If Q4 is the holiday shopping season, then Q1 might be the season of returns, or, more specifically, the season of return fraud.
Retailers and ecommerce merchants are seeing a growing trend of returns and fulfillment scams that drain profit margins after big sales. This fraud was the impetus for Thursday’s launch of Pinch AI, a startup that aims to mitigate such losses to fraud and marketing scams, with $5 million in venture backing.
Pinch was founded by former PayPal and Google ecommerce and ad fraud engineers who saw firsthand the volume of ecommerce fraud and the losses retailers absorb on the back end of sales. This type of fraud is “very underrepresented, but fast-growing,” said Arthi Rajan Makhija, co-founder and CEO.
First-party fraud
One type of ecommerce fraud is straightforward: when bots or malicious fraudsters use stolen identities or credit cards to complete a purchase. But first-party fraud, the type that Pinch is designed to handle, occurs when a shopper uses their own name and credit card but is “skimming the edges” of what they know to be right, Makhija said.
Many such shoppers likely don’t imagine themselves as fraudsters. Often these tactics are circulated in forums like Reddit, Discord and Telegram, she said, where they might be presented as shopping “hacks” or “loopholes.”
One tactic, known as “wardrobing,” involves buying clothing, apparel, jewelry or items that might be used once or twice and then returned, ostensibly unworn, within a given return window. Theoretically, Makhija said, someone doing this could purchase new clothes over the course of the year while paying for none of them.
Another common tactic is “empty boxing,” when a return is made but without the original item inside the returned package. Often the box will be weighted down with cardboard or other junk to give it heft. The refund claim is often paid before someone at a warehouse unboxes the return and realizes the scam.
Perhaps even more insidious is when an older item is returned. Ecommerce companies with extended return windows have discovered customers return a well-worn item expecting to collect a refund. This is another problem entirely, Makhija said, because retailers must also be careful not to resell that item.
Returns on investment
Ecommerce sellers face a quandary with this type of first-party return fraud. Identity fraud and stolen credit card info is difficult to spot but easy to treat. Any online shopper that sets off identify fraud alarm bells is blocked from buying.
But when people are using their own names and info, and aren’t necessarily breaking the law but are skirting the edges of right and wrong, that’s a harder call to make.
“There’s always going to be a gray area,” Makhija said.
If a first-time buyer from a merchant raises some red flags for Pinch but hasn’t been a repeat abuser or isn’t a confirmed return-scam aficionado, should a seller proactively block that customer?
“Risk appetite on that first return is pretty high,” Makhija said. Meaning that retailers are almost always willing to give an unknown but real human customer the benefit of the doubt.
There is also a spectrum of “graduated friction” that can be introduced to the process, she said, based on the merchant’s appetite for potential margin losses on returns and confidence that a particular shopper is a scammer.
The purchase might be allowed, for example, but the merchant could alert that the normal return window is being shortened. Another option is to notify the shopper that, to collect a refund, the purchased item must be returned to a physical store or drop-off location. By “burning the anonymity” of those online shoppers and forcing them to present an undamaged item that can be verified, the fraudsters tend to pack up and try a different online store with more lax policies, she said.
And, on the flip side, Pinch might be used by a retailer’s marketing org to segment out the most desirable customers, too, not just the riffraff.
Pinch tends to work in the CFO org, Makhija said. But marketing also gets involved, because, aside from preventing scammers, Pinch could be used to provide repeat customers (valid repeat customers) with personalized or superior return options. Someone with a high lifetime value who’s purchased previously without making returns could be offered an extended return window on a new item, for instance.
Marketing can also be the impetus or source for some scam ecommerce purchases, she added. Big promo deals attract buyers who’ll buy enough to secure a coupon discount, for instance, and then attempt to return some items at full cost.
“Marketing incentives,” she said, are part of what gets discussed and shared at warp speed within these Reddit or Discord channels where people spread news of retailers with weak return policy guardrails.
Most retailers have their own fraud teams that deal with identity fraud and return scams, according to Makhija. But it’s an easy win for marketers to simply understand who those people are and know ahead of time to avoid targeting them with valuable ad budgets.
