Chapter 7 Closing the Loop—Remanufacturing – Sustainable Operations and Closed Loop Supply Chains, Second Edition

CHAPTER 7

Closing the Loop—Remanufacturing

7.1 Scope of Remanufacturing in the United States and the World

Remanufacturing is the process of restoring a used product to a common esthetic and operating standard.1 Broadly speaking, remanufacturing comprises the following steps: disassembly, cleaning, reworking, reassembly, and testing. Disassembly and reassembly are labor-intensive regardless of the product or industry. Cleaning is labor-intensive for most industries, and in automotive remanufacturing the process also takes a lot of capital and energy. Reworking is both labor- and capital-intensive. In automotive, tire, and industrial machinery remanufacturing, the process requires significant capital investments because it uses more advanced technology. Plus, products in these industries have a significant number of movable parts and are therefore more subject to mechanical wear and tear, implying a more comprehensive process (as opposed to, say, electronics, cartridges, and furniture).

An estimate of the size of remanufacturing in the United States from the United States International Trade Commission (USITC) is $43 billion, employing 180,000 people.2 Perhaps due to the different terms, firms use to describe remanufactured products—such as “refurbished,” “rebuilt,” “reconditioned,” “overhauled,” and “restored”—it is difficult to pinpoint the largest remanufacturing industry. However, aerospace and automotive (including heavy-duty vehicles and parts) remanufacturing are among the largest, together accounting for at least half of all remanufacturing sales.3 There also has been significant growth in information technology (IT) equipment and consumer electronics remanufacturing (such as in cell phones), likely because the fast pace of change in these industries has made available a large number of used products with significant value. For example, the U.S. market for remanufactured IT networking equipment has grown from a tiny figure in 2000 to over $2 billion in 2017, according to UNEDA, the trade association.4

Remanufacturing is mostly done by small, third-party firms. The USITC survey revealed that 2,900 firms with 20 or more employees perform remanufacturing in the United States. They also estimate 5,000 remanufacturing firms with fewer than 20 employees in the United States. While a number of original equipment manufacturers (OEMs), such as Hewlett-Packard, Dell, Ford, General Motors, Pitney Bowes, Bosch, and many others, offer remanufactured products, in many cases, these companies outsource the remanufacturing operations per se to other firms. The remanufacturers could be large, established companies (e.g., Solectron, Flex, Caterpillar) or small, independent third-party firms.

For small third-party firms, remanufacturing simply is a profitable proposition, as evidenced by the growth in the remanufacturing of printer cartridges. OEMs, on the other hand, typically see remanufacturing as an opportunity to expand their product line and offer a cheaper branded product to consumers who cannot or are not willing to pay the price for a new product. OEMs also offer their own remanufactured products as a way of protecting their brand, considering that most third-party remanufacturing firms follow their own quality standards when remanufacturing and that the brand may suffer if a third party offers a poor quality product that was originally manufactured by the OEM. Finally, remanufacturing may be the only option for unique products, those with low volume production, and those with long useful lives, such as defense items (e.g., weapons systems, fighter jets). However, OEMs may not engage in remanufacturing for fear of cannibalization of their product line, as we discuss later in this chapter.

An example of an OEM that remanufactures is Pitney Bowes, shown in Figure 7.1. Pitney Bowes is a Connecticut-based OEM that manufactures large-scale mailing equipment used in businesses. Pitney Bowes equipment matches customized documents to envelopes, weighs the parcel, prints postage, and sorts mail by ZIP code (a considerable source of savings given significant discounts offered by the U.S. Postal Service for sorted mail). Pitney Bowes leases most of its new equipment, with a typical lease of four years. At the end of a lease, customers may upgrade to newer equipment if available. Used equipment is returned to Pitney Bowes, which evaluates the condition of the used machine and makes a disposition decision: recycling (done for the worst quality returns); dismantle for parts harvesting (done for medium quality returns), or remanufacturing (done for best quality returns). The remanufacturing process at Pitney Bowes includes total or partial disassembly, cleaning, replacement of consumable parts, cosmetic operations, upgrade of certain modules, and reassembly and testing. Remanufactured products are sold as a cheaper alternative to new products. The forward and reverse flows in a closed-loop supply chain (CLSC) impact each other: customers may opt for either remanufactured or new products, depending on their perception of qualities and prices for both products. The quantity of leased new products determines the availability of returns for remanufacturing in future years. As a result, management of a CLSC requires coordination between forward and reverse flows.

