Rethinking the Reverse Supply Chain

By William T. Walker -- Supply Chain Management Review, 5/1/2000

How well you design your supply chain for increased market share, profitability, return on assets, and free cash flow is of little concern to the customer. He or she simply wants to place an order, take a delivery, pay for the purchase, and sometimes make a return.

In reality, customers interface with up to four different supply chains—an experience that they can view as pleasantly integrated or horribly dysfunctional. The four supply chains are:

• The forward supply chain—delivering existing products and services to the customer.
• The new-product introduction supply chain—conceptualizing a new product or service with the customer and then delivering.
• The consumables supply chain—restocking regularly consumed items like batteries or film packs.
• The reverse supply chain—servicing product defects, product returns, and product discards.

The new-product introduction and consumables chains are really variations on the forward supply chain theme. Most companies spend considerable time and effort developing their forward capabilities, while overlooking or ignoring the reverse supply chain. Yet it is in the design and implementation of this critical channel that the competitive battle can be won or lost. This article outlines the key considerations in designing and implementing the reverse supply chain and outlines the supply chain management principles that can be applied in this effort.

Defining the Reverse Supply Chain

Our definition of the supply chain is a commonly accepted one: "A supply chain is the global network used to deliver products and services from raw materials to the end-customer through engineered flows of information, physical distribution, and cash."¹ It's important to note that the key elements of this definition embrace all supply chains—forward and reverse. In designing their reverse supply chains, companies need to consider carefully each of the three flows in an integrated context with the forward supply chains. In today's world of mergers, outsourcing, and business reengineering, the reverse supply chain should not be allowed to evolve by chance.

Information Flow

In designing information systems for a reverse supply chain, the first thing to remember is that most legacy systems were never designed to run backwards. Don't even attempt to track the return of a serialized product or to credit a customer's payment against a return. Forget about trying to match information about the field recovery of a loaner unit against information about customer delivery of the repaired unit under warranty. And don't waste time figuring out how to price a new unit differently from a rebuilt one or how to price a warranty repair differently from an out-of-warranty repair.

The reverse supply chain cannot run on these legacy systems effectively. What's required is a new worldwide data warehouse coupled with extranet and intranet technology. This capability offers a cost-effective means of connecting customers, forward supply chains, and reverse supply chain trading partners with the necessary information flows.

Physical Distribution Flow

In the forward supply chain, inbound logistics means the flow of parts to a factory trading partner; typically, the flow is a consolidated, high-volume shipment on a fixed routing from the supplier. Outbound logistics in this chain means the flow of new product from a factory trading partner; in this case, the flow often is a single-unit shipment following a random routing to the customer.

In the reverse supply chain, on the other hand, inbound logistics means the flow of single defective units and other returns from the customer, where the inbound flow follows a random routing. Outbound logistics is the shipment of repaired and remanufactured product as well as the low-volume shipment of parts for recycling. Outbound logistics in the reverse supply chain can follow both fixed and random routings. The two key physical distribution questions here are: (1) how to set geographical boundaries around the front-end collection of defective units and parts and (2) how to forecast the warehousing requirements over time as they are driven by the cubic volume of the returns.

Cash Flow

The customer expects to get a refund on a return. The distribution center expects to be paid for a loaner that is not returned. The customer expects to get a discount on a new purchase when returning a unit or core. (A core is that part of a used product that can be made into a rebuilt product.) The repair depot expects to charge a fee for an out-of-warranty repair. Cash flows in the reverse supply chain are a world of credits and discounts. Unit warranty tracking is done by product serialization. Customer payment may take the form of a credit card reversal or a cash discount. A discount may be withheld until it can be applied to a future customer order. Cash flows in the reverse supply chain can become very convoluted. Furthermore, it is difficult to forecast the cash outlay exposure during periods of high returns.

Companies need to keep the financial aspects of the reverse supply chain as simple as possible. One effective technique is to use simple pricing rules to differentiate new, used, and rebuilt products. Another is to make it easy for customers to receive a credit for a return.

In addition to understanding the three flows, companies need to recognize that the reverse supply chain also encompasses a new set of trading partners and supply chain architectures. These are described in the accompanying sidebar on page 56.

Reverse Supply Chain Financials

In designing the reverse supply chain, you need to understand the related financial impacts. (Exhibit 1 summarizes these impacts, showing the revenue opportunities and expenses associated with different reverse supply chain activities.) The most lucrative is the sale of service contracts that extend the warranty period. These contracts are based on the statistical expectation of a product's lifetime reliability. The customer is buying peace of mind, while the enterprise is playing the odds that the up-front revenue will more than cover warranty expense down the road. Capital-goods manufacturers, such as automotive, airframe, electronics, machine tool, and major appliance companies, commonly sell service contracts as a way to increase revenues by as much as 20 percent.

