The Return Rate Multiplier

Do you know how much returns are actually killing your profits?

If you are like most, including me, you spend most of your time increasing sales. But what if I told you that reducing returns by, e.g., 2pp (percentage point) has a more significant impact on your profits than increasing sales by 2pp?

Using real numbers from our business in a simulation, a 2pp increase in sales increases profits by 2%. Not surprising. The surprising result is that a 2pp decrease in returns increases profits by 2.9%.

Conversely, a 2pp decrease in sales reduces profits by 2%. But a 2pp increase in returns decreases profits by 3%.

That’s a ~1.5x difference both ways! I call this the Return Rate Multiplier.

See here how profits change with different changes in returns:

Notice the non-linearity of the image. A 15pp decrease in returns increases profits by almost 20%, and a 15pp increase in returns decreases profits by 18%.

So why is this the case? The obvious factor is shipping costs. In the EU, we’re obliged to pay back standard shipping costs if a customer returns an order. So if a customer is returning an order, we still lose the shipping cost to the customer.

But if I remove all shipping costs, a 2pp decrease in returns still increases profits by 2.88%. Why? Because we can ask the customer to pay for the return shipping. In our case, we’re taking a fee for each return to covers some of the shipping costs. So the shipping costs are partially covered.

Instead, the main driver of the multiplier effect is wages. If I remove wages from my simulations, the multiplier effect almost disappears. A 2pp decrease in returns only increases profits by 2.026% compared to the 2.9% with wages. And the slight increase comes from our return shipping costs not being fully covered.

You are most likely underestimating how much you are paying per order in wages. I did, at least, until I talked with the owner of a $33M e-commerce business acquired due to their highly efficient logistics. They are incredibly efficient in their fulfillment center. Still, their wage cost/order was much higher than I would have ever guesstimated.

But it’s not surprising when you think about it. Every time you have an order, you pay for someone to pick and pack the order. And if it’s returned or exchange, you are paying for someone handling that as well.

For a return, you are paying for your personnel handling the order two times without getting any revenue. And for an exchange, you are paying for your personnel handling the order three times (first send, return, exchange), but you’re compensated exactly the same as if the customer got it right the first time.

Maybe you should spend some more time reducing your returns?

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Godspeed,Mathias