Figure 7.1 Closed-loop supply chain for Pitney Bowes.

7.2 Product Acquisition

In regular manufacturing, the inputs—raw materials and components—are homogeneous. For example, two parts, with the same part number, supplied by the same supplier, are virtually identical. Sourcing parts from a certified supplier consists of ordering a given quantity of parts. In most cases, the quantity is at the manufacturer’s discretion. The timing of arrival of these parts at the manufacturing plant can be predicted with a high degree of accuracy, as the order cycle time is usually known. In contrast, the inputs in remanufacturing—product returns, or cores—are heterogeneous in quality, quantity, and timing.

Particularly for end-of-use returns, the quality of returns is highly variable, depending on customer usage patterns and operating conditions. For example, an analysis of a sample of mailing equipment returned to Pitney Bowes in a given month, after a four-year lease, revealed the number of cycles (number of times the machine was used to run a job) to be between 200,000 and 1.6 million. Clearly, the amount of work, in labor and parts, necessary to restore these machines to a common esthetic and operating standard will vary significantly. In settings in which the quality of returns varies highly, firms need to implement a quality grading scheme. Incoming returns are graded according to a finite number of quality categories. This categorization is critical for planning capacity and managing the inventory of returns, particularly when returns exceed demand for remanufactured products and excess returns can be salvaged (for recycling or spare parts for example). Better quality returns have lower remanufacturing cost, consume less production capacity, and have higher salvage value. An academic study has concluded that five quality categories (e.g., worst, bad, medium, good, and best) are sufficient for deriving most of the benefits of quality grading.5

The uncertainty in timing and quantity of returns is mitigated when the firm leases most of its production, as is the case with Pitney Bowes, and can be minimized by implementing a proactive acquisition strategy that controls the incoming return stream. Such strategies include:

1. Offering trade-in rebates. Cummins offers a trade-in rebate for customers who buy a new diesel engine, if they return their old diesel engine. The trade-in rebate ensures a flow of returned diesel engines, which Cummins can remanufacture.

2. Prepaid mailers. Dell offers free collection and recycling of computers to residential customers upon the purchase of a new computer; this is done through a prepaid mailer.

3. Higher prices for better quality returns. Some cell phone remanufacturers control the quality of their return stream by offering higher prices for better quality returns.

7.3 Remarketing

Remanufactured products often are perceived to be inferior to new products. Researchers6 auctioned identical new and remanufactured power tools on eBay and identical new and remanufactured Internet routers on eBay Business. The remanufactured and new products had identical manufacturer warranties. The researchers found that the winning bid—a measure of a consumer’s willingness-to-pay—for the remanufactured product was 15 percent lower, on average, than the winning bid for the new product. Another study7 found average price discounts for remanufactured products relative to new products ranging between 15 percent for some consumer electronics and 40 percent for video-game consoles at eBay; the remanufactured and new products had similar warranties. The large USITC survey8 of American remanufacturers in diverse industries (such as compressors, automotive parts, office furniture, electrical motors, and industrial machinery) finds that remanufactured products command a 30–50 percent discount relative to comparable new products. Volkswagen remanufactured engines and parts in Europe command the same warranty as corresponding new engines and parts, at 24 months. Warranties for new and remanufactured products are about the same in the office furniture, power tool, and consumer electronics categories, even though the remanufactured products are cheaper by 40 percent, 15 percent, and 15–20 percent on average. Warranties for remanufactured toner cartridges can be as much as twice the length of new-cartridge warranties, although remanufactured cartridges are about 50 percent cheaper than new ones. Overall, it appears that, on average, the warranty period for remanufactured products is slightly shorter than that of new products. Shorter warranties only partially account for the price difference between new and remanufactured products. It appears that most of the price differences are better explained by consumer perception of remanufactured products.

Because of consumers’ lower willingness-to-pay for remanufactured products, OEMs that remanufacture their product returns (e.g., HP, Bosch, Pitney Bowes, and Cummins) price their remanufactured products at a lower point than new products. By doing so, they are able to expand their customer base by attracting customers who would not buy their new products because of the higher price. This is the market expansion effect. Still, price points (and corresponding warranties) must be chosen carefully to minimize the cannibalization effect, which is when customers who are willing to buy a (higher margin) new product buy a remanufactured product if it is priced significantly lower. To decrease cannibalization, many OEMs do not sell remanufactured products in the same channel as new products. For example, consumers cannot buy remanufactured HP computers at Best Buy. Instead, they must go to HP’s online outlet store. Other OEMs, such as Cummins, offer remanufactured and new engines at the same dealers, because they believe the market expansion effect outweighs the cannibalization effect.

