Consumer Goods Returned – Performance Measurements

By Mark Biskeborn

Some IT solutions vendors in the reverse logistics market include a business intelligence component, complete with a digital dashboard that offers a set of key performance measurements in “gauges” that managers can read “at a glance” and understand the daily progress of subunit performance.

Consider an example case of a consumer goods retailer like Best Buy, Circuit City or Staples that has Service Center operations across and outside the U.S.A. We focus our calculations only on the services centers that handle the customer services and support, the returns operations. We see from the calculations below, that using operating income as the only measurement is to ignore the difference in size of investment needed at each service center to generate each operating income.

Investment represents the assets needed to generate income. The question is how large is the operating income in relation to the investment made to earn it?

ROI=income/investment

ROI is popular because it includes revenues, costs, and investments into a single percentage that can be compared across different subunits inside and outside the company.

Consider the ROI figures for the service centers:

Boston: $260,000/$1,000,000 = 26% with goal: 30%

Oakland: $308,000/$900,000 = 34% with goal: 35%

Seattle: $180,000/$450,000 = 40%

Senior management can set a performance goal for each of these service centers as indicated. The subunit managers would have to attain their goals by carrying out any of a number of actions including working with other subunit managers such as the contact center or field services to streamline process, even to reduce returns by better handling any frustrated callers; by decreasing assets such as receivables while maintaining operating income; by increasing revenues via better warranty sales in the contact center; by reducing costs via better use of process design, technology and information.

Residual Income (RI) = Income – (required rate of return X investment)

Boston: $260,000 – (0.12X$1,000,000) = $140,000

Oakland: $308,000 – (0.12X$900,000) = $297,200

Seattle: $180,000 – (0.12X$450,000) = $126,000

As a tool to guide and motivate managers to achieve performance goals, RI is often preferred to ROI because it focuses on maximizing the more visible dollar amounts.

When we consider the performance of the service centers by ROI and RI, we might make different business decisions than if we considered only ROI. For example, the Oakland service centers might consider spending $80,000 to upgrade its contact center where incremental costs to handle frustrated callers is smaller compared to the higher incremental costs to handle returns. This upgrade is estimated to increase income by at least $18,000.

Consider the math:

Pre-upgrade ROI: $308,000/$900,000 = 34%

Post-upgrade ROI: ($308,000+$18,000)/($900,000+$80,000) = 33%

Compared to:

Pre-upgrade RI = $260,000 - (.12X$1,000,000) = $140,000

Post-upgrade RI = $326,000-(.12X$1,080,000) = $196,400

Using RI, we decide to upgrade.

Economic Value Added (EVA) is a specific type of residual income calculation.

EVA=after-tax operation income–[(weighted-average cost of capital) X (total assets–current liability)]

Boston: $260,000 X 0.7 – [0.102 X ($1,000,000-$95,000)] = $89,690

Oakland: $308,000 X 0.7 – [0.102 X ($900,000-$75,000)] = $131,450

Seattle: $180,000 X 0.7 – [0.102 X ($450,000-$50,000)] = $85,200

For EVA, value is created only if after-tax operating income exceeds the cost of investing the capital. To improve EVA, managers must: earn more after-tax income with the same capital, use less capital to earn the same income, or invest capital in higher earning projects. EVA guides managers to more astute decisions.

To monitor and manage service center performance and its subunits, ROI, RI, and EVA are appropriate calculations that some IT vendors deliver as real-time information for management decisions. Each of these measurements has its own characteristics; we are wisest to use all of them while understanding each.