Return Fraud: Merchants Beware

For most merchants in the ecommerce space, a robust return policy is crucial to an effective business strategy. User-friendly return policies are highly important to customers, who rely on them as a failsafe for every purchase they make. In fact, a recent study showed that 74% of shoppers research a merchant’s return policy before buying.

But even though returns are such a large part of the retail industry, many merchants aren’t aware of the prevalence of return fraud or the true cost of returns and how that cost can impact their business.  

Returns Are on the Rise

Returns are on the increase, according to many studies, including Incisiv’s 2023 Onmichannel Returns Index, which reports that returns increased by 70% from 2021 to 2022, and that 91% of merchants are experiencing an increase in return rates. This may not be surprising with the state of the economy over the past few years. The COVID pandemic hit many families hard financially, and inflation continues to be an issue in the subsequent economic downturn. With money being so much tighter, it makes sense that customers are pickier about the items they choose to keep.

Ecommerce retail in particular can lead to higher return rates. When a customer chooses an item in a physical store, they can see exactly what the item looks like and usually test it out or try it on. None of those things are true for online shopping; customers may purchase an item online, only to discover after it arrives that it doesn’t fit or isn’t what they thought it would be. Customers may even discover that the item doesn’t work, was broken in transit, or never arrived at all. Item not received (INR) is a huge issue for online merchants that simply doesn’t exist for physical stores.

The Cost of Returns

Though customers clearly expect a return option for items purchased online, it doesn’t come cheap for merchants. According to the National Retail Federation (NRF)’s 2022 Consumer Returns in the Retail Industry, U.S. retailers lost $212 billion in online sales from returns. The Incisiv report mentioned above states that 70% consider free returns to be an important factor when purchasing online. If returns are not free, customers are likely to abandon their carts and not shop with that merchant again. Therefore, the cost of handling returns falls almost entirely on the merchant.

Below are just a few of the costs associated to returns that ecommerce merchants must prepare for:

• Shipping – Customers, by and large, hate to pay shipping costs. This is even more true for returns. But the returned merchandise has to get back to your warehouse somehow, so merchants have few choices except to shoulder the high costs of return shipping. With online stores, people can order (and return) items from all over the globe – and that distance can really start to add up, whether you’re paying a third-party shipping company or handling supply management in-house.
• Restocking – Once the returned items reach your warehouse or storage location, they need to be restocked – and that’s not free, either! Merchants must pay for inventory staff to handle restocking, robust inventory software for accurate tracking, and quality auditors to ensure the items being returned are in the same condition the customer claimed during the return request.
• Buy-Online, Return-In-Stores (BORIS) returns – A majority of customers – 62% according to Incisiv– prefer to return items in brick-and-mortar stores. The NRF’s Customer Returns report says that 26% of total online purchases were returned to brick-and-mortar stores in 2022. Though this may cut down on shipping costs (by letting merchants use their own supply chains to transport goods back to their warehouses), there is a cost involved in BORIS. Merchants who want to take advantage of this trend either need to staff their own physical locations or partner with a brick-and-mortar retailer (which is what Amazon is doing with Kohl’s).
• Return fraud – The NRF reports that online return fraud in the US cost merchants $22.8 billion in 2022! And in fact, they predict that BORIS return fraud will be 48% higher than shipped returns, so that number will only grow. Return fraud can take many different forms. Below, we’ll talk about the two big categories – first-party and third-party.

First-Party Return Fraud

First-party fraud (FPF) is fraud that a customer commits under their own name with their own payment instrument – and most times can be considered abuse rather than outright fraud. These acts may or may not be malicious; some customers commit FPF with intent to take advantage of merchants, while others are simply unaware of the impact their actions have on merchants.

Some common ecommerce first-party return fraud tactics are:

• Excessive returns – Online shopping can make things easier for the average customer (they don’t need to leave home), and more difficult for them (they don’t get to see what the product actually looks like until it reaches their door). This can cause customers to make excessive returns compared to their overall purchase rate. Customers may even use the “bracketing” shopping method, where they over-purchase, selecting multiple sizes and colors of an item to try on at home, then return the rest. While not explicitly abusive, this tactic does cost merchants considerably in shipping and inventory management.
• Wardrobing – Some customers seek to take advantage of merchants by buying clothes, accessories, furniture, and other products to use for a specific event, and then returning the items after the event is over. Since these items have been used by the customer – even if only for a short time – they can be damaged or show other obvious signs of wear that make them impossible to resell. Merchants in this case not only lose out on shipping and inventory costs, but also on any resale value. The NRF says this is a type of abuse that 50% of merchants experience.

