Profit from Managing Returns. Yes, Returns.

What do a typical hospital and a typical retailer have in common? They both have a problem managing returns. Let me explain.

About a year ago, I spent a day with the President’s Cabinet of a major medical center. This is one of the most prominent institutions in the country, with a very talented and dedicated management team. During the day, we reviewed and discussed a number of important topics, ranging from prospective healthcare legislation to growth plans.

One comment in particular caught my attention. A senior physician noted that the hospital didn’t systematically monitor readmissions - patients who are discharged and soon return to the hospital for additional care.

I thought about a friend who had started a company to oversee the care of patients who had a particularly difficult chronic illness. He had done studies of patient care, and he found that a surprisingly large portion of hospital readmissions occurred because of simple logistical errors. For example, when many patients were discharged, the oxygen or other medical supplies were not delivered to their homes in time. This resulted in very costly readmissions.

A few years ago, I did a number of studies of product returns in retail and distribution companies. I found that virtually all companies viewed returns as a logistical hassle to be managed primarily to minimize the handling cost and maximize residual product value.

My studies showed something very interesting, however. When I compared retailers in the same industry, their rate of product returns varied significantly. Not only that, but even within the same retailer different associates had very different returns rates - even for the same product.

The conclusion: the returns rate was really a measure of the quality of the sales process. The retailers and associates who had low returns rates were very good at diagnosing a customer’s real needs, and had a good understanding of what supplemental instructions a customer typically needed. The others did not.

The traditional way of managing returns turned out to be to not manage them at all – just to handle them efficiently. The right way to manage returns is very different: to view them as a quality feedback loop that enables a manager to pinpoint the places where the sales process breaks down, and to formulate sharply targeted measures to improve the process.

In a sense, the hospital readmissions rate is very much like the retail returns rate. Some patients legitimately need additional care, but many simply come back because they experience avoidable errors – most of which are not the hospital’s fault. And in most institutions, this critical measure is not systematically analyzed.

Both the hospital and the retailer had the potential to monitor their “returns” not just for handling efficiency, but more importantly to improve the quality and drive down the cost of their core organizational processes.

The big profit leverage that comes from managing returns – not just handling them efficiently – is that the returns rate offers a very important window into how well the institution or business provides service to its customers.

In both business and not-for-profit management, there are a number of “hidden” quality measures like the returns rate. The insightful manager will seek out these measures, and use them to maximize the overall performance and profitability of his or her organization.

Unlikely Sales Heroes - Supply Chain Managers

You finally landed your first orders from that really important high-potential account. When should you bring in your supply chain managers?

In most companies, the standard progression is for the sales rep to focus on ramping up the sales volume, with a courtesy call from the company’s local supply chain manager only when the account is “safe.” Wrong answer.

This “sales first, supply chain last” way of dealing with account development is an obsolete and counterproductive approach to customer management that stems from the past “Age of Mass Markets.”

For most of the past century, businesses operated in the Age of Mass Markets. In this era, companies sought economies of scale through mass production, and they distributed their products as widely as possible through arm’s-length relationships. Most of our current management processes were developed in this earlier era. During this period, managers correctly focused on aggregate revenues and aggregate costs, and the role of a logistics manager was to move and store products at the lowest possible cost.

Today, all that is changing. We are in a new era, which I call the “Age of Precision Markets.” In this new era, companies form very different relationships with different groups of customers, and these feature very different degrees of supply chain integration and coordination, with vastly different profitability. The big problem is that all too often supply chain managers are not systematically involved in creating and managing these relationships. Instead, many are still primarily focused on internal cost control – like the logistics managers of old.

The consequence of this deficiency is a pattern of profitability that I have seen in my research and consulting with leading companies in over a dozen industries over the past two decades. In virtually every company, 30-40% of the company is unprofitable by any measure, and 20-30% provides all the reported profits and subsidizes the losses.

How can a top manager change this? By making supply chain managers essential partners with sales and marketing at every stage of the account development cycle – and even before the sales cycle begins.

The key success factor is to get sales, marketing, and supply chain management on the same page in three key business processes:

Relationship structure. If your sales reps are free to agree to a wide variety of customer requests and demands, it places a huge cost burden on your supply chain. The answer is for sales, marketing, and supply chain management to agree on a set of perhaps 4-8 standard customer relationships – ranging from arm’s length to highly integrated. Each relationship should have measurable value for both parties, and a clear to-do list for each party. Then your supply chain managers can create a streamlined process to support each relationship.