The sale of remanufactured product into an aftermarket is another good revenue stream. Clearly, the aftermarket will not support the same level of pricing as the original-equipment market. The aftermarket, however, usually represents an incremental customer segment that expands the enterprise's total manufacturing volume. This increase in unit volume can exert a favorable cost impact on the single-sourced components used to build both the original and the remanufactured product.

In addition, recyclers have revenue opportunity in the pickup and disposal services they provide. There's also a significant revenue stream in the sale of raw materials to recycling. Wood, paper, copper, aluminum, steel, plastic, gold, and so forth have some intrinsic value to recyclers.

A reverse supply chain also differs from its forward counterparts on the expense side of the ledger. For one thing, the warranty cost line item is a reverse supply chain line item. Further, the profile of freight and duty in the reverse supply chain looks different from the forward path—it's typically lower volume and more sporadic. Reverse freight that requires special handling or is considered to be hazardous material will cost more per kilogram shipped. In addition, the reverse supply chain adds incremental material costs for repair parts and packaging materials along with operational labor costs. A reverse path routing also may have more transportation legs than a forward path routing. (The good news here is that because busy freight managers tend to monitor the costs of returned freight less closely, there may be ample opportunities to catch expensive mistakes in freight billings for returned goods.) The bottom line message in all of this: Any given reverse supply chain can run at a significant profit or at a loss.

Applying Supply Chain Management Principles

With an understanding of the reverse supply chain flows and financials, you can start designing your reverse supply chain. A proven approach in this effort is to apply certain supply chain management principles³ as follows:

• Build a competitive infrastructure.
• Leverage worldwide logistics.
• Synchronize supply with demand.
• Measure performance globally.

The first and second principles focus on the design of a competitive supply chain architecture. The third and fourth principles center on the competitive operation of an extended enterprise supply chain.

Build a Competitive Infrastructure

A supply chain design should accelerate both the velocity of the order-to-delivery cycle time and the velocity of the cash-to-cash cycle time. An order-to-delivery cycle is defined as the time between a customer's placement of the order and when the next trading partner in the chain who holds inventory fulfills the order. Downstream in the supply chain, the order is a customer order, and the inventory is finished-goods inventory. Upstream, the order is a replenishment order, and the inventory is the subassembly or component part. The longer it takes to traverse the complete path from initiating the order to delivering it to the customer, the less competitive the supply chain's infrastructure. For example, a customer with a defective product needed for a mission-critical application would rather be serviced through a Web-enabled replacement order delivered overnight through FedEx than by a non—Web-enabled order sent via regular surface mail.

Likewise, cash-to-cash cycle velocity is a key competitive measure. The parts supplier may invoice a reverse trading partner for a repair part before the customer has actually paid for the repair. This invoicing system forces the repair center to act as a bank to the supplier. A cash-to-cash cycle is defined by a trading partner's receiving an invoice and the next trading partner in the chain originating the cash payment. The cash-to-cash cycle should be analyzed in the reverse order of trading partners from the order-to-delivery cycle. This is because the customer initiates the order, which then propagates upstream, while the supplier initiates the invoice, which then propagates downstream. The most competitive cash-to-cash cycles occur when the customer's payment becomes available before any invoice is issued. The cash payment should be made electronically before any favorable timing advantage is lost.

Leverage Worldwide Logistics

Reverse supply chain design needs to address the central issue of how to provide a consistent mean time to service throughout the geographical service area. If the service area is local, then it may be feasible to send the best service technician to the customer's site. If the service area is regional, it may be better to transport defective products to one central depot where the best technicians are located.

But what if the service area is global? Then, more than one repair depot will be required—in which case the skill level of the technicians may vary considerably from facility to facility. Some worldwide reverse supply chains are organized into spoke-and-hub arrangements with a repair depot located at each hub. In this scheme, logistics costs need to be controlled carefully throughout the total number of transportation legs that make up a round trip. With a global service area, the total round-trip transit time can be long. If any of the transportation legs involves an international freight movement, there could be considerable delays associated with customs clearance or export release.

