How to identify and stop e-commerce refund fraud and return fraud

Today’s online and in-store shoppers have high expectations for refund and return policies. When they need to refund or return something, they want businesses to make the process easy. They want to be able to change their minds about a purchase without judgment or consequence.

And businesses would be unwise to refuse good customers these opportunities. After all, even if a business can’t save the sale, they can still create a good experience and keep their brands in a positive light. But customer-friendly or lax refund and return policies make businesses targets for an activity like “did not arrive” (DNA) and fake tracking ID (FTID) refund fraud. Preventing refund and return fraud means businesses should first understand how these types of fraud differ for e-commerce.

What is refund fraud?

“E-commerce refund fraud is about getting a refund for goods that you purchased without needing to return the goods,” explained Brady Harrison, Senior Data Analyst at Kount. “Bad actors are attempting to defraud the refund process so that goods are not returned.”

E-commerce return fraud is known by a few names. But whether you call it refund fraud, shipping fraud, or cargo loss, it’s a big problem for any company that ships goods or accepts returns. Essentially, e-commerce refund fraud happens when bad actors exploit gaps in logistics or fulfillment processes to turn a profit or get goods for free. Such is the case for empty box (EB) or partially empty box (PEB) and fake tracking ID (FTID) refund fraud.

“The fraud prevention industry has struggled to put a name on it, but bad actors have settled on refund fraud,” said Rich Stuppy, Kount’s Chief Customer Experience Officer, at Kount’s Fall 2020 Digital Protection Summit. “They’re promoting this method as a powerful way to use customer-friendly processes and capabilities against merchants and marketplaces.”

Refund Fraud Quote

Some bad actors are part of larger, more organized groups abusing policies for refunds. But it’s important to know that not all bad actors are in those bigger groups. Some are opportunistic customers who abuse policies or take advantage of busy seasons. And, unfortunately, refund fraud is the kind of fraud that happens without a chargeback or a traditional dispute. Not having that dispute makes refund fraud — or what Stuppy calls “the new chargeback fraud” — hard to detect and harder to fight.

“There are rumors in the market that refund fraud is a bigger problem than chargebacks,” Harrison explained. “From a loss and dollar perspective, it’s more difficult to determine if someone at a warehouse messed up an order or if a merchant is dealing with a bad actor. Unlike chargebacks, which have a well-defined control regime around fraud-to-sales ratios, industry controls around refunds are limited. As a result, a lot of merchants will see higher losses in refunds than chargebacks.”

Types of e-commerce refund fraud

1. Did not arrive (DNA) refund fraud

Bad actors use “did not arrive” (DNA) refund fraud to claim that a package never arrived or was taken by a porch pirate. The bad actor will attempt to get a full refund, which puts businesses in difficult positions, especially when they know the package arrived or the customer signed for it. The bad actor won’t necessarily dispute the initial purchase but the merchant’s logistics and fulfillment processes.

2. Empty box (EB) or partially empty box (PEB) refund fraud

With empty box (EB) refund fraud, a bad actor may claim a business didn’t pack an item properly or the item was stolen in shipment. Partially empty box (PEB) refund fraud is a little more sophisticated.

In this case, a bad actor may have ordered a small, high-value item with a large, low-value item. When they want to commit fraud, they’ll claim the high-value item was not in the box. Logistics play a big role in the appeal of this type of refund fraud. Because merchants may have the least controls in logistics like packing and shipping, it’s easy for bad actors to get refunds.

3. Fake tracking ID (FTID) refund fraud

Fake tracking ID (FTID) refund fraud is among the more complicated types of refund fraud. In this scheme, a bad actor uses refund channels to request a refund for a high-value item. Because the business needs the item returned before refunding money, they send the bad actor a shipping label.

When the bad actor receives the shipping label, they fix it to an envelope or piece of junk mail. And because it’s mail and not a package, it goes to a business’s mailbox where someone may discard it, not knowing it’s refund fraud at work. Later, the bad actor can claim they returned the item and now need their money back.

