The eBay factor: the online auction solution to the riddle of reverse logistics.

Wyld, David C.

ABSTRACT

Cottrill (2003) observed that "reverse logistics is no longer an afterthought, as companies discover gold in the mountains of returned products at the back end of the supply chain" (p. 20). This article examines this proposition, looking at the increased focus on the handling of returned and excess goods and merchandise through reverse logistics operations. The article outlines the dimensions of the returns problem and gives an overview of the concept of reverse logistics, examining the ways that management of the "reverse supply chain" differs markedly from a firm's forward facing operations. The article explores how and why online auctions through eBay are becoming an integral part of leading retail and consumer goods' companies reverse logistics strategies. It offers guidance as to what key questions executives face in developing a proactive strategy for handling returns and excess goods and whether to do so in-house or via third-party providers.

INTRODUCTION

No company wants to see its products returned. No retailer wants to see customers lined-up at its service desk with armfuls of merchandise. No store wants to see goods languishing on the shelves far past their saleable date, such as computers with processing speeds that are too slow or licensed apparel for movies that are long forgotten. Likewise, no OEM (Original Equipment Manufacturer) wants to see its products arriving at its loading docks, rather than being shipped out. In short, returns are an area that no one wants to deal with, but which all partners in the retail supply chain inevitably have to.

With today's competitive business environment, every consumer-facing company must concentrate on maximizing the efficiencies and effectiveness of its forward supply chain (Lee, 2002). However, we have reached the point today where electronic methods for both acquisition and sales support have, in effect, become simply defacto standards for all firms. Now, no less an authority than Dr. Michael Hammer (2001), the founder of the reengineering movement, has observed that because e-procurement and CRM (Customer Relationship Management) techniques have become competitive necessities today, "competitive advantage must be sought in parts of the value chain that thus far have been either overlooked or under-addressed" (p. 4).

Now, attention is being focused on the "flip side of the supply chain" (Mason 2002, p. 42). Writing in the Harvard Business Review, Guide & Van Wassenhove (2002) labeled the handling of returned goods and merchandise as the "reverse supply chain," which they describe as "the series of activities required to retrieve a used product from a customer and either dispose of it or reuse it" (p. 25). This area is now referred to as reverse logistics, defined by The IQ Business Group (2003) to be: "The process of managing the movement of specific goods away from their typical final destination in order to maximize its value or for proper disposal" (p. 1).

In this article, we will look at the problem of returned merchandise and how an effective reverse logistics strategy, including online auctions of a significant portion of these items, can produce dramatic results for companies. We will examine the scope of returns today, examining the size and scope of the problem. Then, we will look at the practice of reverse logistics and how it can help companies cut the costs of returns, even producing positive revenue for leading edge companies through online auction sales. Finally, we will conclude with advice on how to pursue an online auction strategy as part of an overall reverse logistics operation.

RETURNS--"THE UGLIEST PART OF THE RETAIL ENVIRONMENT"

We may not think much about the fishing pole, oil filter, or cereal that we return to our local Wal-Mart. However, in the aggregate, customer returns represent 4% of retailers' total revenues-or an astonishing total of approximately $100 billion per year (Trebilcock, 2001)!

Current statistics show that the overall return rate for products sold in the United States is approximately 6%. The rate of returns for different categories of products can be staggeringly high-up to 50% of all products shipped for some goods. For instance, for the consumer electronics area, the return rate is 8.5%. (Lee, 2002). There are some ninety million individual items returned items annually (Cox, 2001). The cost to manufacturers just in handling, processing and transporting returns has been estimated to be up to $150 per item, which amounts to over $40 billion annually across the American economy (Mannella, 2003). This corresponds to an estimate from the Reverse Logistics Executive Council, which approximated that in the U.S. alone, the costs associated with reverse logistics are approximately $35 billion annually (Kim, 2003).