Carefully consider the geographical locations of reverse supply chain trading partners with respect to the forward supply chain's inbound and outbound logistics paths. In the best-case scenario, a company can engage one strategic freight forwarder to manage all of the forward supply chain and reverse supply chain nodes worldwide. This approach gives you some leverage over the low-volume freight routings associated with the reverse logistics path. In addition, the added volume and weight shipped through the reverse supply chain can be used to negotiate lower rates for the forward supply chain. A single freight forwarder also can provide better overall shipment tracking throughout its worldwide network. Every freight movement now becomes a forward-path movement from the forwarder's perspective.

Backhauls afford another leveraging opportunity. Do not overlook the possibility of using a backhaul from the forward path to reduce transportation costs for a routine freight shipment along the reverse path.

Synchronize Supply With Demand

The profitable operation of a reverse supply chain depends upon the identification and effective management of the system constraint. For a repair operation, that constraint might be the capacity of a skilled technician or of a supply allocation on a failed part. For a remanufacturing operation, it might be the incoming core rate. For a recycler of printed circuit assemblies, the system constraint might be the ratio of the weight of gold recovered from surface plating to the total weight of the waste stream. In each of these cases, the system constraint determines the end-to-end throughput of the reverse supply chain.

The capacity of the system constraint should be matched as closely as possible to the market demand. If the demand greatly exceeds this capacity, then any improvement in the system constraint will result in higher end-to-end throughput and higher profits for each of the trading partners. If the market demand falls short of the system constraint capacity, then supply chain inventories will rise—and all of the trading partners will suffer lower profits.

In a synchronized supply chain, the throughput of each work center for each of the trading partners should be matched to the rate of work through the system constraint. Reverse supply chains are notorious for accumulating "lumps" of inventory in the corners of the chain. One common operational error, for example, is to wait until the defective material builds up to a full pallet load before transporting it to the next operation. The rationale behind this is the conventional wisdom that small shipment quantities incur higher freight costs. This line of thinking, however, fails to recognize that the next operation may be starved for material and is unable to function. A synchronized operation keeps the entire supply chain charged with nearly equal flows of equivalent sets of materials throughout the length of the chain. Equivalency is defined by the rough average of lower-level assemblies or parts that are equivalent to one unit of complete product.

Measure Performance Globally

A reverse supply chain should be managed from end to end as an integrated whole—just like a forward supply chain. And while the clockspeed of the reverse flow may be relatively slow, it must be continuous. Companies need to take an overall process approach to manage any low-volume, high-mix returns operation. End-to-end throughput and total reverse supply chain inventory are key global performance measures that should be monitored in real time to run the business. These two measures help keep all of the extended enterprise trading partners in alignment. The order-to-delivery cycle time and the cash-to-cash cycle time used to design the reverse supply chain architecture should be measured periodically to validate that the process is working as planned. Also, it is important to measure the statistical spread of on-time repair (or calibration) and delivery against the date first promised to the customer.

End-to-end throughput can be measured in terms of a rough equivalency of physical materials throughout the chain. This equivalency of physical materials is defined as the number of returns disposed per day, the number of products repaired per day, the number of products remanufactured per day, the number of assemblies disassembled per day, the number of parts recycled per day, and so forth. Each of these should represent approximately equivalent flow rates in a synchronized supply chain. When each equivalency is balanced with the system constraint, the returns process runs smoothly and throughput is maximized.

Total supply chain inventory can be defined in terms of the dollar value of product inbound from customers, plus inventory in the returns area, plus inventory awaiting repair (or calibration or remanufacture), plus good inventory held in reserve for customer service, plus scrap outbound to recyclers. The returns process information systems should be able to provide a view of the total supply chain inventory each day as well as the daily throughput equivalency.

Considerations in the Product Life-Cycle Phases

When applying the basic principles discussed above, remember that each phase of a product's life cycle presents a different set of management issues for the reverse supply chain's operation. Product life cycle can be defined in terms of three phases: new-product ramp, mature sales, and end of life. The reverse supply chain plays an important role in each phase.

New-Product Ramp Phase

In the rush to introduce a new product and ramp up production, design of the reverse flow can be easily overlooked. But it is precisely at this time that the extended enterprise needs flawless performance in its reverse supply chain the most. There are two reasons for this. First, a timely solution of any latent product-design problem depends upon the ability to return defective products from the field for analysis. It is extremely difficult to analyze and solve a new failure without first seeing the "dead body." Second, the inability to quickly swap out good product for bad ultimately will limit the market share captured during new-product roll out.

The production ramp is usually capacity constrained at the start-up, and product is in short supply. During this critical period, word will spread quickly about any unresponsiveness to a customer problem. A particular problem may be that all of the inventory that was built in anticipation of a new-product announcement now has a latent design defect and must be returned to the factory for rework and reshipment. Without a reverse contingency plan that includes the stocking of rebox cartons, the returns process will be chaotic. And when new customers cannot obtain a new product, they quickly will switch to the competition.

