May 2014 | Commentary | Reverse Logistics

Liquidate Inventory or Leave Money on the Table

Tags: Reverse Logistics

Reverse logistics programs aim to efficiently remove returned and obsolete inventory from the primary sales channel to maximize recovery values while minimizing related financial risk. Retailers and manufacturers liquidate more than 95 percent of overstock inventory and customer returns on the secondary market.

When evaluating the effectiveness of their returns process, many executives focus on transportation and processing costs. While managing these expenses is important, the actual costs are low compared to the potential revenue companies can gain by maximizing their inventory's liquidation value.

For example, the cost of transporting and processing returns ranges from 30 cents to $2 per item, depending on the product's volume, size, and type. Manufacturers and retailers can sell items on the secondary market for 15 to 50 percent of the product's value, depending on its characteristics, and whether it is sold to a bulk liquidator, pallet buyer, or directly to a consumer.

If a company dramatically improves its reverse logistics processes, it might reduce transportation and processing expenses by 10 percent. If the average value of returned items is $20 per piece, the company saves three to 20 cents per unit processed.

If, however, the company focuses on increasing liquidated items' recovery value by 10 percent, it could increase profits by 30 cents to $1 per unit. A company liquidating three million returned units per year that focuses on reducing processing costs adds $600,000 to its bottom line—at best. But if it improves its liquidation recovery rate by 10 percent, it increases its bottom line by $900,000 to $6 million.

Yet because they do not fully understand liquidation's potential, many companies leave this money on the table.

The Secondary Market

Liquidators buy and sell goods from retailers and manufacturers into specialized markets comprising three types of buyers: bulk, pallet, and item.

Bulk buyers maintain broad, well-developed buyer lists, and can purchase millions of dollars of goods weekly, in multiple truckloads they sell primarily to smaller pallet buyers. The pallet buyers have limited funds, sometimes require terms when buying, and sell their product via eBay, Craigslist, local flea markets, or small salvage shops.

Companies can liquidate product following three basic financial models:

  1. Consignment. Liquidators charge about 10 percent of gross revenue for products they sell on the manufacturer's or retailer's behalf. The seller maintains the title until the buyer pays for the item, and can maximize recovery value by taking advantage of seasonal demand peaks.
  2. Revenue share. Also known as gain-sharing, this model allows sellers to set a floor on the percentage recovery rate, minimizing market risks, and providing an upside if the market demand is great.

    For example, the liquidator agrees to pay 12 percent upfront, plus 50 percent of any recovery exceeding 12 percent. Some liquidators negotiate a gap between the floor amount and when the gain share starts. The split on the gain share is typically 50/50, but some liquidators push for more.

  3. Purchase. When the liquidator purchases goods outright from the seller, the recovery value may be significantly lower—but so is the seller's risk. In exchange for paying immediately, however, liquidators want a reduced price to minimize potential impact on their profits.