Refund fraud is a significant issue for U.S. retailers, costing billions of dollars annually. In 2023, fraudulent returns accounted for a staggering 13.7% of all returns, resulting in $101 billion in losses. To make the issue worse, this trend shows no sign of slowing down, as fraudsters continue to develop new and innovative methods to exploit retail systems.
With the rise of ecommerce, direct-to-consumer (DTC) retailers are particularly vulnerable as their online-only presence provides fertile ground for fraudulent activities. As the threat continues to grow, DTC retailers must take proactive steps to protect their bottom line.
Understanding Refund Fraud
Refund fraud occurs when individuals claim refunds they’re not entitled to, effectively tricking retailers into believing they’ve incurred an expense when they haven’t. This deceptive practice takes various forms, each designed to exploit different vulnerabilities in retail systems.
One common tactic is receipt fraud, where fraudsters will attempt to return stolen items or items purchased at a discounted price, with an altered or fake receipt. Another prevalent method is the abuse of chargeback systems. In these cases, customers dispute legitimate charges with their credit card companies, falsely claiming non-receipt of goods or dissatisfaction with services received. Similarly, “wardrobing” is also a common tactic used by fraudsters. In this scenario, bad actors will purchase an item, use it or wear it once while keeping the tags on and then return it.
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Increasingly, criminals are turning to digital methods like smishing (SMS phishing) and phishing to obtain login credentials and financial data from unsuspecting victims. Once they’ve gained access to legitimate accounts, these fraudsters can commit refund fraud on a larger scale, often remaining undetected for extended periods. The online nature of DTC retail makes it particularly susceptible to these tactics, as fraudsters can easily create multiple accounts to commit fraud systematically.
How to Prevent Refund Fraud
To protect businesses from the growing threat of refund fraud, DTC retailers must adopt a multi-faceted approach. This strategy should begin with a thorough evaluation and strengthening of return policies. Retailers need to implement clear, consistent guidelines that outline the conditions for returns and set reasonable time limits on receipts. Adding verification steps or introducing slight delays in the refund process also can help deter fraudulent claims without significantly impacting the experience of legitimate customers.
Data analytics plays a crucial role in identifying and preventing refund fraud. Retailers should leverage velocity checks to detect suspicious activity on their platforms. These tools monitor the frequency of transactions and can help pinpoint vulnerabilities in existing policies. By tracking patterns such as multiple refunds to the same customer, frequent returns of high-value items or sudden spikes in refund requests, retailers can quickly identify and investigate potential fraud cases.
Investing in advanced technology is perhaps the most critical step in combating sophisticated refund fraud. More advanced fraudsters often use multiple or compromised devices designed to look like distinct ones, making it difficult for traditional device-based fraud prevention methods to detect patterns.
As a result, relying solely on device-based solutions won’t catch the connections between these fraudulent transactions or recognize that systematic refund fraud is taking place. That’s where behavioral signals and location intelligence become crucial. By analyzing patterns in network signals and device locations, these technologies can associate different devices and identify suspicious activity at scale, such as a sudden spike in refund requests or multiple returns of high-value items.
Incorporating these technologies allows retailers to track suspicious patterns, identify fraudulent accounts and prevent abuse of refund policies.
The Bottom Line
Refund fraud poses a serious threat to the bottom line of both retailers and e-tailers, with increasingly sophisticated tactics that allow fraudsters to exploit weaknesses in digital retail systems.
Relying on outdated systems guarantees failure. Instead, retailers must invest in user identification solutions that analyze device attributes and user behavior to reveal suspicious activity at scale. Success in this battle hinges on the ability to act swiftly and intelligently, protecting revenue while building customer trust.
André Ferraz is the Co-founder and CEO of Incognia, an innovator of next-generation identity solutions that enable secure and seamless digital experiences. As a seasoned entrepreneur and technologist, Ferraz has co-developed one of the most precise location technologies in the world. Ferraz started his first company at University in Brazil, and before Incognia, he and his co-founders established In Loco, an ad tech business acquired in 2020. Ferraz and his team have spent over a decade perfecting the location technology that has been recognized by ACM, IEEE, and Microsoft Research for its unmatched performance and precision. As an active member of multiple startup and entrepreneurship support organizations like Endeavor, Ferraz is committed to giving back by mentoring other founders and inspiring the next generation of innovators. Incognia is securing hundreds of millions of devices across 25 countries. It is headquartered in California and has teams in Brazil and the U.S.
