Refund Fraud

Table of Contents

1. What Is Refund Fraud?
2. What Are the Most Common Methods of Refund Fraud?
3. How Can Merchants Prevent Refund Fraud?

While no merchant relishes the prospect of issuing a refund, especially if there are shipping costs involved, it's usually better to grant a refund than to deny one and be forced to deal with a chargeback instead. Refunds don't come with the extra fees that chargebacks do, nor do they impact a merchant's chargeback ratio. That doesn't mean that refunds can't be harmful as well, however.

Fraudsters who know how to exploit merchants’ refund policies can be quite adept at profiting from refund fraud, and for merchants, the consequences can be quite expensive. How does return fraud work, and what can merchants do to avoid falling victim to it?

Customers are a diverse and eclectic group, but on some issues, they speak with one voice, and customers are very clear about wanting easy, flexible, generous return and refund policies—especially in e-commerce, where they’re often ordering goods they haven’t been able to examine firsthand.

Easy returns encourage shopping, boost sales, and promote positive feelings toward merchants. They’re also helpful for reducing chargebacks. Any time you can resolve a dispute by offering a refund instead of getting hit with a chargeback, you’re saving fees and avoiding an increase to your chargeback rate.

The challenge for merchants is getting the balance right. When refund policies are too generous and too easy to take advantage of, merchants may find themselves the target of refund fraud.

That means they’re being deceived into giving out refunds that the customer is not entitled to—for instance, giving out a refund even though the customer received and is keeping the product they ordered.

This isn’t a small or theoretical concern—according to the National Retail Federation, nearly 6% of returns may be fraudulent, adding up to more than $25 billion in retail fraud per year. The last thing merchants need is another form of fraud to worry about, but retail fraud cannot be safely ignored.

Refund fraud can overlap with practices like wardrobing, where a customer purchases goods with the intent to use them once and return them for a refund. And because refund fraud often involves claims about shipping and delivery problems, it may also be categorized as shipping fraud. The bottom line is that refund fraud involves exploiting the merchant’s policies in order to steal from them.

Some refund fraudsters may operate in an organized fashion, but it is not uncommon to see opportunistic fraud from customers who convince themselves they’re just “outsmarting” the merchant’s refund policy rather than engaging in criminal conduct.

In this sense, refund fraud is not unlike friendly fraud—the perpetrator doesn’t necessarily think of themselves as a fraudster, but it’s all the same to the victimized merchant. Unfortunately, since refund fraud doesn’t impact chargeback processes, it can be harder to identify and track.

Unfortunately, the possibilities for refund fraud are only limited by the fraudster’s imagination and the merchant’s refund policies. That said, there are some common scams that show up again and again.

Many refund fraudsters will falsely claim that the package never arrived or that the box was empty when they receive the goods they ordered. Even when merchants track deliveries, fraudsters may suggest that porch pirates stole their package.

Other fraudsters may use more advanced schemes, like manipulating shipping labels to make it look like a return has been sent. The merchant can insist that they never got it, but the fraudster can point to their confirmation and demand a refund anyway.

In some cases, customers may order an item with the intention of using it and then returning it. We already mentioned wardrobing, where someone orders expensive clothes for an event and then returns them. Any other item that's typically used infrequently can also be targeted by this scam.

It’s also not uncommon for fraudsters to switch a product with a counterfeit or a substantially similar product with a lower value. One common scam is to order packs of collectible cards, replace them with cards of low value, and return them after resealing the packaging.

One widespread form of refund fraud that can be difficult to identify is when fraudsters use social engineering to convince merchants to allow a refund due to some special circumstances. In this case, it’s not the merchant’s policies that are being exploited, but their willingness to hear their customers out and go above and beyond to make a bad situation right.

In many cases, allowing some flexibility in offering refunds is a good way to prevent chargebacks, but unfortunately, it's something fraudsters can take advantage of as well.

Unfortunately, preventing refund fraud altogether is unlikely. Not only can it be hard to identify, but efforts to prevent it can put you at odds with your customers. Tighten up your refund policies too much, and your good and loyal shoppers may feel mistreated and take their business elsewhere.

Even stopping return fraudsters in the act can be difficult: if you stonewall them on their demands for a refund, they’re likely to go and file a friendly fraud chargeback instead.

In these cases, the best option may be to offer a refund to preserve your chargeback ratio and blacklist the customer from future purchases.

The first step to getting a handle on a refund fraud problem is to track your refund activity and analyze the data to identify patterns of refund fraud. This may point out repeat offenders, products that seem to invite high levels of refund fraud, and other vulnerabilities that you can address.

It’s also essential to review your return and refund policies carefully to look for any loopholes or inconsistencies that might be getting you into trouble and train your customer service staff on how to respond to customers who are attempting to obtain a refund outside of the normal channels.

Because it’s hard to track and the claims can be hard to disprove, it’s easy to minimize the problem of refund fraud and remind yourself that at least a refund isn’t as bad as a chargeback. But with fraudulent return rates as high as they are, this often isn't the best option for merchants who care about protecting their revenue and avoiding fraud. Refund fraud must be included in the list of threats that are accounted for in a merchant’s overall defensive strategy.

When you do decline refunds you believe to be fraudulent, many fraudsters will simply give up, knowing their scheme has failed. In other cases, however, they will go to their bank and request a chargeback. If the bank grants it, it's time to fight that chargeback in representment. While you'll still receive a chargeback fee and an increase in your chargeback ratio, these illegitimate chargebacks can be reversed with the right evidence.

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