A common mistake made at the time of a new-product launch is forgetting to classify the product, each of its major assemblies, and all of its replacement parts for a return. Classification for import duty and export licensing takes some leadtime—but it is an essential activity. While a new sale is an export, its return could become an import. While a new sale is shipped as a whole product, missing accessories or returns for failure analysis may be shipped in pieces. Returns must be hassle-free during the start-up period so that you can learn as much as possible about market acceptance. Agree to dispense with return authorizations and willingly pay the customer's return freight charges. The information learned in this way from an early product return may be priceless.

The Mature Sales Phase

After the product has been in the field for a while, the focus turns to the returns receiving area where product disposition takes place. When the return is received, it must be identified properly as to its product or assembly number, option level, serial number, and date code. Disposition must then be determined according to the return's condition and the controlling time constraints involved. (See Exhibit 2 for a summary.) The shipping carton should be inspected for obvious damage and unusual wear. Once the carton is opened, the product should be checked for completeness. The returns area needs easy access to complete bills of materials for every stock-keeping unit (SKU) and option it may encounter. It needs to check whether the tamper-proof seal (if used) has been removed. The serial number should indicate how long the product has been in the field and whether it is under warranty. At the end of the returns receiving process, the product goes to rebox and restock, or to repair, or to scrap.

The volume of product to be processed through a returns receiving area can be staggering. In the personal computer industry, for example, returns can run 10 percent or more of total shipments. (Sometimes it's not even your inventory that is returned. A value-added PC distributor I visited recently told me about an unusual package that had just come into his returns area—a place setting of dishes packaged in a competitor's shipping carton!) Inventory should be kept separated by type throughout the returns process. The main categories are awaiting disposition, new, restock, repairs, calibration, and scrap. A chronic problem during the mature sales phase centers on the lack of discipline in maintaining first-in, first-out (FIFO) returns stock rotation. This causes serious shelf life and warranty-tracking problems.

Another issue during the mature sales phase is how to remove the burden for properly packaging and labeling a return from the end-customer. It's unfortunate, but true, that returns often are damaged in shipment because they are improperly packaged. And sometimes a return is never dispositioned correctly because it is sent to the wrong address. The manufacturers of replacement toner cartridges have developed a good solution to these returns problems. Customers receive their replacement cartridge in a reusable shipping carton, made from recycled materials, with a set of self adhesive, preprinted return labels. The old toner cartridge is then boxed in the reusable shipping carton. The new labels are attached, and the spent cartridge is sent on its way to a toner cartridge recycling facility.

The Product Obsolescence Phase

By the end of a product's life, many managers stop thinking about reverse logistics. It's just not very exciting. Unfortunately, this attitude invites some potentially large financial exposures. At obsolescence, some product will go into the ground. Reverse supply chains that have not carefully considered all of the environmental and legal ramifications of disposing of such product can find themselves at risk. In addition, some scrap parts—once separated from their parent product assemblies—may become classified as hazardous material. Batteries are one example. Manufacturers must show due diligence that any hazardous material is delivered to legitimate, licensed disposal companies and that there is management oversight of the specialized transportation and fees involved. Their reverse supply chain is responsible for keeping careful records of the final disposal, which may occur years after the product is taken off the market.

Even packaging materials as common as cardboard boxes and plastic cushions can become an expensive proposition at the end of their life. Some printing inks used to decorate cardboard boxes contain carcinogenic heavy metals. In addition, some common plastics are not biodegradable when placed in a landfill. The good news is that it is possible to recycle certain packaging materials multiple times, thereby gaining a cost advantage while minimizing the cubic volume of waste materials.

A Powerful Payback

In some industries customer-service contracts add 15 to 20 percent to the revenue line. This represents a significant incremental revenue stream for the business. At the same time, the returns rates in the distribution channels can approach 10 percent of shipments. In industries with razor-thin margins, high return rates drive the business back toward break-even volumes—and jeopardize company profits.

This article has shown how the principles of supply chain management can be applied to the design and operation of an integrated, competitive reverse supply chain that is customer friendly. The returns interface with the end-customer should have the look and feel of the forward, the consumables, and the new-product introduction supply chains. The architectural design of the reverse supply chain should be focused on improving cycle time velocity and on providing a consistent service level throughout a geographical service area at the lowest logistics cost. Operational excellence in the reverse supply chain should come from synchronizing throughput to the system constraint and from daily balancing between end-to-end throughput and total supply chain inventory.

