The Houthi attacks on cargo ships in the Red Sea, which started last year, sparked concern about the impact on retailers confronted with increased shipping rates and longer journey times as freight is rerouted from the troubled region.
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For the last three years, Robert has used a different email address to take advantage of a Black Friday Hulu promotion that most recently offered new customers a yearlong subscription for just $1.99 a month instead of the usual $7.99 monthly cost.
The social media manager has used similar tricks to score multiple first-time customer deals on sports betting websites and when buying Manga, a form of Japanese comics.
“I really don’t have empathy for a major company. I genuinely just don’t care,” Robert, a 31-year-old who asked to be referred to by his first name only because of privacy reasons, said in an interview with CNBC from his home on Long Island, New York.
“It’s easy to do it online where all you’re doing is just creating a new email address or creating a new account and it’s like, you’re never actually going to have to speak to anyone about it and there’s really no accountability, so, why not do it?” he said.
This type of “friendly fraud” might feel harmless and seem like a small drop in the bucket for powerful corporations. But taken together with more nefarious forms of fraud, it’s costing retailers more than $100 billion per year, according to Riskified, which published a new study on the problem on Thursday.
Riskified uses artificial intelligence and automation to fight fraud and boost revenue at major retailers including Wayfair, Peloton, Revolve and Canada Goose. For the study, it surveyed over 300 global companies with more than $500 million in total annual revenue.
The firm found retail policy abuses, such as return fraud and using fake email addresses for promo codes, is rising for some retailers. The practices tend to spike during the holidays or during times of high inflation.
About 90% of the companies polled in Riskified’s study said offering generous refunds, return policies and promotions to drive sales and increase customer loyalty are important to their overall business strategies. However, the misuse of such policies is proving to be a major drain on profits, forcing some to think twice about offering such freebies as retailers look to protect their margins while they face high costs, rising shrink and a slowdown in discretionary spending.
“In our experience with merchants over the past two years, especially as they’ve been sharpening their pencils around profitability, they’ve really started to take a harder look at this,” said Riskified CEO Eido Gal.
“When you think about how easy it is to call in and say I never received my item, I received the wrong item, I want a different size, you can get a refund or a new item incredibly easily,” Gal said. “It’s much more easier to do that than it is to steal financials or credit card information and I think fraudsters have caught up to that.”
The spectrum of abuse
In some cases, friendly fraud is considered a cost of doing business and something retailers must contend with as part of customer acquisition.
It includes practices like using multiple email addresses to take advantage of promotions more than once, buying multiple items with the intention of returning most of them or wearing an item with plans to return it and not pay for it.
However, serial and professional fraudsters are exploiting those lax policies and taking those abuses a step further, according to the study.
In one example analyzed by Riskified, a company identified 137,000 fake accounts created by just 4,000 abusive customers looking to take advantage of a steep 35% discount promotion for first-time customers. It cost the company more than $14 million annually.
In another case, a top pet supply company based in the U.S. lost $3.5 million in the first quarter of 2023 alone after a small group of serial fraudsters exploited a promotion code for a 35% to 50% off discount.
In other cases, fraudsters claim they never received an order when they actually did, so they can receive a refund and get the items for free.
A majority of respondents, 55%, said their costs from those kinds of tactics were “very significant” in 2022, suggesting it has become more common and costly compared with other types of abuse, the survey said.
“Merchants don’t have the time or resources to follow up on claims. In fact, it could cost them more to investigate these claims one by one than to just accept what the customer claims,” the survey said. “Companies that ship products to consumers all over the world may not have visibility into who their last-mile delivery partners are, thus they can’t invalidate claims with any certainty.”
Other types of nefarious policy abuse include returning empty packages for a refund or using bots to buy out highly valued, limited-edition items, only to resell them for a higher cost on a third-party platform. The technique is common for limited-edition sneaker drops and concert tickets, which happened during sales for Taylor Swift’s Eras Tour.
What are retailers doing about it?
Sixty-five percent of the survey’s respondents said they rely on manual reviews for at least a majority of their refund and return claims. The process can be costly, time-consuming and ineffective.
“One survey respondent even said they would rather have a customer break into their warehouse and steal an item than order it and return it because their returns process was so long and costly,” the survey said.
Gal, Riskified’s CEO, said the “smartest” companies are starting to be more selective about who should receive freebies, and are using customer histories to determine who should have to pay for a return and who can send one in for free.
