What is the real cost of
returns? At what point does the cost make them unprofitable or marginally
profitable? What do you do when an account reaches that point? I had to face
those questions in 2005.

In the spring of 2004, Borders
Books purchased 300 copies of my book Bicycle Vacation Guide through my
distributor. A year later, at the beginning of a new bicycling season, they
returned 86 books, all damaged. Throughout the summer of 2005, Borders continued
to return damaged books until I had 163 in my basement.

I’ve worked most of my life as a
publisher and as an employee in the bicycle industry. Bicycle retailers pay
distributors a restock fee of 15 percent for all returns. Distributors do not
accept damaged products, and any retailer that returns more than 1 percent of
its purchases loses its rebates and other customer incentives. If returns rise
above 2 or 3 percent, the dealer could lose its right to do business with the
distributor. By contrast, when I protested the huge Borders’ return to my book
distributor, I received the equivalent of a palms-up shrug.

Doing business in a culture where
all risk belongs to the publisher is difficult in the best circumstances. At
some point it isn’t worth pursuing. To quote Bruce Merrifield, a consultant to
the distribution industry: “Sales are vanity. Profits are sanity.” These are
jarring words in an industry that continues to throw money down the returns rat
hole as if there were no other choice.

Determining the point at which a
sale is not worth the cost of doing business requires math and hard decisions.
The math tells sobering truths. For instance, selling 100 books and getting 30
of them back as returns does not give you the same profit as selling 70 books.
In the tables below I have calculated the cost for 100 books with returns at
various levels.

This is an oversimplification of
the true cost of returns. Accountants want to know about gross margins,
overhead costs per transaction, and a number of other details. While all those
factors are important, I wanted a simple guideline for making decisions about
which accounts are profitable and which I should turn down.

The last line of Table 1 shows the
cost of the Borders’ return to me. Both tables use numbers derived from my
experience. Check “Where the Numbers Come From” belowfor additional information.

Table 1. Cost of Returns

COGS, $3.99; Average Sale
Price, $7.10

Where the Numbers Come From

#
Sold, Total Sales, Total COGS, Gross Margin: Self-explanatory.

Outbound
Handling Costs: From Table 2.

Gross
Profit: Gross Margin –
Outbound Handling Costs. My profit if there are no returns.

Damaged
Returns: Reflects the percentage
of returns. A 30 percent return rate is 30 returns on 100 books.

Refund: Sale Price × Damaged Returns.

Net
Sale: Total Sale – Refund.

Returns
Handling Costs: From Table 2.

Net
Profit: Damaged Returns: Gross
Profit – (COGS × Damaged Returns) – Total Handling Costs
(from Table 2).

Net
Profit: Resaleable Returns: Same
as Net Profit: Damaged Returns without subtracting COGS.

Table 2. Handling Costs

Where the Numbers Come
From

These numbers are somewhat
arbitrary. I don’t process each order and return sold through my distributor.
Nor do I pay for each shipment from my distributor’s warehouse. The numbers,
however, are close enough to make a valid point.

Outbound
Invoicing: Approximate time for
invoicing an order times a moderate hourly rate. Invoicing costs do not change
with the size of an order.

Outbound
Processing: Picking, packing,
labeling, and shipping an order. Costs go up marginally with the number of
books or cases shipped.

Freight
Outbound: Based on shipping a¾-pound book and 40 books per case. I used the FedEx rate with PMA’s
PartnerShip program. My books ship to a distributor 60 miles from my home office.

Outbound
Handling Costs: Total of above.

Process
Credit Memo: Same cost as creating
the original invoice.

Damaged
Returns: See Table 1, Damaged
Returns.

Returns
Processing: Higher than Outbound
Handling Costs per book because the returns have to be inspected before being
shelved.

Returns
Handling Costs: Sum of all columns
to the right of Damaged Returns.

Total
Handling Costs: Sum of Outbound
Handling Costs and Returns Handling Costs.

As you can see, a damaged-return
rate of 30 percent is unprofitable for Bicycle Vacation Guide. Even with a 10
percent return rate for damaged books, the bottom line takes a hit of nearly
$125. This is eye popping, because the cost of goods sold (COGS) on 10 books is
only $39.90. Transaction costs account for the rest of the amount.

