its returns by more than $100 million per year.

In 1998, I was presented with an opportunity: head up a returns management department within Philips Consumer Electronics and help lead efforts to control a major cost driver—product returns. At that time, Philips Consumer Electronics had no returns management department, and reverse logistics was not yet part of the language of most manufacturers.

But management and Ken Goins, the vice president/general manager of Philips Service Company who approached me with the opportunity, recognized that the company was facing relatively high return rates. The impact of those returns on the bottom line was significant, amounting to tens of millions of dollars in losses. Philips management was under pressure to reduce the cost of returns. They realized that the company needed to develop a core competency in returns management, whether the actual processes were handled in house or via outside partners. Management believed that it needed a department with a dedicated director and focused staff to accomplish these goals, hoping that such a department would end up paying for itself in the process.

When Ken approached me, I was working in the product marketing group after a decade in sales with regional and national accounts. My background was new for the returns management role. Normally, the credit, finance, or service groups within most companies handle returns. But Ken understood that returns really are "reverse sales," and they are often caused by product-marketing decisions.

As we began to study the situation, we discovered a returns environment that was out of control. In general, returns in the United States have been increasing due to a "take it back" culture, propagated by retailers with liberal and almost unlimited return policies. Retailers were found to be giving refunds to consumers over two-thirds of the time. In many of those situations, consumers did not have a copy of the sales receipt for their purchases. Store policies that were in place were not easy to enforce, making it difficult to reduce improper product returns. The rise of returns was further fueled by the increase in products that could not be serviced in the home coupled with the demise of the independent service providers who performed in-home repairs.

Most consumer electronics companies viewed returns as the cost for the steady sales growth in new retail channels. But along with the increase in overall returns was another disconcerting statistic—the rate of products returned with "no defect found" (NDF) was very high, averaging more than 70 percent for consumer electronics, more than 85 percent for PC products, and even over 90 percent for some small appliances. Retailers and manufacturers were paying significant reverse logistics costs to move products that were not defective.

The situation at Philips reflected this external environment. Because we had no one focused on returns and no clear returns policy or procedures, Philips had developed a culture of "take anything back from anybody anytime." The total cost of returns had never been exposed to the product business owners or even identified collectively for the company. Philips had never attempted to implement returns solutions across department lines or by working with retailers. This lack of attention to returns was hurting us: Until 2000, the returns rates at Philips were even higher than the industry average. Adding to our problems, many major retailers had begun the practice of deducting for returns upon shipment back to vendors. The claims, counter claims, and reconciliation processes became time-consuming, manual-intensive nightmares for manufacturers like us. Finally, the secondary market for these goods in the United States was costly for Philips. Many of the liquidators that Philips dealt with had questionable finances. Additionally, in the secondary market we were experiencing poor recovery on the factory costs of our products. As an example, for DVDs sold at liquidators, Philips was only recovering 20 to 30 cents on the dollar.

Clearly, changes needed to be made. Philips first needed to analyze its returns numbers to understand their size and total cost to the company. We also had to understand the consumer and retailer environment in order to make improvements. This involved researching consumers' reasons for returning products—particularly those without defects. Finally a paradigm shift was needed in many areas. That is, we needed to take proactive steps, both internally and in cooperation with our retail partners and service providers, to address the root causes of returns.

Understanding the Problem: Measuring Returns
Everyone recognizes the axiom that what gets measured, gets done. For those of us in returns management, this meant realizing that a key to solving the returns problem lay in having a common set of measurements with the right level of detail. At Philips, the main problem was a lack of consistent measurements. Returns were measured and defined differently in the United States than in the rest of the world, and different parts of the Philips organization used different IT systems to measure them. Furthermore, we could not agree on what time period to use (year to date, monthly, rolling 12 month, delayed measure for retail lag, etc.) or how to classify the returns (carrier damage, stock balance, defectives, warehouse errors, service, etc.). These differences in measurement led to misleading results.

Finally, in 2001, a Philips cross-departmental team established some measurement standards. The team decided to separate returns identified as defective from returns for all other reasons (for example, carrier damage, stock balancing, and order errors). They also agreed to use a rolling 12-month comparison over two periods. This meant, for example, that returns from one dealer for September 2002 to August 2003 would be compared to returns for that same dealer from September 2001 to August 2002. The team believed that this would provide the most realistic view of dealer returns, which are less affected by seasonality trends.