“Let me give my best customers free returns always because that’s the convenient thing and that’s what I want to do to be competitive and let me work through and understand the identities of who’s not my best customer, and they would still have that restocking fee,” said Gal.
ThredUp, which sells pre-owned clothes online, has a dedicated fraud and abuse task force that uses data and enhanced account monitoring to fight bad actors who are taking advantage of programs, the company told CNBC.
For example, the company recently introduced a feature dubbed “Keep for Credit” where customers interested in making a return are given the option of keeping the items in exchange for store credit. It cuts down on the cost ThredUp faces for restocking returned items and brings shoppers back into the store to buy more.
Disclosure: Comcast, which owns CNBC parent NBCUniversal, is a co-owner of Hulu.
Ships in the Singapore Strait.
Andrew Merry | Moment | Getty Images
It’s been a slow summer for shipping routes from Asia to Europe and beyond — and hopes of a traditional peak season when holiday orders are imported are fading.
As firms making goods from apparel to electronics hold excess stock, there’s less of a demand to ship products. This means some vessels are waiting in ports because of sailings being “blanked,” or canceled.
MSC, the world’s largest container company, canceled last week’s voyage of the 366 meter long MSC Deila from Asia to northern Europe due to “slowing demand” on the route, it said on its website.
The massive vessel can carry 14,000 20-foot shipping containers (known as twenty-foot equivalent units, or TEU) and its sailing was also canceled the week before. “We are arranging a contingency plan with alternative services,” MSC added. In late July, the company also blanked a scheduled sailing of the MSC Topaz on a similar route.
“Carriers will be doing … ‘capacity management,’ which means laying up ships,” said Sanne Manders, president of ocean and air at freight broker Flexport, speaking to CNBC by video call. “If you fly to Singapore, you’ll see all these ships outside the port … A lot of ships are parked there waiting till there are better yields,” he added.
The blank sailings come as large shipping companies’ latest earnings plunged. Last month, CMA CGM said its EBITDA (earnings before interest, taxes, depreciation and amortization) for the second quarter was down 73% to $2.6 billion compared to the same time last year, while Hapag-Lloyd’s first-half EBITDA was down to $3.8 billion from $10.9 billion for the same period in 2022.
Maersk reported a sharp fall in its second-quarter profit before interest, tax, depreciation and amortization of $2.91 billion, well below the record $10.3 billion for the same quarter in 2022.
More capacity
“Looking at the next couple of months, there’s still a lot of capacity going to be added specifically on the ocean side,” Manders said. “And that will keep rates … severely under pressure,” he told CNBC.
Indeed, shipping companies ordered record numbers of vessels after the Covid-19 pandemic brought them “enormous” amounts of excess cash, according to investment firm Bernstein in a research note published last week. “The addition of hundreds of thousands of TEUs by the biggest shipping lines will likely keep rates from sustained expansion in the near to medium-term,” Bernstein’s analysts said.
“Freight rates from Far East to North Europe have by now been under significant pressure for a little over a year,” according to according to Niels Rasmussen, chief shipping analyst at the Baltic and International Maritime Council (BIMCO), in an email to CNBC.
Spot container rates reported by the Shanghai Shipping Exchange were down nearly 90% for the three-month period March to May, when compared with the same period in 2022, Rasmussen added.
“Rather than concluding that volumes are weak, we therefore find it more accurate to conclude that liner operators have been unable or unwilling to adjust ship capacity to actual demand,” he added.
Excess stock
Flexport, which is at 10th place in CNBC’s Disruptor 50 list, regularly surveys customers on how much stock they’re holding.
“When we looked in March, there was 62%, saying, I have way too much, or I have too much. In May, it went down to roughly just over 40%. But in July, it’s still just over 40%. So, what we’re still looking at is high inventory levels, which will keep imports relatively modest,” Manders said.
The electronics, high tech and clothing industries have “way too much” stock, he added, while furniture companies are holding about the right amount. “We’ll probably need the holiday season to clear through these inventories,” Manders said.
Blank sailings have been common for several years, according to Simon Heaney, a senior manager for container research at maritime consultancy Drewry.
“The container market is in the middle of a demand slump so blank sailings are once again being used as a bad-aid to try and balance the market. Excess inventory, along with weak retail sales, are indeed part of the reason for the downturn in shipments,” Heaney said in an email to CNBC.
The firm recorded 13 blank sailings on Asia to Europe routes in July, (during the same month last year Drewry counted 18) and expects similar figures for August and September.
Bernstein said U.S. retailers were holding $778 billion of inventory in May, the highest level since 2019. “A peak season is far from assured,” its analysts added.