Some have argued for the existence of a green segment: consumers in this segment prefer a remanufactured product to a new one if they are in the same price range, although many consumers simply do not associate remanufactured products with green.9 There is some evidence that some consumers prefer products with recycled content (but as seen before in Chapter 1, recycling and remanufacturing are distinct operations), as evidenced by the vibrant market for recycled office paper (even though recycled office paper costs about 6 percent more than virgin pulp paper due to the need for bleaching).

7.4 Industry Practice

Remanufacturing practice varies considerably from industry to industry. OEMs in some industries, such as manufacturers of printer cartridges, never offer remanufactured products because they fear cannibalization.

In other industries, such as the power tool industry, remanufactured products are seen by OEMs as an opportunity to expand their customer base and undercut competition from cheaper, non-brand name imports. As in the example of Pitney Bowes’ mailing equipment, some industries have an abundance of product returns relative to demand for remanufactured products. For these industries, remanufacturing is constrained only by consumer demand, while in other industries, such as diesel engines, firms have to put incentives in place to collect the number of returns necessary to meet demand for remanufactured products.

These practices are discussed in more detail for four industries: cell phones and information technology (IT) networking equipment in Table 7.2, and automotive engines and cartridges in Table 7.1. These industries represent a range of products, from mostly mechanical (automotive engines) to mostly electronic (cell phones), as well as a range of remanufacturing processes, from very comprehensive (automotive engines) to faster and simpler (IT networking equipment). The information presented here was collected through plant visits and interviews with managers and from various online sources (e.g., websites of companies and trade associations and various online publications).

Remanufactured products can belong to the same technological generation as new products, or to an older generation. Same-generation technology can be found in industries where the technology does not evolve as quickly (e.g., retreaded tires for trucks), or when the product’s useful life (sojourn time with the customer) is much lower than the product’s lifecycle even if technology evolves quickly (e.g., toner cartridges). Finally, one can find same-generation remanufactured products, such as personal computers, smartphones, printers, and power tools, which originate from consumer returns. In many other cases, such as automotive engines, some Pitney Bowes equipment, medical equipment, and electrical motors, remanufactured, and new products may not belong to the same technological generation. In these cases, remanufacturing may provide some upgrades to the older technology, making the remanufactured product more appealing.

Consumers use remanufactured products as a natural substitute for comparable new products. However, as previously discussed, consumers rarely view remanufactured products as perfect substitutes for new ones. This perception of lower quality is reflected in the different pricing practices: remanufactured engines can be priced 40 percent lower than new engines; larger discounts can be found for older technology products such as some older IT networking equipment (discounts of as much as 95 percent). In general, the data in Tables 7.1 and 7.2 support the 30–50 percent discount range found on a larger-scale survey.10

Estimates of market size are based on the current sales by remanufacturers (e.g., $2 billion for information technology networking equipment) and do not indicate potential market size. Remanufactured products may gain more acceptance as consumers and buyers in general become more educated about their quality and performance levels compared with new products. Consumers’ perception of quality may improve as industries consolidate, more rigorous standards for remanufacturing are adopted (typically through strong trade associations), and established players emerge in other industries. In fact, there is strong empirical evidence that a remanufacturer’s reputation plays a strong role in the buyer’s willingness to purchase remanufactured consumer products.11 Another favorable trend for remanufacturing is the increase in leasing and “pay-for-service” practices, where consumers buy a service rather than a product. For example, in the commercial retreaded tire industry, large fleet operators have contracts with tire shops (who are often retreaders) to provide good tires for a certain number of miles. Whether the shop uses retreaded or new tires is not of concern to the fleet operator. Similarly, Xerox offers services where customers pay for the number of pages printed.

Table 7.1 Remanufacturing practice in the automotive engine and printer cartridge industries

Dimension

Automotive engine remanufacturing

Cartridge remanufacturing

Technological generation

Remanufactured engines are typically of an older technological generation, but not necessarily.

Remanufactured and new cartridges are of the same technological generation.