4. Refund as a service

In this type of refund fraud, opportunistic customers may seek the help of another bad actor to obtain a full or partial refund for goods. Let’s say someone buys a TV and wants their money back on it. They seek support from professional refunders who take down their basic transaction information: email address, shipping address, date of purchase, order number, etc.

The bad actor then impersonates the customer in an attempt to get the refund. They may use chatbots to communicate emotional stories to customer service reps about special items that were lost or broken. That social engineering can get a customer service rep to feel bad and process the refund. Once obtained, the bad actor can take a percentage of the refund.

“Offering refunds as a service appeals to bad actors for two reasons: First it’s easy to manage,” Harrison explained. “The bad actor doesn’t have to walk someone through the process of defrauding. Second, they don’t have to give away their secret sauce to getting refunds.”

How to prevent e-commerce refund fraud

1. Implement a fraud prevention solution that uses AI and machine learning

Kount Command is the predominant fraud prevention software, maintaining a variety of strategies for detecting e-commerce refund fraud. From account creation to login and checkout, Kount’s Identity Trust Global NetworkTM analyzes billions of identifiers to establish real-time links between identity elements and return identity trust decisions. Knowing more about these identity trust elements can help merchants and fraud teams determine when someone is seeking a legitimate refund.

Refund Fraud FTID Stat

“Kount can add identity elements — like shipping addresses, payment tokens, and email addresses — for customers who request refunds often to a grey list,” Harrison explained. “There’s a lot of flexibility, so they can understand more about each transaction before they ship new orders.”

Furthermore, Kount’s AI and machine learning informs refund data. If one merchant declines a purchase because the bad actor’s identity elements are associated with a high volume of refunds, that information informs other parts of Kount’s network. When that bad actor goes to another merchant for a refund, machine learning takes those likely fraudulent refunds into account.

2. Report refund data to your fraud prevention service provider

Reporting refund data to Kount can further inform machine learning and gives merchants more information on customers who engage in excessive refunds or returns. In particular, merchants should report refunds in cases where they don’t get the goods back. For example, if a merchant processes a refund for something they can’t resell, like a food item, their fraud prevention platform needs to know.

In addition, Kount’s Email Insights can inform refund policies. From a policy perspective, a merchant might allow one or two or three refunds for a certain email address. But if an email address is associated with 10 refunds, the merchant knows it may not be a transaction they want to accept. Email Insights is the most robust indicator of an email’s level of trust. It can help predict and stop fraud and help businesses understand a customer’s lifetime value.

3. Educate customer service and logistics personnel on refund fraud

Bad actors found that the more aggressive they are with customer service people, the more likely they are to get a refund. And because refund fraud is easiest to get away with in packing and shipping, it’s important to educate customer service and logistics personnel on fraud.

Merchants and business owners will need to help all personnel understand signs of fraud. Train workers to flag communications for manager review that use social engineering, verify the customer’s identity, and watch out for shipping labels on mail. Businesses might also revise their refund policies to only refund money on store credit or the original payment method.

What is e-commerce return fraud?

e-commerce return fraud (or return abuse) happens when bad actors take advantage of customer-friendly return policies to profit or get goods for free. In some cases, a bad actor may try to return stolen goods or manipulate tags or packaging to return an item for more than it’s worth.

“Return fraud most often happens when someone buys an expensive, one-time-use item for a special occasion and then refunds it,” Harrison explained. “For example, it’s common, right before major sporting events, for people to buy 70-inch TVs and return them.”

Businesses stand to lose a lot to return fraud. In 2019, merchandise returns cost U.S. retailers $309 billion — $41 billion of which came from returns of online purchases. Of the total, an estimated $27 billion in losses came from merchandise return fraud, according to Appriss Retail’s 2019 Consumer Returns in the Retail Industry report.

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Types of e-commerce return fraud

1. Wardrobing return fraud

In this e-commerce return fraud scheme, bad actors wear or use items with the intention to return them later. This is the most common example of opportunistic fraud, wherein a bad actor abuses a policy but isn’t committing fraud on a grand scale. While this is more prevalent among retailers, any business that finds it’s taking a higher-than-average number of returns may be a victim of return fraud. Even if items returned are gently used, businesses can’t resell them at full price. So not only do businesses lose sales on returns, but they lose more on the markdown.