Long-term trend
While excess capacity means retailers moving goods from Asia to Europe can get a good deal on shipping rates right now, supply chain management is getting more complex, according to Manders, with retailers sourcing from many more locations in Asia than they used to.
“On the destination side, the consumer expects delivery within a day … so [retailers] actually need to have all kinds of locations closer to the consumer [as well],” he added.
In the longer term, Manders expects ocean freight volumes to increase, while air freight will decline, due in part to better planned supply chains.
Customers fly goods for three main reasons, he said: If they’re high value, because they’re perishable or when there is a surge in demand. “In the fourth category is everyone who just screws up in their planning. And that’s a big category. For the first three, air is extremely relevant. For the fourth one, if you do better planning … you might actually be able to peel some off and do some air to ocean conversion,” Manders said.
– CNBC’s Elliot Smith contributed to this report.
This is part two of a three-part series on organized retail crime. The stories will examine the claims retailers make about how theft is impacting their business and the actions companies and policymakers are taking in response to the issue. Read the first story here and stay tuned for part three.
Plastic bags hang on a self checkout kiosk at a Target Corp. store in Chicago, Illinois.
Daniel Acker | Bloomberg | Getty Images
Retailers who blame organized theft for lower profits could be overstating crime’s impact to cover up internal flaws or self-inflicted problems, CNBC has learned.
During recent earnings calls, major companies have blamed disappointing bottom lines or shrinking margins in part on roving bands of organized gangs that ransack their shelves. The issue could come up again as a string of major retailers start to report second-quarter results next week.
But behind closed doors, retailers are facing other issues they can better control, including theft by their own employees, that are contributing to losses, according to two sources who advise major retailers. They spoke on the condition of anonymity because they’re not authorized to speak publicly about clients.
Many retailers have invested in technology to better understand what leads to shrink, or the gap between the inventory a company has and what it sells. Some companies have since identified theft from employees as a major contributor to losses, even as they blame external theft in public, said one of the sources.
Losses from self-checkout theft have also become a major issue, the people said.
While some retailers may be seeing higher rates of shrink because of poor hiring practices and self-checkout machines, others such as Target and Foot Locker could be using retail crime as a crutch to obscure internal challenges, experts told CNBC.
“Shrink has been going up but sometimes it’s very difficult to unpack how much is down to theft and how much is down to internal retailer issues and stumbles,” Neil Saunders, a retail analyst and the managing director of GlobalData, told CNBC.
“It is a problem, we know that, it does take money off margins, we know that, but there’s too much opacity in the way in which it’s reported and it is being partly used as an excuse for generally bad performance,” Saunders said.
Theft as an inside job and the curse of self checkout
In the age before shoppers found deodorant and candy bars locked up in drugstores across America, employee theft largely drove shrink, said Patrick Tormey, an adjunct professor at the Lehman College School of Business, who spent more than 40 years in the retail industry.
The trend may not have changed much, despite what companies say in public, according to experts.
“The theme that comes back the most right now is internal theft … they’re realizing that a lot of [losses] come from there,” said one of the sources who advises retailers. “If there’s an occurrence of external theft they would steal let’s say 10 bucks worth of merchandise, but if it’s internal theft, it’d be 40 bucks.”
There is no conclusive data to indicate that employees do steal more goods than outsiders, but retailers have gotten better at identifying internal theft, the person said.
Retail workers have access to entire cases of merchandise in backrooms and it’s “relatively easy” to take large quantities of goods without anyone noticing, one of the sources said. The theft can also go undetected for a long period of time because it’s not as noticeable as a shoplifter who is in public view, the person said.
Internal theft also happens at warehouses and in aisles where online orders are prepared, one of the people said. In some cases, a worker may know the person receiving the goods and may add extra merchandise into a shipment, one of the people said.
“It’s a little bit like organized crime in some way, but not like mafia-style, just a few people [working together],” said the person.
Sonia Lapinsky, a partner and managing director with AlixPartners’ retail practice, told CNBC that retailers have struggled to properly staff stores over the last few years. They can’t always find the right workers, and some have also felt pressure to lower staffing levels to control costs, she said.
“Folks are notoriously working multiple jobs these days and just feeling the pressure and having to pick up jobs everywhere,” said Lapinsky. “If this is not something that they’re necessarily loyal to, or see as a long-term place, then there’s probably more risk of theft as well.”