Use of remanufactured products

Primarily by customers who cannot afford or do not want a new engine. Remanufactured engines have warranties between 1 and 3 years.

As a perfect substitute for new cartridges.

Pricing

Up to 40 percent cheaper than a new engine.

About 50 percent cheaper than a new cartridge.

Market Size

Approximately $2.5 billion in the United States (www.pera.org), although some managers indicate it is shrinking due to competition from cheaper imports.

Lyra Research (www.lyra.com) estimates between $100 million and $500 million, which is only 2–6 percent of the market for cartridges (the remainder comprises OEM new replacements and private brands).

Channels

Some OEMs offer remanufactured engines under a different brand (e.g., General Motors); others offer remanufactured and new engines in the same channel (e.g., Cummins).

Remanufacturers’ websites. Some office-supply retailers (e.g., Office Depot) offer their own brand of remanufactured cartridges along with new OEM cartridges.

Source of returns

From dealers and brokers; typically from automobiles involved in accidents or engines that have reached their end of use, or through a trade-in program.

Customers return empty cartridges to remanufacturers (e.g., Laser-Tone) or retailers (e.g., Staples)

Acquisition cost

Varies significantly.

Low—mostly related to the logistic cost of placing collection bins and transportation, or prepaid mailers.

Remanufacturing cost

Between 40 percent and 65 percent less than the cost of manufacturing a new engine. Logistic costs (freight) are a key cost driver, making it not cost-effective to remanufacture in countries with low labor costs.

Up to 80 percent less than manufacturing a new cartridge.

Competitive landscape

Most OEMs (Ford, GM, Cummins, etc.) offer remanufactured engines; remanufacturing may be performed by the OEM itself (Cummins), or by other firms, such as Caterpillar and Jasper.

Large office-supply chains (Office Depot, Staples) are projected to dominate the market; the share of independent refillers is projected to decrease.

Reasons for OEM to remanufacture

To increase revenues, preempting third party remanufacturers, by offering a complement to their product line, an OEM-branded but cheaper remanufactured engine.

OEMs do not participate in the remanufactured cartridge market. OEMs actively attempt to shut down the market by melting older cartridges, adding chips in the product to disallow refilled cartridges from functioning, or limiting the number of refills.

Table 7.2 Remanufacturing in the cell phone and IT networking equipment industries

Dimension

Cell phone refurbishing

Information Technology (IT) networking equipment remanufacturing

Technological generation

Remanufactured and new products may or may not belong to the same technological generation.

Remanufactured and new products rarely belong to the same technological generation, with some exceptions (demo products, consumer returns).

Use of remanufactured Products

For customers not willing to pay full price for a new phone.

As a replacement for warranty claims and for use during repairs.

In nonprofit organizations (e.g., shelters, emergency organizations) and developing countries.

Remanufactured products have much lower lead times and significant discounts. They are used in network expansion and redundancy, as a source of spare parts, and for training.

Pricing

Refurbished cell phones may command significant discounts (up to 50 percent off new).

Between 10 percent and 95 percent off an equivalent new product’s price.

Market size

About $14 billion worldwide, according to Gortner (http://www.gartner.com/newsroom/id/2986617).

Over $2 billion in the United States, according to the United Network Equipment Dealer Association (UNEDA; www.uneda.com).

Channels

Offered through third-party distribution centers or re-manufacturers’ online stores.

Mostly online channels. Larger remanufacturers have dedicated sales forces.

Source of returns

Donations or customer upgrades to a new model. About 140 million phones are retired in the United States every year.

Technology upgrades, firms that go out of business, demo and training equipment.

Acquisition cost

Can be high ($140 per smartphone), due to significant market for second-hand phones.

Remanufacturers offer cash for trade. More popular products have market prices in an active secondary market.

Remanufacturing Cost

Depends significantly on the condition and type of used phone. Phones that cannot be remanufactured are recycled.

Between 5 percent and 20 percent of the cost of an equivalent new product.

Competitive Landscape

OEMs, trade-in firms, and many small firms, operating mostly locally.

Over 260 firms belong to UNEDA, the trade association

Reasons for OEM to Remanufacture

To increase market penetration into consumers with lower willingness-to-pay.

OEMs such as Cisco have a limited remanufacturing program (<1 percent of sales).