The payback from a well-designed and executed reverse supply chain can be profound. Greater customer satisfaction and higher shareholder value are just the beginning.

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Author Information

William T. Walker, CFPIM, CIRM, is the power-products supply chain manager for Agilent Technologies. He is past president of the APICS Educational & Research Foundation and co-author of the book Supply Chain Management: Principles and Techniques for the Practitioner (APICS E&R Foundation, 1998).

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Footnotes

1 Alber, Karen L. and William T. Walker, "Understanding Supply Chain Management," APICS: The Performance Advantage, January 1999, 39.

2 Ibid.

3 Alber, Karen L. and William T. Walker, Supply Chain Management: Principles and Techniques for the Practitioner, Alexandria, VA: APICS Educational & Research Foundation, 1988, 1.

Different Partners, Different Business Models The extended enterprise is defined by the set of relationships that a company has with its upstream supplier base and its downstream distribution channel. These trading partners can be defined as any organization outside the company that plays an integral role within the extended enterprise and whose business fortunes depend upon the success of that enterprise.2 The set of trading partners found in a reverse supply chain are fundamentally different from those in the forward supply chain because the set of required core competencies is quite different. These differences are reflected in the following five reverse supply chain architectures. Product Return With a Money-Back Guarantee Products are returned for any number of reasons ... they arrived too early or too late, they're defective, or there's no cash to pay for them. Sometimes customers just do not want what they ordered. Lands' End is a good example of a company that believes hassle-free product return is a key ingredient of total customer satisfaction. Product can be easily returned in its original packaging with no questions asked. Because the customer has purchased the item using a credit card, his or her account can be easily credited for the value of the return. The supply chain must inspect the return, determine whether the item is still new or used, and repackage plus restock the item. One reverse supply chain design question is this: Should returns be processed at the main distribution center or should a new trading partner be established to process returns? Return for Repair and/or Calibration This business model applies in at least three cases. First, if product is received by the customer as dead on arrival (DOA), the supply chain must provide a replacement unit immediately and then remove the defective one. Second, this supply chain must provide convenient, predictable, rapid, and cost effective repair service, while differentiating between in-warranty and out-of-warranty time frames. Third, this supply chain also may be called upon to provide routine calibration services, such as those required by ISO 9000 certification. Design challenges for this supply chain architecture include providing a consistent level of technician skills worldwide, predicting when the repair will be completed, controlling logistics costs on products in transit, tracking the warranty period, and maintaining an inventory of the lower-level parts necessary to make the repairs. Return for Remanufacture and Resale The reverse flow for rebuilt starter engines, brake linings, and transmissions in the automotive industry is a good example of a remanufacturing supply chain. Remanufacturing is a highly skilled activity that requires an ability to forecast both the rate of core returns and the probability that a given core is reusable. Some cores are beyond being saved and need to be recycled in an environmentally responsible way. Others will require extensive rework with many replacement parts, resulting in lower profitability. And some will prove to be quick and easy to remanufacture; these will drive supply chain profits. The remanufacturing supply chain components include a remanufacturing factory, access to cores from the primary market, distribution centers for rebuilt parts, access to a secondary market to sell rebuilt products, a source of spare parts, and a means of disposal for scrapped cores. Return for Upgrade An example of this model can be found in the personal computer industry, where new generations of hardware and software appear every few months. In this dynamic environment, customers want to protect their investment. More and more, they are asking at the time of purchase for the option to return their original products to the factory for the latest upgrade. Customers are keenly aware that the book value of expensive electronic capital equipment is depreciating with every tick of the clock. From the factory's perspective, a high volume of returns for upgrade can choke the forward supply chain production and cut off current revenue. One key design decision for this model is where to make the upgrade: on-site, at the factory, or at a third-party facility? In all cases, the supply chain will be under the gun to complete the upgrade against an aggressive schedule. Inevitably, the customer expects the equipment to be back on line immediately for a mission-critical function. Return for Recycling The disposal of spent sealed lead acid (SLA) batteries is one example of a return-for-recycling supply chain model. SLA batteries are shipped from their manufacturer as common cargo. But, once these batteries are spent and separated from their host equipment, they become classified as hazardous corrosive material. The return-for-recycling supply chain includes a separator who can safely disassemble the return into a set of primary waste streams for proper disposal. The model also includes logistics trading partners who are licensed and knowledgeable about handling hazardous and nonhazardous waste streams. The growing customer expectation that manufacturers will remove all dunnage materials, cardboard, and plastic from the ship-to site is one factor driving the need for more of these types of supply chains.

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