When looking at statistics such as these, it is clear that product returns should be an area of concern for all consumer goods companies. The high level of returns in areas such as retailing, computers, mass merchandising and publishing makes managing them effectively a "competitive necessity" (Pathania & Andrews, 2003, p. 9).

In the consumer area, returns have been categorized by Jeff Roster, a senior analyst with Gartner, as "the ugliest part of the retail environment ... (being) all expense with no upside" (op. cited in Sant, 2000). Until recently, most companies have looked upon the area of product returns as a "black hole" (Anonymous, "Reverse Logistics Services: New Prospects for Carriers," 2003). In fact, the landfill was often the most attractive option for firms dealing with such volume of reverse flow. For instance, before implementing a companywide reverse logistics solution, large retailers, such as Sears and Radio Shack, routinely saw the landfill as the best route for returned goods to take (Mason, 2002). For instance, Estee Lauder used to dump $60 million worth of cosmetics annually that had been returned to them (Caldwell, 1999).

REVERSE LOGISTICS

Reverse logistics has been categorized as "the 'neglected child' in the extended family of the supply chain" (LIS, 2003, p.1). The concept was first defined in the academic literature by Murphy & Poist (1989) as "the movement of goods from a consumer towards a producer in a channel of distribution" (p. 179). de Brito, Dekker, and Flapper (2003) categorized reverse logistics as a newly recognized and increasingly academic field of study, examining "the processes associated with the reverse stream from users/owners to re-users" (p. 1). Yet, while there is increasing interest amongst firms in reverse logistics, most articles dealing with reverse logistics are still published in practitioner-focused magazines and newsletters, rather than in academic journals (Dowlatshahi, 2000).

The flow of goods encountered in reverse logistics operations has been dubbed every company's "worst nightmare" (Lee, 2002, p. 1). This is far from hyperbole. Clay Valstad, Director of Reverse Flow and Specialty Distribution for Sears, categorized the principal difference between forward and reverse logistics as being that: "on the forward side, you deal with order. On the reverse side, you deal with chaos, trying to create order" (quoted in Harps, 2003, n.p.). Think of it, on the procurement side, an organization is dealing with an organized flow of items, coming into its possession in an organized manner (in truckloads, pallets, and cases) and clearly labeled and packaged. On the opposite end, reverse logistics deals with a random flow of goods and materials of all types. To compound the problem, these items, which have been accurately referred to as "castaway stuff", comes in various states of operability and usability and with varying degrees of marketability and value (Wilder, 1999). This led Veerkamolmal & Gupta (2002) to observe that the operational characteristics of reverse logistics were fundamentally different than the forward logistics involved in manufacturing and distribution.

As Kim (2003) points out, managing the reverse supply chain is a very different and much more complex matter than trying to make an organization's forward supply chain more efficient and cost-effective. According to Zeiger (2003), the barriers to effective reverse logistics include: company policies, competitive issues, financial resources, the relative importance placed on reverse logistics, the lack of systems, legal issues, management inattention, and personnel resources. This is compounded by the fact that because the complexity of reverse logistics means that there really is not, at present, an effective "off-the-shelf" software solution available to handle the reverse flow.

IS REVERSE LOGISTICS A COST OF DOING BUSINESS?

Are these costs associated with returns just a cost of doing business? Today, many astute companies are answering "no." They are working to cut their net costs in handling returns and even finding ways to derive positive revenue from these operations.

Managing returns is not a core competency of any traditional organization. Thus, companies today that do not actively manage their reverse logistics to dispose of excess inventory and surplus assets efficiently incur sizeable costs. These are brought on by inefficiently allocating internal resources to manage the administrative burdens of this non-core function. These costs, both of the obvious and hidden variety, include: opportunity costs, poor space utilization, depreciation expenses, tracking and inventory expenses, maintenance costs, insurance costs, lower ROA (return on assets), and higher taxes (Mannella, 2003). Poor management of returns can thus be a significant drag on a company's financial performance, or worse, actually push a business towards bankruptcy. Companies must ultimately decide whether to handle returns internally or to outsource much, if not all, of the process to a growing sub-industry of third-party service providers (3PSPs) emerging in the reverse logistics area.

