Retail Return Fraud: What It Is, and How to Balance Security With Customer Satisfaction

Return fraud is one of the biggest threats to an ecommerce merchant’s bottom line. According to a 2023 study from the National Retail Federation, 13.7% of 2023’s retail returns were fraudulent or abusive, costing retailers more than $100 billion.

Lost revenue isn’t the only threat. Another significant challenge is handicapping the post-purchase customer experience in an effort to discourage return fraud. Suppose you charge high return fees or force the customer to call a live agent if they want to return an item. These tactics can alienate honest customers with legitimate returns, causing them to switch brands.

Combating fraudulent returns without alienating legitimate customers isn’t easy, especially as fraudsters’ methods become more sophisticated. But there’s good news — fraud-prevention techniques are getting more sophisticated, too. They protect your business while helping safeguard customer trust. And there are many techniques you can put into practice today.

Most common types of return fraud

Before you can take steps to reduce retail return fraud or refund abuse, you must understand its most common types. Unfortunately, the list that follows will only grow longer as merchants get better at deflecting fraudsters’ schemes because fraudsters will continue to get better at finding new ways to take advantage of merchants.

Wardrobing

This type of return fraud is most destructive to fashion merchants, but it can also apply to electronics. Fraudsters will purchase a shirt online, wear it briefly with the price tag on, then return it claiming non-use. 

Sure, you get the product back. But now you may have to discount it for future buyers since you can’t confirm that the shirt is still “new.”

Bricking

Bricking occurs when a shopper purchases some electronics item (like a laptop), strips it of resellable components, then sends the item back as defective.

As a merchant, you often can’t tell from the item’s exterior that it’s been bricked, so you issue a full refund. The fraudster gets their money back, and they make money from the parts they stripped.

If somehow that bricked laptop goes back into inventory, the next customer who buys it will return it. You’ll likely have to pay for return shipping and devote labor hours to figuring out what went wrong.

Fake Tracking ID (FTID) Fraud

This type of fraud is when someone modifies a return postage label to go somewhere other than the returns center. The fraudster will typically send an empty box or a piece of junk in place of the correct item, and the tracking information will show the package as delivered to the returns center.

Defective Return

Suppose a customer buys a waterproof speaker and drops it accidentally, breaking it. That customer becomes a fraudster if they purchase an identical speaker and return the damaged one, claiming it arrived broken. 

Price Arbitrage

Price arbitrage starts when a fraudster buys an expensive item like a Gucci handbag as well as a cheap knockoff. They then return the cheaper item as the original, requesting a refund.

Returning Stolen Goods

In many cases, fraudsters returning stolen goods won’t have a receipt, which means merchants won’t issue a cash refund. Many will instead offer a store credit or gift cards. Once issued, fraudsters can go shopping on your dime.

Tender Liquidation

Fraudsters “tender liquidate” when they buy an item with a stolen credit card and return it later. They’ll have a receipt, bolstering the likelihood of getting a store credit.

Tender liquidation can be a more damaging type of fraud than returning stolen goods. If a bank determines that you, the merchant, is using outdated or less-secure technology, you may be liable for what’s called a chargeback. The bank will force you to reimburse the fraud victim.

Your bottom line takes a double hit in these situations. You’ve already issued a credit to the fraudster; now you’ll have to pay out that amount a second time.

Empty Box Fraud

These types of fraud occur when a shopper orders a product but then claims the package arrived without the product inside.

Ecommerce fraud prevention tactics

Return fraudsters often use multiple accounts and fake identities in their schemes. Any fraud-prevention technique you deploy must take these practices into account. Here are some best practices ecommerce stores are already using.

#1: Require more contact information for returns.

Many financial institutions require two-factor authentication to confirm someone’s identity before they can access their online accounts. Use the same method to help confirm a customer’s identity before authorizing a return.

If you have a return portal in place, you likely ask the customer for an order number and email address before they can proceed. But suppose a stolen credit card was used to place the order, and a fraudster is trying to get quick cash from you.

Fraudsters who steal credit card numbers often steal phone numbers, too, since ecommerce orders require them. They often pull these numbers from the dark web or obtain them from a data breach. Many of these fraudsters won’t have a phone connected to these numbers.

