At holiday time, two words strike fear into the hearts of distribution center managers— reverse logistics. As customers rush to return ill-fitting or broken gifts, the warehouses that shipped them have to figure out how to handle the process backwards.

That challenge is particularly tough for companies that sell through catalogs and Web sites. They deal directly with consumers, and can't rely on brick-and-mortar retail shops to provide customer service and shipping channels. Their percentage of returns is also higher because customers can only browse virtual products, never trying on the real thing.

A typical retailer will get 5% of its product returned every year, but that number can rise above 20% for other channels, says Curtis Greve, president of GENCO Retail Services. Multiply that by a flood of holiday orders or by orders to a popular Website, and it can spell trouble.

The 2002 holiday season showed little growth for retailers, with November up 0.4% and December up a disappointing 1.2%, according to figures from the U.S. Commerce Dept. This year the giants struggled, with sales down (compared to last December) at Target, Federated, and Sears, and barely up at J.C. Penney and Walmart. But even a small Christmas rush puts great strain on warehouses.

But the bad economy spells good sales for reverse logistics companies, since retailers are desperate to squeeze every cent of value from the products they handle.

"In the dot-com boom, reverse logistics rose as a priority, because there are a lot more returns in the direct-to-consumer environment," says David Landau, director of product management at Manhattan Associates. Part of the challenge is that there are so many reasons that products get returned, he says. In the chaos of Christmas, products can be delivered to the wrong address, arrive too late, or get broken during delivery. Furthermore, picking errors can send the wrong product, or clothing can be the wrong size or color. In every case, a DC must decide whether the returned product can be re-sold, repaired, or just recycled.

One solution is to ship a return label with every order, says Ray Greer, CEO of Newgistics. That provides two benefits: it makes the process more convenient for customers, and it lets warehouses track the path of every return by scanning the unique bar code on every label. In a recent application with catalog orders from Eddie Bauer, Spiegel, and Newport News, Newgistics found that 77% of customers making returns used the pre-paid, pre-addressed, return shipping label that was packed with their order. No business can predict its returns, but by planning ahead it can keep customers happy and preserve the value of the twice-mailed merchandise.