If a company looks to sell the portion of its returned goods inventory that is saleable, the traditional method has been through the use of liquidators or auction houses. Traditional liquidators represent a quick path to cash, but they rarely are a method through which firms can achieve the best possible price on their returns. A company may deal with two or three liquidators who bid within a narrow range, sometimes averaging only 3 to 5 cents on the dollar. In addition, most liquidation houses won't take small lots, resulting in additional warehousing and handling costs to the firm. On the other hand, traditional auction houses focus on one-time sales of surplus, rather than providing an ongoing solution to companies' surplus needs. Traditional auctioneers emphasize physical events that bring together a limited number of buyers in one place to bid at a specific time. Thus, the limited market produces limited recoveries on firms' returns. Additionally, the associated logistics costs, sales commissions and long lead-times can significantly affect total return on assets.

Companies certainly benefit from the sale of such surplus items. In fact, according to ATKearney (2002), 70-90% of every dollar generated through asset recovery goes straight to the bottom-line. Thus, even at low rates of recovery, companies gain from simply disposing of the unwanted "stuff" and gaining revenue from formerly lost goods.

The market for surplus goods has been accurately described as being a difficult market, characterized by inefficient processes and illiquidity (Draenos, 2000, p. 126-127). The chief reason that the market is illiquid and inefficient is poor information, making it hard for buyers and sellers to connect (Hickey, 1999). Traditionally, the surplus market has also been localized in scope, with trading being geographically confined (Norman, 2003).

In market after market, the Web is forcing transparency throughout the economy, making information sharing an economic imperative today (Hof, 2003). According to Hannon (2001), "the core benefit of online exchanges is that they disseminate real-time information globally ... opening up previously isolated markets" (p. 24). The market for surplus is thus another area of the economy where the use of e-tools can create whole new ways of doing business. One such e-tool is the use of online auctions.

THE ONLINE AUCTION SOLUTION

Surplus auctions were defined by Hickey (1999) as a mechanism that "liquidates surplus at the best possible prices by allowing a range of potential buyers to bid for products at below market prices" (p. 29). According to Connection to eBay (2003), online auctions for surplus can be defined as "a dynamic pricing structure where buyers compete for the product(s); therefore, pushing the price to fair market value and maximizing cost recovery versus other disposition options" (p. 3).

According to Investor's Business Daily, total online sales will double over the next four years reaching over $100 billion annually by 2007 (Barlas, 2003). Forrester Research estimates that online auction sales are expected to reach $54.3 billion annually by 2007, with eBay projected to have an 85-90% share of this marketspace (Johnson, 2002).

The key for any online auction site is for it to reach "critical mass," in that you need a sufficient number of bidders and enough merchandise to interest them for to get competitive pricing (Teschler, 2000). Writing in Decision Sciences, Bapna, Goes, Gupta, and Karuga (2002) stated that online auctions, in the absence of spatial, temporal, and geographic constraints, provide an "alternative supply channel for the distribution of goods and services" (p. 558). Online auction sites such as eBay benefit from what economists term "network effects." In essence, this means that: "The more buyers who go to eBay (or other auction sites), the more sellers they attract, who in turn draw even more buyers as the site becomes a larger source of supply with more competitive prices" (Schonfeld, 2002, p. 54).

Leading original equipment manufacturers (OEMs) and retailers are increasingly looking to online auctions--and primarily, though not exclusively to eBay--as a way to dispose of excess inventory and returned goods (Hannon, 2001). These include household names, such as: Disney, Donna Karan, Ford, Hewlett-Packard, J.C. Penney, IBM, Kodak, Nike, Nokia, Ritz Camera, Sears, and Samsonite (Kemp, 2001; Berkowitz, 2003; Junnarkar, 2003).

