Retailers' common view that the "consumer is king" has increasingly led some customers to abuse their power, claiming returned products are flawed when they actually have no defects, says Mark Ferguson, assistant professor of operations management at Georgia Tech College of Management.

Ferguson has conducted research on how to reduce the growing incidence of "false failure" returns, products with no verifiable cosmetic or functional flaws. They are estimated to cost U.S. manufacturers $100 billion a year.

"Because of the significant financial impact, manufacturers are interested in reducing false failure returns through improved relations and contracts with retailers," Ferguson says. "Right now there's no incentive for retailers to put in extra effort to reduce the number of false failure returns because the manufacturer provides full credit for every returned product."

But manufacturers could motivate retailers to help solve the problem via a target rebate contract, which rewards sellers for keeping false failure returns below a predetermined target level, according to Ferguson and his research collaborators, V. Daniel R. Guide Jr. of Pennsylvania State University and Gilvan C. Souza of the University of Maryland. Their study, "Supply Chain Coordination for False Failure Returns," will appear this fall in the journal Manufacturing and Service Operations Management.

"There are a number of actions that retailers can take to reduce false failure returns, such as spending extra time with customers and listening to their needs before recommending a particular product," Ferguson says. "As a result, customers have a higher probability of purchasing a product that matches their needs the first time. Retailers can also train their sales force to clearly explain the proper operating procedures of a product to customers before they purchase it. A surprisingly large number of technology products are returned because the customer could not figure out how to operate it correctly."

Reasons for false failure returns include not only customers' misunderstanding of product operation or installation, but also buyer's remorse. Some consumers, who are often referred to as "devil" customers, actively abuse the liberal return policies of many U.S. retailers, buying a product such as a power tool and taking it back after their project is done, Ferguson explains. Many retailers like The Home Depot and Best Buy are getting more aggressive about identifying and discouraging customers with excessive returns.

Why don't manufacturers charge the retailers for false failure returns? "There is a lot of competition in most product categories," Ferguson explains. "The manufacturers are afraid to penalize retailers who might instead push their competitors' products where there is no danger of being penalized. Some retailers may even refuse to sell the manufacturer's products completely."

Although false failure returns can often be resold, manufacturers incur significant costs and time delays for the process of testing, refurbishing (if necessary), and repackaging the products. "For companies such as Hewlett-Packard (HP), this process can take up to three months, a significant percentage of the total lifecycle of a technology product," Ferguson says. "If a new model has been released before the product returns to the market or the customers demand a discount for buying a refurbished product, manufacturers lose revenue."

The researchers examined HP, where product returns were treated as a low-level problem until a thorough analysis showed that their total cost was equivalent to 6 percent of total sales. For HP's inkjet printer group, false failure returns can account for up to 80 percent of their inkjet printer returns.

HP has experimented with a formula devised by the researchers to calculate where to set the limit for target rebates, which retailers receive for every false failure below the predetermined level. The formula takes into account historical data on false-failure returns. "Our research results indicate the profit improvements from using target rebate contracts are substantial. Best of all, they increase profits for both the manufacturers and the retailers," Ferguson says. "Even the customers are better off because the retailers spend more effort ensuring they purchase the right product and understand how to use it before taking it home. Thus, everyone wins."

Writer: Brad Dixon, College of Management