By adding SMS verification to your return portal, you can better confirm the shopper’s identity and deflect fraud coming from stolen credit cards. 

Is this method foolproof? No, but it can discourage and prevent inexperienced fraudsters from taking advantage of you.

#2: Track buyers’ digital footprints.

A single return attempt might not set off a fraud alarm. It often takes months or years to recognize patterns of user behavior that indicate fraudulent activities. Tracking shoppers’ digital footprints helps you pin down these unusual patterns.

A customer’s digital footprint is a record of their online behavior. To combat return fraud, you should zero in on the following behaviors in particular:

• Social media activity. Suppose you suspect a fraudulent return request. If you connect the customer’s email address with unused social media accounts, or with accounts featuring disturbing posts, the return request’s fraud potential increases.
• Online transactions. A sudden flurry of orders followed by excessive return requests might be a sign of wardrobing.
• Device information. Customers place ecommerce orders with a laptop or mobile app. If a shopper with an Indonesian IP address requests a return for an order associated with a US billing address, you could have a fraudulent request.
• Communication data. A fraudster with a bricking or price arbitrage scam in mind might use multiple emails to order products and then return them. Often these emails have patterns that link them to a single source, like j.ohndoe, jo.hndoe, joh.ndoe, and john.doe. Recognizing these patterns is key to stopping potential return fraud.

Of course, tracking digital footprints has privacy implications. Before moving forward with it, make sure you understand the privacy laws in the states and countries where you do business. 

For example, California’s Consumer Privacy Act (CCPA) gives customers the right to know what information you have about them and how you use it. IP addresses of visitors to your website that can be linked to a consumer or household may qualify as “personal information.” To avoid problems, it’s a good idea to mention in your return policy and privacy statement that you might use them for fraud prevention.

#3: Assign customers a risk score.

Risk scores are numbers that indicate how likely a customer activity, like a return, is fraudulent. You’ll need to purchase fraud detection software to start assigning scores, but it will pay for itself with the revenue you’ll save from fraudsters.

To assign risk scores, the software feeds user activity through a set of “rules” you set. The more rules the activity breaks, the more likely the activity is fraudulent.

Suppose a customer starts an online return, and the software gathers these data points among many others:

• The IP address the customer is using is from a spam blacklist.
• The customer’s phone number is valid.
• The customer’s email address is undeliverable.

If one of your rules is that undeliverable emails are red flags, the software might assign ten points to this violation. A valid phone number isn’t usually a red flag, so it gets zero points. The higher the final point total, the greater the risk of return fraud.

Based on point thresholds you set, the software can accept or reject a return automatically, or submit the return request for manual review. 

Remember the possibility of using SMS verification to confirm a returner’s identity? If you worry it creates too much friction, use risk scoring to hold that requirement for shoppers whose return request raises a certain number of red flags.

#4: Use artificial intelligence to validate return claims.

AI is especially important if your company needs to process returns on a large scale. Hiring more customer service personnel to process returns manually usually doesn’t make long-term financial sense. And if you overload existing employees with manual claim processing, the risk of erroneously denying a valid return — or approving false claims — goes up.

For AI to improve your return process, you must train it on vast amounts of existing data and create algorithms that help it interpret that data. Today, that data can include the billions of Google images and lists of known bad actors who’ve taken advantage of merchants like you.

How is this helpful? Imagine a situation where a fraudster wants to return a laptop because they claim it was damaged during transit. In reality, they “bricked” it. 

If you request photos of the damage, the fraudster might pull an image from Google. AI can detect this scam much better than a human, and if the person shows up in the database of bad actors, you can quickly deny the return.

AI systems not only help keep fraudsters at bay, but they can also boost customer satisfaction. Thanks to AI’s ability to compare one return claim against customer data gleaned from millions of other claims, it can approve legitimate claims in a matter of seconds. The customer will be delighted by both the speed of the claim resolution and the knowledge that the replacement product is on the way.

Combat return fraud to reduce retail shrink

Return fraud is a major source of inventory loss or retail shrink, which you as a merchant must account for on your balance sheet. Fortunately, there have never been more affordable tools in place to safeguard the customer experience while deflecting fraud.

If you’re still unsure how much fraud is impacting your bottom line, read this article about retail shrink and its crushing impact on your financial stability.