Return reports are now issued by dealer, by product category, and by model. (An example of a template for such a report is shown in Exhibit 1.) To keep the return numbers in perspective, we chart them against gross sales and trends in return and sales rates for the entire company, which would show any specific increases or decreases. The reports also include a target percentage reduction and a return percent rate column to keep all eyes on our goals.

My role in returns management for Philips requires that I disseminate this returns information to the key sales, service, finance, and product groups, including senior management. But I understand that information alone is not knowledge. For this reason, each summary review has to include key returns issues by model, group, or dealer, along with my recommendations or updates of activities for improvement.

The consistency of the reports played a key role in getting the key players to accept both the reports themselves and the responsibility for returns-reduction goals. Product managers had to see the same results for their categories as the sales groups saw for their totals. Our newly installed information system (SAP) enabled us to provide this level of consistency. Anyone in Philips, anywhere in the world, who is trained to access the reports will see the same data. SAP also enabled our return reports to drill down to model- and dealer-level detail. This is a massive report for a company like Philips, where we ship over 10 million boxes per year. In addition, the built-in flexibility of SAP still allows us to generate some reports that track returns at the monthly and year-to-date level. These reports are given to groups such as finance and logistics that need the information presented this way for forecasting and warehouse planning.

Getting Inside the Consumer's Head
Understanding the returns situation depended on knowing not only how many returns we were handling but also why products were being returned. In 2001, Philips was able to work with a national retailer to survey its customers who had bought and returned selected Philips products with higher than budgeted return rates. The retailer's market research group contacted some 400-plus consumers with an agreed-upon list of 25 questions about their shopping and return experience. To get participation and hopefully to gain more accurate feedback, we offered gift certificates for these extended phone interviews. Surprisingly, more than 75 percent of the consumers admitted knowing their returned products were not defective. The survey identified the primary reason for the returns as "misinformation at point of sale." The secondary reasons related to difficulties in hook up, use, or operation.

Another disconcerting statistic was that the retailer gave cash or credit refunds for two-thirds of the returns. This statistic was particularly troubling to Philips because in the majority of these cases the retailer did not use a repair service provider. Instead most of the returns were sent back to the manufacturers as defective. As returns increased, carrier volume grew. In response to that increase, we had begun to develop reverse-logistics processes that made moving these goods back through the supply chain more efficient. Yet, while efficient reverse logistics helped minimize our losses, they did nothing to address the profits that were still being lost at every point of the returns process.

Based on the survey results, Philips and the retailer recognized that returns were not tied to the actual quality of the product. Instead, many of these issues were related to product packaging not clearly representing the product or the product's operating requirements, such as subscription services. An additional factor was inadequate training of retail salespeople for communicating product features and benefits to the consumer.

At Philips, the research also helped us to understand better the reasons for the increase in call center time spent on many of our new, digital products, such as home theaters, satellite systems, digital video recorders, and even DVD players without standard antenna jacks. The complexity and technical problems with these products was further increased by products from one hardware manufacturer having to work with software or services from a different provider, such as TiVo, AOL, or WebTV. One digital Internet device with this dual ownership had return rates of more than 25 percent and a no-defect-found rate of more than 90 percent. Such results point to usability problems and lack of product-packaging clarity.

The survey substantiated many intuitive beliefs for the retailer and for Philips. It was obvious that steps needed to be taken to improve product clarity, usability, and interoperability. But the real challenge was how to correct the perceived entitlement among American consumers for returning purchases back to retailers. This phenomenon is much more prevalent in the United States than in other countries. In most other countries, consumers are encouraged to repair damaged products or accept alternative solutions, such as contacting the manufacturer directly, instead of receiving cash refunds for returns. But in the United States, Philips (and other global companies) have to find ways to start working differently with retailers so that they can reduce the flow of goods in the reverse supply chain—especially those products that are not truly defective. If we don't, the estimated costs for both sides are enormous.