Market mapping. This is the process of matching customers to relationships based on an assessment of where each customer should wind up. This assessment involves both sales and supply chain factors, like buyer behavior and capability to partner. This is very different from simply asking the customers what they want. Your sales process should be focused on moving customers to the right relationships.

Account management. In major account relationships, the account development process must involve both sales reps and supply chain manages from the start. In a well-integrated relationship, your supply chain managers can dramatically lower both your customer’s costs – and your own costs – by influencing your customers’ inventory levels, order patterns, and other key (mostly supply chain) factors. When you increase your customer’s profitability, it almost always drives sales increases of 35% or more, even in highly-penetrated accounts. As a top executive of P&G once noted at MIT, “Our customer is Wal-Mart’s CFO.”

The bottom line is that it is essential to bring your supply chain managers into your earliest sales efforts. They will naturally work with their customer counterparts to identify areas of cost reduction that will come from working together. In the process, your supply chain managers will identify and nurture allies within the customer, and together develop a strong business case for selecting you as the premier supplier-partner. Today, both supplier selection and revenue growth are rooted in the foundation of trust developed between your company’s supply chain managers and their customer counterparts.

I recently gave a presentation on “The Coming Revolution in Supply Chain Finance” to a national conference of supply chain management professionals. Here was my message:

In leading companies today, supply chain integration leads directly to sales increases of 35% or more, even in highly penetrated accounts. Supply chain management is the fastest and surest way to increase revenues.

At the same time, top companies that structure their sales processes to bring in revenues that fit their supply chain’s capabilities see cost reductions of 30-40% or more. All revenues are not equally profitable, and thoughtful sales discipline is the best way to create quantum increases in supply chain productivity and efficiency.

Welcome to the new world: supply chain management driving huge revenue gains; sales discipline creating massive new supply chain efficiencies. In the process, financial performance going through the roof.

Unlikely Operations Heroes - Sales Reps

A few weeks ago, I met with the top operations managers of a major multinational consumer products company. These executives were very interested in understanding how to become more innovative. What could they do? What have other companies done? What is the current best practice?

Innovation is a very broad topic that can apply to many different things, so what was their specific problem? The cause of their concern was that their production facilities were very efficient, but the company’s rate of product innovation was becoming so rapid that they were worried that they might not be able to support it without major changes. This is what they meant by innovation.

As we discussed the situation, they mentioned the company’s sales and marketing group as the source of this situation. Suddenly, the pieces fell into place.

The sales reps’ problem

A few years ago, I had an opportunity to work with one of the company’s major distributors on sales force productivity. I spent several days riding with several sales reps and understanding their situation. It turns out that these sales reps, also, were having serious problems with the company’s accelerating pace of product innovation.

How was this product innovation manifest? The sales reps were being bombarded by an endless stream of changes. A few were large, like the introduction of an important new product line. But most were small, almost trivial, like a new point of purchase display for a minor product.

What was most striking about this situation was that each innovation, large or small, was accompanied by a new sales objective that became part of the sales rep’s bonus calculation. The reps actually had 15-20 different objectives!

I knew that a sales rep can’t simultaneously maximize 15 objectives, and the customers would balk at responding to all these changes. So what did the reps do?

Each rep picked the two or three objectives that he or she thought would make the most difference, and ignored the rest – and often these varied from rep to rep. How did this crazy situation arise?

I remember talking to the sales reps and customers, and thinking about the portfolio of product innovations.  I had an image of dueling product managers at headquarters, each producing a stream of product (or packaging) changes because each had to show “progress’. Each vying for slightly enhanced revenues.

And each product manager seemingly oblivious to the big picture, including the critical second-order consequences for both sales and operations.

Who’s driving the boat?

In our meeting, I related my experience with the sales reps. I suggested that if I had a room full of their sales reps, the sales reps would have expressed the same frustration with the company’s situation.

In this company, it appeared that product management was “driving the boat”. Each product manager was focusing on only one rather narrow primary measure: his or her product revenue or gross margin – without regard to the overall effect, or to the important (but hard to measure) second-order effects on both sales and operations, and on the customers. The operations and sales groups were stuck essentially “waterskiing behind the business”.

Why was this occurring? The answer stems from the transition we have been going through from one business era to another.

What happened?

In the prior Age of Mass Markets, which occurred throughout most of the twentieth century, revenue maximization was the win strategy. Companies had relatively uniform pricing  (for much of the period, manufacturers could actually set retail prices), cost to serve was relatively uniform as the product was just dropped at the customer’s receiving dock, and economies of scale meant that large production volumes led to diminishing unit costs. And diminishing unit costs meant more profits.