But why wouldn’t I accept 10
percent returns, since I still make a net profit of $155 per order? That $155
represents $1.55 per book. I’m an author/publisher. As an author, I spent a
large amount of time researching and writing the book. As a publisher, I
invested time and money bringing the book to market, promoting it, and selling
it. I can’t justify a return of $1.55 per book for the two roles. If I were the
publisher and not also the author, I would have to pay the author 6 to 8
percent on the sale price of each book. That would take 42 to 56 cents off the
margin, bringing the profit per unit down to approximately $1. Take away the
cost of overhead, and the profit margin wouldn’t sustain a minimum-wage income.

Even returns that come back to the
publisher in good shape cost a lot. For example, a return rate of 30 percent
brings the net profit down from $280 to $52, a net loss of nearly $228.
Furthermore, the actual profit, $52, reflects a net of just 52 cents on each
book sold.

A hard look at the numbers makes
things amazingly clear. Over the years, I’ve seen numerous articles by PMA
members accusing wholesalers like Ingram of everything from incompetence to
nefarious schemes to avoid payment on books. These accusations are useless. It
doesn’t matter if the folks at Ingram are dunderheads or crooks. It doesn’t
matter if Ingram is my only channel for book sales to the major chains. What
matters is whether I can make a profit selling to Ingram. If it orders 100
books from me, returns 30, then orders 100 more and returns another 30, I’ve
made two transactions, and each one nets me 52 cents per book. It isn’t worth
doing business with anyone under these conditions. Merrifield again; it’s worth
repeating: “Sales are vanity. Profits are sanity.” Without profits, your
business can’t survive. Without a business, you can’t make sales.

One more point. If Ingram returns
30 books and I manage to sell those books through other outlets, it doesn’t
make my transaction with Ingram more profitable. It means I’ve been forced to
sell the books twice, and the first sale, to Ingram, wasn’t worth making.

Axing Accounts When
Returns Start to Climb

I’m in the process of reselling,
copies that Borders returned. When people buy them at events and bike expos,
I’m recovering the cost of goods sold, and that means the transaction was less
of a money loser than it might have been. But if I want to sell damaged books,
I don’t have to send them to Borders first. I can easily do the damage at home
and save a lot of transaction costs. I’m not aware of any changes that Borders
has made to reduce the number of damaged returns in the future, so I’ve
instructed my distributor to stop selling all Little Transport products to the
chain.

Where do I draw the line? In an
industry that routinely accepts 30 percent returns, can I insist on a 1 to 2
percent return rate? Not now, but I will always strive for that goal. For now,
I study the monthly sales reports from my distributor in detail. If an account
shows a trend toward returning 10 percent or more of the books it buys, I tell
my distributor that the account is on probation. We discuss the likelihood that
it will improve, and if the answer is no, I ask that the account be blocked
from future sales.

Those discussions have paid off.
In the past, my distributor would sell any number of books to any account
without consulting me. That has changed. Recently, my contact at my distributor
called to tell me that a buyer had placed an order for more than 500 Milwaukee
Bike Maps, a new product for 2006, and she suggested that I refuse the order.
“Their returns range from 6 to 45 percent, and lately they have been trending
more toward the 45 percent level,” she said. “Furthermore, they don’t use
packing material when they return the product. Any returned maps will probably
be damaged.” I didn’t need a spreadsheet to make that decision.

As a micropublisher, I don’t have
much leverage. When I encounter an account that has a large number of returns,
I have two options: Sell to them according to my distributor’s terms, or refuse
the sale. Publishers that sell directly to bookstores or to wholesalers like
Ingram have a wider range of options for reducing the number of returns. Part 2
of this series will address those options.

Doug Shidell, who runs Little
Transport Press, is a past president of MIPA (Midwest Independent Publishers
Association). He has been a publisher for more than 20 years and the author of
books and columns on bicycling for more than 30. If you’d like to determine
your own costs for accepting returns, email him at info@littletransport.com and
ask for the spreadsheet with cost variables.