Manufacturer's Steps: Improving the Out-of-the-Box Experience
Based on this research, we identified factors at the manufacturing, retail, and service supply chain that were contributing to the high rate of returns and looked for potential actions to take to alleviate them. One of the main messages of the survey was that it wasn't poor product quality that was driving returns, but the complexity of the product. Internally, at Philips, we recognized "ease of use" as the next barrier for consumers and began working to improve the out-of-box experience for the consumer. We have increased service support with Web and call center enhancements, such as FAQs, hook-up downloads, and free product upgrades for DVD and other digital products. Additionally, Philips is now including "stop sheets" in the box with the product. These sheets are emblazoned with a stop sign and direct the consumer to contact the manufacturer first before taking the product back to the retail store. All of these actions have helped reduce returns by encouraging the consumer to contact the manufacturer to try to solve the problem.

Philips is also examining ways to increase local or central depot repair and offer easy exchange programs. Under such a program, Philips would pay retailers or servicers a handling fee to send returned products directly back to us. These programs might possibly include providing drop-off centers for returns at places like Staples or Mail Boxes Etc. or providing UPS call/ship tags for warranty service.

In addition to these efforts, Philips joined the Ease of Use (EOU) Roundtable (www.eouroundtable.com) in 2002. The Ease of Use Roundtable is a PC and consumer electronics industry association committed to improving the consumer experience with high-tech products. Participants include leading manufacturers and retailers. Intel founded the roundtable in 1998 when industry data indicated that the number-two reason people were not buying PCs was because they were too hard to use.

The Ease of Use Roundtable looks at how companies can base new product creation, design, and operability on the desired user experience rather than developing a technology and looking at how to sell it afterwards. For example, high- tech companies may look at designing printers and computers so that a when a printer is hooked up to a computer, the computer recognizes and sets up the software needed for it to work. This is accomplished through using human-factor engineering (HFE)—a growing discipline in the PC and consumer electronics industries—to create Initial Experience Predictors (IEPs). An Initial Experience Predictor is a checklist tool that provides the design team with a series of questions that help predict what a user's out-of-box experience with a product will be. The IEP was invented by Intel and further developed by the EOU Roundtable. It can be used during product development to take the end consumer's needs into account when designing the operation, packaging, and instructions for use of a new product. Doing this should decrease the number of no-defect-found returns as well as reducing support center calls and improving customer satisfaction. Such improvements will add significantly to the bottom line for all manufacturers, avoid unnecessary returns at retail, and lower call center and other support costs driven by product complexity. All of this will help expand the market for easier-to-use PC and consumer electronics products.

Yet, while there is much potential in using human-factor engineering and Interactive Experience Predictors, room for improvement still exists. Philips has begun using these techniques in designing its products but with varying degrees of success. While returns have decreased, we have found it difficult to account for differences in how consumers around the globe approach electronic products.

EOU Roundtable members also participate in setting industry standards for usability. The EOU also publishes guidelines to help development teams produce design enhancements that reduce the setup time for new computer operating systems. The Ease of Use Roundtable guidelines and white papers have helped the high-tech industry, including Philips, develop and expand the use of quick setup guides and reduce over-designed owner's manuals. Manufacturers, such as Philips, that adopt "ease of use" as the next frontier beyond quality will win at the retail and consumer level.

Retailer Steps: New Policies and Technologies
Retailers, for their part, also have been making changes to reduce returns and their reverse logistics flow. Based on Philips research, some retailers have improved store signs to include important information, such as subscription service fees and minimum systems requirements, at the point of sale. Retailers also are training their sales associates to provide customers with more information about product operation and subscription service fees for such things as satellite TV.

Additionally, in the last two years, retailers have made an effort to gain more control of returns from consumers. Some of these efforts simply involve enforcement of previously existing return policies. Many retailers, such as Best Buy, now post their return policy in plain sight. These policy statements identify any restocking fees—and more retailers are actually collecting them. Some retailers, like Target and Kmart, have begun to strongly enforce their requirements that all product returns must have a receipt and fall within the specified return period. Other retailers have added new policies to deal with the problem. Some retailers are offering manufacturer contact information (such as 1-800 numbers) or local servicer information. To reduce arguments at the store service desk, Wal-Mart, now offers a direct-to-vendor warranty repair program to accommodate customers without a sales receipt or with products beyond the return period. Under this new policy, Wal-Mart offers to send the "defective" unit to the manufacturer for repair or like replacement. This policy has maintained customer satisfaction while also avoiding large numbers of returns as consumers frequently choose not to send back the product—possibly since the goods are not truly defective.