Remanufactured and new products may be distributed through the same channel as new products—that is the case with automotive engines remanufactured by major OEMs such as Ford, General Motors and Cummins, Caterpillar’s equipment sold at its dealer network, or remanufactured toner cartridges in large office-supply chains such as Staples. In many cases, remanufactured products are distributed separately, in outlets or online stores, due to fear of cannibalization. This was clear in interactions with managers of consumer electronics and business-to-business IT equipment firms. Across a sample of 274 remanufacturers in diverse industries, a study found that 64 percent of remanufactured products were sold directly to the user. Only 15 percent were sold through retailers and distributors.12

Returns (or cores) are the main input to remanufacturing, and they may come from a variety of sources. In the toner cartridge industry, consumers (or businesses) mail old cartridges to remanufacturers to be refilled. The firm mails back in-stock remanufactured cartridges. Ford collects cores from 4,000 dealers, using the same third-party logistics company that distributes new engines (through milk-runs). Cores are shipped to a location where they are evaluated for quality; bad quality cores are disposed of and good cores are kept in a warehouse for future remanufacturing. Ford maintains several months’ worth of inventory of cores to accommodate long remanufacturing lead times and ensure that the remanufacturing operation is not halted because of a lack of cores. Consumer returns are a natural source of returns for remanufacturing for firms selling to consumers (as opposed to businesses) such as Hewlett-Packard, Dell, and Bosch. The cost of collection and transportation can be a significant cost driver for acquisition in such industries as automotive engines and large and heavy equipment.

Remanufacturing cost is a fraction of the cost of manufacturing a new product. Our experiences with many firms indicate that this cost ranges between 5 percent and 40 percent of the cost of a new product. However, some managers in industries where remanufacturing is labor intensive and technology is complex (e.g., automotive engines) indicated that remanufacturing cost is rising compared with cheaper imports.

For firms considering remanufacturing—whether an OEM or a third party—industry structure (i.e., concentration, number of players) as well as the dynamics of competition between remanufactured and new products are significant factors. As discussed previously, a reason for OEMs to remanufacture is to expand their customer base by reaching a customer segment that cannot afford or is not willing to pay the (higher) price for a new product. By offering a cheaper remanufactured alternative, OEMs also drive away some of the competition from third parties. This reasoning is clear in the automotive engine industry, where most OEMs offer remanufactured engines in addition to new ones. Caterpillar also offers remanufactured equipment side by side with new equipment. It is also in the interest of the OEM to offer remanufactured products from consumer returns, due to the significant potential for value recovery and the relatively lower volume, which outweighs cannibalization concerns. The cannibalization threat, however, can be significant to the point that OEMs refuse to engage in remanufacturing (or do it to a limited extent), as seen in our discussion of toner cartridges, cell phones, and information technology networking equipment. In the tire retreading industry, OEMs develop the retreading technology and license it to other shops, in essence outsourcing the remanufacturing. It is common for the OEMs to outsource the remanufacturing process to certified third parties, as do Ford, Hewlett-Packard, Pitney Bowes, and many others. Most remanufacturing industries are fragmented, with a large number of smaller players, as discussed in the introduction.

7.5 Strategic, Tactical, and Operational Issues in Remanufacturing

For managers considering engaging in remanufacturing—whether as third-party firms or OEMs—there are a number of strategic, operational, and tactical issues to consider:

Strategic. How should the reverse supply chain be designed? Specifically, where are the locations of collection, consolidation, remanufacturing, and recycling sites? Should an OEM remanufacture? If so, what should be the prices and corresponding warranties for remanufactured products? Should the firm lease or sell its products? Should an OEM (over) design certain components of a product so that these components’ parts can be reused for remanufacturing in the future? If so, which components should be reused and which components should be replaced with new components upon remanufacturing?

Tactical. Product acquisition for remanufacturing: How many returns should be procured, at which quality level, and at which price? Production planning for remanufacturing: How many returns of each type (quality grade) should be remanufactured and disposed of in each period? How many returns should be kept in stock for future use?

Operational. How should the different remanufacturing operations be scheduled at the shop? Disassembly planning: What is the sequence and depth of disassembly?

The reader interested in some of the issues in more detail is referred to Ferguson and Souza.13

7.6 Web Resources

RIT Center for Remanufacturing: http://www.reman.rit.edu/gis/remanufacturing

Remanufacturing Industries Council: http://www.remancouncil.org/

Automotive Parts Remanufacturers Association: http://www.apra.org/

USITC Report: https://www.usitc.gov/publications/332/pub4356.pdf