2. Multichannel return fraud

This type of e-commerce return fraud is prevalent among businesses that sell online and at brick-and-mortar locations. In this scheme, a bad actor buys goods with a stolen credit card, then attempts to return items for cash refunds. Unlike opportunistic return abuse, multichannel return fraud is intentional and may be part of widespread fraud activity.

3. Check or eGift card fraud

In this type of return fraud, a bad actor may buy an item with a bad check in one location and attempt to return the item for cash before the check bounces. Thanks to today’s technology, it’s become increasingly easy for bad actors to forge or counterfeit checks to commit fraud. In addition, bad actors can apply similar tactics to commit eGift card fraud. They may steal a gift card balance to purchase an item with the intent to return the item for cash later.

4. Price manipulation return fraud

Bad actors may engage in price manipulation before committing return fraud. In this type of return fraud, a bad actor may alter an item’s price tag, increase its price, and return the item for cash. They may also place a less expensive item in the packaging of a higher-priced item and attempt to make a return.

Return Fraud Graph

E-commerce survey reveals consumer return habits

To learn more about return activity, Kount surveyed over 1,000 U.S. adults and 500 employees at the manager level and above in the 2020 Holiday E-commerce Guide. Among employees surveyed, 42% said that their organizations or businesses allow customers to abuse promotions. For example, these businesses may permit customers to buy enough merchandise to get free shipping but return items later. And that aligns with consumer sentiment on returns, particularly around the holidays.

39% of consumers would be comfortable returning something they’ve worn or used, even if it wasn’t defective. Respondents aged 35 to 44 years and respondents aged 25 to 34 years feel the most comfortable returning items they’ve worn or used, even if items weren’t defective. And when it comes to buying enough to meet a shipping threshold and returning later, 84% of respondents 65 years and older would not engage in this activity. But over half of respondents aged 18 to 24 years (60%) and 25 to 34 years (54%) would.

Overall, 36% of consumers typically return five or more items to retailers for a refund after the holidays. 84% of respondents 65 and older typically return one, two, or no items after the holidays. But younger age groups were more likely to return five or more items after the holidays:

  • 49% of 18- to 24-year-olds return five or more items.
  • 47% of 25- to 34-year-olds return five or more items.
  • 56% of 35- to 44-year-olds return five or more items.
  • 32% of 45- to 54-year-olds return five or more items.
  • 24% of 55- to 64-year-olds and older return five or more items.

How to prevent e-commerce return fraud

1. Use a fraud prevention tool that provides identity trust data

The more identity trust data a business has for each transaction, the better equipped it is to prevent return fraud. Kount customers can enhance their customer knowledge with Data on Demand, which provides thousands of additional data points from Kount’s Identity Trust Global Network. Having additional data means Kount customers can continuously monitor and adjust rules and policies based on near-real-time fraud trends.

For example, being able to see previous purchases can reveal buying trends. If a customer makes higher-value purchases and returns those items around the New Year consistently, merchants can decide whether to accept future returns. Knowing where a customer makes purchases can also be helpful if that customer frequently buys from one location and attempts to return items at another.

2. Cross-train customer service personnel on return fraud trends

Not all store associates or customer service reps have a fraud mindset. But knowing common signs of fraud can help every employee recognize return abuse in action. Train workers to thoroughly check returned items for any signs of wear or damage, especially to price tags. To detect cases of multichannel return abuse, workers might request multiple forms of ID, original receipts, and the item’s original packaging.

3. Enforce clear return policies

One of the best ways to prevent return abuse is to enforce clear policies with associates and customers. That might be adjusting return windows or not allowing returns without receipts or original price tags and packaging. Differentiating which items are eligible for return and refund and which are eligible for exchange can deter opportunistic shoppers. At the very least, businesses could be losing money on policies that associates and customers don’t understand.

Kount’s AI-driven platform delivers the most accurate refund fraud protection

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Kount’s AI-driven platform delivers the most accurate refund fraud protection

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