In some cases, new industry circumstances have required changes to existing policies. The rapid turnover of new, improved models for technology products, such as CD burners and digital cameras, has challenged the 90-day return policy popularized by mass retailers. Because these products have such a quick lifecycle, the 90-day policy allows consumers to return their nondefective products for a new, higher-speed CD burner or higher-resolution digital camera. To cut down on the number of "upgrade" returns, many retailers have reduced the window for returns for selected products (such as digital products) and some have reduced the window for all products. This policy change also has helped to decrease weekend or vacation "rental" use of products and the number of fraudulent returns.

Consumer abuse of returns policies has received publicity from such media channels as The Phil Donahue Show and the Wall Street Journal. The attention has served to highlight the problem and to encourage retailers and manufacturers to step up efforts. With experts estimating that 10 percent of all returns are stolen goods returned for cash, some retailers have chosen to eliminate cash refunds and offer store credits as the only option. Likewise, Philips has been more vigorous about enforcing its own return policies with the retailers themselves.

In addition to these policy changes, retailers also implemented many improvements to point-of-sale systems to help them identify and stop repeat policy offenders. Some of these systems track returns by customer or by credit card, which allows the retailer to ensure that a customer bought that product at its store and also to track repeat returners. Additionally, many point-of-return desk computers are beginning to show photos of the product and key accessories for the clerks to match. Both of these systems provide retailers with strong backup materials that allow them to refuse an improper or fraudulent return.

One of the most promising systems-based approaches to eliminating unqualified product returns is SiRAS (www.siras.com), a patented electronic registration program. Many national and regional retailers have implemented this system, which captures a product's serial number at point of sale. This program gives retailers the best way to validate a return when there is no receipt—which may be more than 75 percent of the time. SiRAS has worked with retailers such as Wal-Mart and Target to flag selected higher-ticket electronic products to be scanned a second time at the point-of-sale register for the serial-number bar code. The information about the store and date of sale for that specific product (but not about the consumer) is transmitted to the SiRAS data warehouse for use as needed in the future. When the consumer wants to return one of these registered products but does not have a sales receipt, the retailer can validate proof of purchase either with a scan or a phone call to the SiRAS database to confirm where and when the unit was sold. In as many 70 percent of the cases, the database identifies that the product was not sold by that retailer or is well beyond the approved store policy period for a return.

Philips and other manufacturers have found the SiRAS program to be invaluable and have been able to stop recording the serial numbers of individual product shipments. The complexity of the forward supply chain made such a practice too costly and ineffective for the manufacturers to do themselves. Current warehouse tracking systems cannot provide the type of information needed to enforce warranty and return policies. Warehouse systems only identify point of shipment and retailer. Warranty periods and return policies, however, depend on the date of purchase by the end consumer not date of shipment. At the same time, new tracking systems such as RFID (radio frequency identification) are still years away. SiRAS has provided a good alternative.

Warranty validation is also complicated by the fact that very few consumers send in warranty cards, and fewer still save their original receipt. Return periods for consumer electronics, however, can be very long with the average lifecycle of a model being one year.

Furthermore, some dealers may extend that warranty up to one year after the last shipment they receive from the manufacturer or until the last inventory of a model is sold. All of this makes it difficult to ensure that the store is following the proper warranty policy. According to research by Philips and a national retailer, a significant number of returns occur well beyond the store policy—after the end of the product life and the last sales of the product.

Electronic registration allows retailers, manufacturers, servicers, return centers, and call centers to apply fair business policies to a return or to provide properly qualified support to the end consumer. All licensed partners have easy access to the date and place of purchase from the SiRAS system. Because the program is installed in the point-of-sale register systems at most retailers, costs are minimized and the manufacturers pay the registration cost per unit. A growing number of manufacturers (primarily of higher-cost goods) are licensing this electronic registration program, making SiRAS a de facto industry standard.

Like many other manufacturers, Philips has seen the benefits of SiRAS. For example, in 2000 when Philips and a national retailer planned a one-day sales blitz for a product, we decided to use SiRAS to help reduce improper returns. Normally, a sales item of this type generates 7 to 9 percent consumer returns. But by using the electronic registration program, we ended up with a returns rate of less than 2 percent, which is much closer to the true defect rate of consumer electronics products. The SiRAS program was so successful that Philips arranged to use electronic registration on another sales blitz item in 2001.