What to do About Ecommerce Return FPF

Several big-name merchants have implemented “try it on” programs, where customers can try something out and return it while remaining compliant with the merchant’s return policy. These programs usually either cost a small fee for customers or are part of the merchant’s loyalty program, and they usually put limits in place about how many items a customer can try on and return. This helps merchants recoup costs while giving customers a more realistic return rate goal they can easily stick to.

To help prevent wardrobing return fraud, merchants should clearly specify that only unworn and undamaged merchandise with intact tags can be returned for a refund (barring damage in shipping, of course). They should also use highly visible or even clunky tags, to prevent wardrobers from easily tucking the tags away while using the item at an event. If the customer returns a worn or damaged item or an item missing tags, the return policy should clearly state that no refund will be given – or that only store credit will be given or an exchange made, as suits your business.

Third-Party Return Fraud

Third-party fraud (3PF) is fraud that a bad actor commits using fake identity details and a stolen payment instrument. This is always malicious, with deliberate intent to defraud merchants.

Some common ecommerce third-party return fraud tactics are:

• Returning stolen merchandise – According to the NRF, over 41% of merchants experience this type of fraud. In brick-and-mortar stores, the initial theft is generally done via shoplifting. Ecommerce fraud is less physically risky and can be done at greater scale, so it offers considerable benefits to the bad actors or organized crime rings that commit card-not-present (CNP) fraud. Some items stolen in this way go toward resale, but others are returned to the merchant as a way of laundering money – the bad actor will usually request the refund to be issued on another payment instrument, and the now-clean money can be used for other purposes.
• Item not returned (INR) fraud – Things can and do go wrong in shipping, and it’s not uncommon for products to be lost in transit. In this case, merchants only have two choices: refund the item or replace it. Bad actors realize merchants are in a tight spot when it comes to INR and seek to take advantage – often by claiming they never received an item that was in fact safely delivered. The bad actor essentially gets two for the price of one, on the merchant’s dime.
• Returning other items – Another way for bad actors to play the system is by sending something else in place of the item they’re claiming to return. Anything of the right approximate size and weight will work – a brick, an older model of the item, a broken item. Because many merchants want to provide refunds as quickly as possible (to get the customers shopping again), they’ll often issue the refund amount as soon as the item has been scanned at the shipping service. This means the money is returned before any audits can be done on the item, and there’s no chance for the merchant to withhold a refund if the item is not as described in the refund request.

What to do About Ecommerce Return 3PF

Return fraud is like any other fraud; it can be combatted with the help of a fraud prevention team. The easiest way to catch the bad actors is to catch them at the point of purchase, not the point of return. Once an item has been sold, more variables come into play, and it becomes more difficult for a merchant to control the transaction.

However, there are ways to help prevent return fraud after the initial sale. Perform audits before issuing a refund – this may require a small amount of patience from customers but could save you big on fraud loss. Make sure your inventory team is well-trained on how to spot fraudulent returns, and have them perform audits as quickly as possible after the item has been returned. Any red flags can be directed to your fraud prevention team for a wide-scale investigation into the customer’s purchase and return history to determine if the user should be blocked outright from continuing to do business with your platform.

Merchants should also invest in geo-tracking and picture proof of delivery for their shipments as a way to cut down on false INR claims.

The Fine Line Between Fraud Prevention and Customer Friction

Returns are clearly costly to merchants – and even more so when there’s fraud involved. Yet having an easy return option is important to customers. Return policies can make or break a sale. Every merchant should ask themselves how they balance these two factors in a way that still generates profit.

Some merchants are going against the grain to try to recoup return costs, such as these brands that have started to charge a return fee to offset shipping costs. This, of course, is wildly unpopular with customers. Some merchants with new return fees do waive them for BORIS, so that could be an option for more customers in the future (predictions of increased fraud rates notwithstanding).

On the other hand, return fraud is still a significant problem, even if other costs are mitigated. Merchants may be tempted to implement an across-the-board strict return policy to prevent fraud, but this could cause a significant drop in sales. Research from Salesforce shows that 81% of shoppers have abandoned a brand or merchant after only one bad return experience, and Incisiv says that 58% want a smooth no-questions-asked return experience.

But there is another option: a customized, dynamic return policy based on risk management principles. And that’s something our fraud prevention consultants at IP Services can help you develop!

Our human intelligence team also has considerable experience with the hands-on work of mitigating return fraud by collaborating with your customer service team and analyzing customer data you’re likely already collecting. By looking at account setup criteria, purchase history, and service ticket or return request details, our team can work manually or partner with your existing AI risk solution to identify both first- and third-party return fraud before bad actors have a chance to increase your fraud loss.