Why eBay? According to Kane (2003), eBay is fast-shedding its reputation as an "online flea market" and attracting the large, corporate sellers. Now, particularly in the area of technology products, these goods are finding a ready, global pool of both individual and corporate buyers. eBay-or more precisely the individuals and companies selling on the site--"create markets where none existed before" (Schonfeld, 2002, p. 56). Based on dollar volume, business buyers now comprise 10% of all purchases on eBay (Connection to eBay, 2003).

The numbers on eBay are mind-boggling. According to the e-commerce analyst, eMarketer, on an average day in late 2003, eBay racks-up: 20 million listings, 120 million searches, 7.4 million bids, $64 million in goods sold, and 100,000 new users (Berkowitz, 2003). eBay is the most visited website online, with visitors lingering 3.5 times longer than on any other site. The "sales velocity" of items on eBay is startling, when one considers that, on average, three consumer electronics products are sold each second in the online marketplace (Connection to eBay, 2003). eBay's sales of over $20 billion in 2003 mean that the value of the trading volume on the firm's site exceeds the Gross Domestic Product of 130 of the nations of the world (Hof, 2003).

Kane (2002) pointed out that the lasting technologies of e-commerce are ones that help facilitate transactions. She cited eBay's introduction of the "Buy-It-Now" feature as one such example. Since introducing the feature in 2000, eBay has brought in buyers who might otherwise have been unwilling to participate in the auction process, with its inherent uncertainty and time demands. With approximately 20% of all transactions being consummated through the "Buy-It-Now" option, eBay has seen its average auction length shrink dramatically.

Companies are finding that eBay represents an ideal outlet for what Rogers and Tibben-Lembke (2002) labeled the "'B' channel," for goods that have been through a reverse flow. While the "B" channel is intended to operate separately and distinctly from a companies primary sales channel (their "'A' channel"), the "B" channel can also handle first quality and never used items as well. By operating as a "B" channel, companies can derive positive revenue, without harming their "A" channel. According to Barbara Gore, eBay's Senior Director of Marketing and Industry Relations, companies are often surprised to learn that their products are already being sold on the eBay marketplace, listed by individuals and bulk resellers who are hawking the firms goods online (op. cited in Berkowitz, 2003). For instance, according to Connection to eBay (2003), in 2002, approximately $2.2 billion in consumer electronics products were sold on eBay by manufacturers and retailers. Yet, in the same year, individuals sold approximately the same volume of used consumer electronics on eBay.

eBay can also be used not as a sales outlet, but as a dynamic source of market information. Today, many companies routinely use eBay for the pricing intelligence that can be gained by monitoring sales of like items on eBay. In this way, companies can glean a no-cost gauge on what they should be charging for their surplus or excess inventory items to see them move, whether in an online or offline sales environment (Berkowitz, 2003).

What kind of results on surplus sales are companies finding on eBay? Research has shown that companies that employ auctions increase their recovery prices on assets by, on average, 25% (Queree, 2000). According to Bill Angrick, CEO of Washington, DC-based Liquidity Services, Inc., online surplus auctions produce returns 50-200% higher than in-person, physical auctions (cited in Norman, 2003, n.p.).

CONCLUSION

Andre Brysha, Chief Marketing Officer of Ritz Interactive, observed that there will always be a need for remarketing refurbished and excess inventory, so long as American retailers continue to have liberal return policies (op. cited in Battey, 2001). As we have seen, reverse logistics is on the rise as an important part of a complete supply chain management strategy, and online auctions are increasingly being used as a tactic for turning returned goods and merchandise from a "black hole" into positive revenue. Far from being the "small beer" that Cottrill (2002) characterized them as, it is clear that online auction venues, led by the predominant eBay marketplace, are perhaps the most significant channel for returned and surplus merchandise for marketers of all stripes today.

Thus, firms will have to examine how directly they want to engage with their "B" sales channel through eBay. The overarching goal, of course, should be to maximize returns on the assets being auctioned, while minimizing costs of all forms (direct and indirect) associated with these items (Tulip, 1998).

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David C. Wyld, Southeastern Louisiana University