Servicer Steps: Revitalize the Network
A thorough returns management program would not be complete without a network of authorized service centers, either as fully owned factory branches or independent chains. While Philips has a large number of authorized servicers, our network has declined dramatically over the past few years. The decline in the number of servicers has come as the quality of most consumer electronics has improved. Additionally, servicers in the past derived a significant share of their revenue from both warranty-claim repairs and from affordable, out-of-warranty repairs for higher-cost products. A growing number of products, however, have turned into exchange-warranty products. The price of consumer electronics has decreased while the speed of product upgrades has increased. As a result, it is often more economical for consumers to buy a newer and better product than to repair an out-of-warranty one. Manufacturers have not been able to increase repair rates at the levels needed by the independent servicers to grow their business.

The growth of these less-easily-repaired digital products, such as computers, requires a paradigm shift. The repair industry needs to offer a wider range of services to grow revenue and to support manufacturers' efforts to reduce the flow of nondefective returns. Some servicers now perform additional activities for Philips, such as product plug-and-play testing of returned products or inspection programs at selected retailers. Servicers also have begun to work with retailers and manufacturers to provide installation assistance for customers of complex electronic products, such as home theatre systems and large-screen TVs. The need for this type of service is growing because home delivery business is increasing but carriers are not able to provide installation expertise.

In addition, servicers can work with manufacturers to analyze a product's quality, first failure of new models, and consumer operational issues. This collaborative effort encompasses not only providing immediate feedback to the manufacturer on these issues but also identifying key problems for new models just released into the marketplace. Philips has begun working with servicers to provide this sort of analysis and is looking to expand these efforts into more product categories. The servicers can also help manufacturers provide a same-day response program to repair high-priced products in the consumer's home and prevent a costly product return. They also can offer to handle the manufacturers' exchange-warranty products. This might involve an advance swap program, where the manufacturer ships replacement units to the servicer before the defective units actually arrive back at the manufacturer's facility. By offering all these programs, the service provider could become a one-stop shop for handling a manufacturer's returns.

Servicers can and will act as a third-party intermediary for inspections, field scrap, and claims reconciliation in the returns arena. But all of these activities require revitalizing the service network to focus on preventing high-tech products from moving back to manufacturers in the reverse supply chain. Expanding such a proactive service network would be beneficial, as companies can no longer afford to focus solely on reverse logistics to minimize returns. Reverse logistics is generally concerned with providing the lowest cost movement of goods back to manufacturers. A servicer, however, can add value by stopping the return and enhancing customer satisfaction. This type of service would be particularly useful for high-priced digital electronics that have rapid price erosion, such as computers. Additionally, the right service support can build brand loyalty with retailers and consumers. Ultimately, well-structured service programs not only will reduce costs as well as the most efficient reverse logistics system but also will provide additional benefits to consumer electronics manufacturers. Philips is currently in the midst of transforming its service network to provide these high-value services to the end customer.

The Results
The results of all of these returns reduction initiatives over the last five years have been significant for Philips. The first two years (1999-2000), when Philips still had a divided returns group and multiple areas of accountability, the company was above the consumer electronics industry rates for defective returns. The next two years (2001-2002), we used enforcement of the Philips returns policy and gatekeeping efforts to bring the return rates to industry level. In 2003, we added several returns initiatives, including expanded use of electronic registration and field service to repair products in the home as well as improvements in ease of use. With these initiatives, Philips is seeing our total return rates below the consumer electronics industry benchmarks. The numbers are truly dramatic. Since 1998, Philips has reduced returns by more than 500,000 units and more than $100 million dollars per year.

Yet, in spite of all of our success at Philips, I still have a hard time explaining to my family what I do. When they do understand, I usually have to field the blame from anyone who has been refused a return by a retailer. My wife holds me personally responsible for the change in some retailers' return policies to receipt required. I try to remind her that if the high costs of returns are eliminated, the overall price of products eventually will go down or stay down. She doesn't really believe me. Then I remind her that it's my job—returns management.

Tony Sciarrotta is the Director for Returns Management at Philips Consumer Electronics.