In this situation, product management was indeed driving the boat. Their job was to maximize revenues. Most consumer product companies were characterized by a relatively small number of high-volume brands. In this situation, the cost of the small “tweaks” in products and packaging were small compared to the huge gains in scale.

Over the past thirty years, however, our business system has changed enormously. We have entered what I call the Age of Precision Markets. In this new era, companies have instituted complex pricing varying from customer to customer, and even product to product. Cost to serve varies again by customer, and even by product within a customer. Products have proliferated into all ecological niches, and flexible manufacturing and outsourcing have enabled many niche products to achieve minimum efficient scale.

Today, profit maximization requires a deep understanding of the interaction between pricing and cost to serve on a very granular basis (individual products within individual accounts). It also requires the tight integration of product management with the groups responsible for the second-order costs it so often produces. Chief among these are the critical costs of sales inefficiency and operations complexity – just what the top operations managers and sales reps were so concerned about.

A natural alliance

In today’s business era, sales and operations have surprisingly aligned interests. They are poised to form a natural alliance to maximize profitability, often without realizing it.

Several months ago, I wrote a widely circulated blog post, “Unlikely Sales Heroes – Supply Chain Managers”. The thrust of the post was that the traditional way to sell to important accounts – sales rep ramping up sales volume, then bringing the operations manager in at the end for a courtesy call, or “sales first, supply chain last” – is an obsolete and counterproductive approach to account development that stems from the past Age of Mass Markets.

In today’s Age of Precision Markets, all this has changed. Leading companies have found that the most effective way to develop and accelerate sales in their most important accounts, their “islands of profit”, is to introduce their operations and supply chain managers to their counterparts in the key customers early in the account development process. The operations managers naturally bond with their customer counterparts, and together they quickly develop innovative ways to work together to create new efficiencies.

This process has two very important results: (1) the customer will become much more profitable handling and selling your products, and this will create huge, rapid sales increases for your company; and (2) in the process, you will lower your own cost to serve. Think about this: your operations team creating huge new revenue increases coupled with lower cost to serve. The best of all worlds.

In my graduate class at MIT and in my executive courses, I often ask whether in a company all revenues are equally profitable to serve. The answer is “of course not”. It is clear to everyone that some revenues fit the supply chain and operations, while others do not.

This leads to a very important conclusion. The most important way to achieve quantum increases in operations productivity is for the sales force to bring in revenues that fit the company’s supply chain and operations. This means that in a well-run company, the sales reps are primary determiners of operations productivity –  the unlikely operations heroes.

Does this mean that we must turn away important new sources of revenue because they don’t fit our current operation? Of course not.

It does mean, however, that both sales and operations have to develop a deep understanding of the complex interaction between revenues and costs on a very granular basis (individual products in individual customers), and they must have highly efficient processes to coordinate and align their sales and operations activities.

When your sales and operations are fully aligned, your revenues will be maximized and operations costs will be minimized. Today, your supply chain managers should be your most important sales heroes, and your sales reps should be your most important operations heroes.

What about the product managers?

Returning to the recent meeting with the consumer product company’s top operations managers, it became clear that the company’s product managers were maximizing a small portion of the company’s profit picture. They were not aligned with either sales or operations.

In the past, this was not a big problem, but today it was causing enormous headaches.

This led to a very important question. How could the operations managers (and sales force) change position from “waterskiing behind the business” to helping “drive the boat”.

The answer was that they had to shift their activities from a focus on finding ways to cope with an untenable situation (which they saw as a need for innovation), to a new focus on developing effective ways to partner with their counterparts in sales and product management in order to create alignment.

And this was nearly impossible to do when everyone was so busy fighting the fires caused by the counterproductive, over-rapid pace of product innovation.

The key to gaining alignment was to open a parallel discussion on how to work together over the next few years in order to maximize profitability and profitable growth. This would surely involve new coordinative mechanisms, new metrics, and new incentives.

The net result, the true definition of success: all three key groups “driving the boat” together.

Unlikely heroes

In the Age of Precision Markets, the key to long-term success is to develop effective processes to tightly align your key functional areas – sales, operations, and marketing – in both your company’s day-to-day activities and in its positioning for the future.

In this new era, your supply chain and operations managers should be sales heroes, and your sales reps should be operations heroes – all working together to raise your company’s performance through the roof.