Paul Curwell, CPP, CFE, CISSP

What is Returns Fraud?

Returns fraud is a deceptive practice where customers purchase a product from a retailer so as to either temporarily ‘borrow’ the item, or to obtain a refund or store credit. Returns Fraud involves deception on the part of customers, who seek to return a product under ‘false pretences’. Common returns fraud typologies include:

• Online returns fraud – where customers make a false claim in order to obtain a refund or store credit. Typically, these customers claim that they did not make the purchase (when buying using a credit card), that the goods did not arrive, or that the goods which arrived were faulty, damaged or did not match the description when purchased. Many customers do not return these products whilst also claiming a refund, meaning they actually keep the goods and profit from the refund.
• Product substitution with lower cost items – customers purchase a high-quality item from one store / brand, and a similar but low quality item from another store. They may remove product tags or labels, or place the substitute product in the high quality product’s packaging before returning. Often returned goods are not properly scrutinised, or may be returned to third party service providers, and by the time the fraud is detected it is too late.
• Product substitution with counterfeit items – this typology is the same as with lower cost items above, except the substituted product is a counterfeit item. This creates issues for retailers if the counterfeit item is repackaged and released for resale without proper inspection, and can result in brand damage or create consumer safety issues.
• Wardrobing – a common problem especially for online retailers, consumers purchase items of clothing for a specific event (such as a party), use the item of clothing, then return it for a refund or exchange without declaring this use to the retailer.
• Use of fraudulent receipts – some consumers alter or forge sales receipts and use these along with often substituted or second hand goods to attempt a refund without having purchased the item. Physical retailers without robust returns processes, who do not verify information on receipts against their records, or who place returned items to one side to process in quiet periods, are particularly vulnerable.

Returns Fraud can be perpetrated by external parties (i.e. opportunistic individuals and actual customers), employees (i.e. trusted insiders), and external parties in collusion with trusted insiders.

How does Returns Fraud impact retailers?

If not properly managed, Returns Fraud can have significant implications for retailers and may even send struggling businesses to the wall. Returns Fraud will impact profits, operating costs and brand in the market. Examples of the impact of Returns Fraud on retailers include:

• Increased Operating Costs – Retailers may need to employ additional staff to manage and process returns, as well as spending more on loss prevention or fraud protection programs. In some cases, specialist expertise may be required, particularly for high value or complex disputes which retailers are not equipped to handle.
• Card Scheme penalties – Card Schemes such as Visa and Mastercard apply financial penalties to retailers (merchants) where a customer disputes a transaction, such as in the case of ‘online returns fraud’ (above).
• Customer Experience and Trust – Retailers who implement stringent policies risk frustrating or offending legitimate customers, resulting in complaints, negative ratings online, or refusal to deal with the brand again. Balancing customer experience with retail security is a huge challenge.
• Returned Inventory Management – The ‘reverse supply chain’ is challenging for any retailer, but it needs proper attention to mitigate risks of substituted, damaged, soiled, or counterfeit product being accepted, repackaged, and resold as legitimate by a retailer with potentially disastrous results.
• Financial losses – As mentioned in my previous post ‘Product Security is fundamental to Product Management‘ (see “Security and integrity risks need to factor in pricing decisions“, link below), once a product has been stolen or diverted a retailer needs to sell significantly more product units to recover those losses. Over time, these losses erode revenue and impact profit margins, potentially making the business unviable.

The challenge with Returns Fraud, as with any other security program, is the need to balance the inherent risk of Returns Fraud with customer service and customer experience. Some retailers have accepted a high incidence of Returns Fraud, only to find it has eventually sent the business bankrupt as word gets around the retailer is an easy target and the incidence of fraud increases.

Three simple steps to mitigating Returns Fraud risk

Recent media reporting indicates the incidence of Returns Fraud is increasing worldwide, particularly wardrobing and online returns fraud; however, there are three steps businesses can take to mitigate the risk:

• Return policies – Policies must be clear, legal, compliant with card scheme rules (for credit card payments), and transparent to allow consumers to understand retailer expectations and conditions of sale. Policies should be displayed prominently on the website and in-store, and customers should acknowledge conditions of sale in writing prior to payment. Evidence that a customer has read and acknowledged these policies should be retained by retailer systems and processes in the event of a legal dispute.
• Using data analytics for fraud detection – data is essential for detecting unusual patterns or behaviours indicative of returns fraud. Provided the required data is collected, typologies can be developed and dashboards built to quickly facilitate detection. Examples of indicators retailers might look for in their typologies include customers who frequently return items (analysed data should include customer name, address, phone number, or email address to identify common purchases using fictitious names); returns of specific products or product categories within 48-72 hours after purchase; and returns of ‘prestigious’ items which consumers might not be able to afford. Early detection, proper investigation, and collection of evidence is crucial to minimising a loss.
• Build high levels of employee awareness and a strong security culture – Employees are one of the most important elements of any security or fraud program. Poor awareness of fraud and security creates ignorance of the risk, preventing staff from being able to recognise problems and respond in a timely manner. Staff should be trained both on commencement and periodically (at least annually) throughout their employment, with targeted training being undertaken in response to new trends or criminal tactics. Further information on improving security culture can be found below.

As you can see, the risk of Returns Fraud is real and must be properly understood, assessed and managed by retailers to mitigate unplanned losses and vulnerabilities. Failure to properly consider and plan for Returns Fraud in any retail business is likely to result in substantial financial loss, legal disputes, and brand damage, and may even send the business into insolvency.

Further Reading

• Curwell, P. (2022). Typologies demystified – what are they and why are they important?
• Curwell, P. (2023). 6 steps to improving security and integrity culture in the workplace
• Curwell, P. (2023). Often overlooked, Product Security is fundamental to Product Management
• Curwell, P. (2023). What are the main e-Commerce frauds targeting online stores?

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