David Johnston, the vice president of asset protection and retail operations at the National Retail Federation, said employee theft has long been the largest contributor to shrink and staff have at times been involved in organized theft rings. However, he thinks internal theft is now “second place” to external theft.
Retailers have another self-made problem that can lead to more stolen goods. Self-checkout machines also increase the risk of theft, and they have become a major source of losses, the two company advisors told CNBC.
The machines come with increased costs. In some stores with high rates of theft, losses are outweighing the investments companies made in them, the people said.
“You create a problem where there wasn’t one,” one of the people said.
Shrink references reach a ‘fever pitch’
Retailers started to blame organized theft for lower profits as the industry’s performance started to suffer.
Janine Stichter, a retail analyst and managing director at BTIG, has been covering the retail industry since 2008. She didn’t really hear companies talk about shrink in their earnings calls until about a year and a half ago — right around the time the economy started to soften, she said.
“It’s really kind of hit a fever pitch,” said Stichter.
Home Depot, Best Buy and Walgreens were some of the first retailers to start speaking out about theft. Now a range of companies are saying it has reduced their margins, some for the first time in recent years.
“I think there is a bit of bandwagoning at the moment,” said Saunders from GlobalData. “I think one of the things that happens is somebody mentions it and it then becomes a bit of a buzzword and then everyone pays attention to it and it suddenly starts getting called out.”
A Walgreens aisle with locked and unlocked areas
Gabrielle Fonrouge | CNBC
In May, Target rattled investors when it said it was on pace to lose $1 billion this year from inventory losses driven by stolen goods. Two days later, Foot Locker said “theft-related shrink” contributed to a 4 percentage point drop in its gross margin.
“This has been a multiyear dynamic in the industry. We are not immune to it. It’s increasing. You’ve heard Target talk about it and others. And so, it’s having an increased impact on Foot Locker,” CEO Mary Dillon said on a call with analysts. “We’ve seen a significant increase of theft from stores and usually through this lens of an organized retail crime type of action.”
The reference came as Foot Locker reported dismal results for the quarter. It was the first time it called out shrink cutting into its profits in more than 14 years, according to records accessible on FactSet.
The retailer said its merchandise margins fell 2.5 percentage points because of “higher promotions” and the rise in theft-related shrink.
Three analysts who cover Foot Locker told CNBC the vast majority of that drop likely came from promotions. At the time, the company was grappling with high inventory levels and soft sales, forcing it to rely on discounts to drive revenue.
Foot Locker did not return repeated inquiries from CNBC about how much of its margin hit came from promotions and how much of it was due to shrink.
Foot Locker Inc. signage is displayed in the window of a store in New York, U.S.
Michael Nagle | Bloomberg | Getty Images
Tormey, the Lehman College professor, said retailers have thrown around the words shrink and theft so often, investors “chalk it off as a sign of the times,” which can allow companies to use it as a “crutch” for poor merchandising, store design and other internal flaws.
“It’s just a quick aspirin for the headache, so to speak,” said Tormey. “It’s a lot harder to pin down exact numbers so they can use it and people just kind of nod their head, ‘Oh, yeah, it’s a shame,’ without really [questioning], was it your employees stealing from you? Was it shoplifting? Was it vendor misconduct? You know, are you a sloppy retailer?”
Over the last two decades, Target had not mentioned shrink hitting its margins during earnings calls until August 2022, when the company and other retailers were buried in inventory they were having trouble unloading, according to FactSet.
At the time, Target’s inventories had climbed 36% year over year and its profits had dropped nearly 90% in the quarter ended that July. The company had marked down items significantly to clear out excess merchandise that was no longer in demand.
When Target explained why its gross margin had fallen nearly 9 percentage points year over year, it blamed higher markdown rates, lower-than-expected discretionary sales and higher shrink.
By the following quarter, when inventories had begun to moderate but were still up 14%, Target mentioned organized retail theft during an earnings call for the first time in its modern history. It said shrink had contributed to profits plunging by about 50%.
“As [CEO Brian Cornell] mentioned, this is an industrywide problem that is often driven by criminal networks, and we are collaborating with multiple stakeholders to find industry-wide solutions,” Target’s finance chief Michael Fiddelke told analysts. “For example, because stolen goods are often sold online, Target strongly supports the passage of legislation to increase accountability and prevent criminals from selling stolen goods through online marketplaces.”
While theft has hit Target’s bottom line, it also has to contend with high shrink from other parts of its business. Spoiled food from the retailer’s grocery aisles and its inventory practices can both weigh on profit.
When companies deal with higher than usual inventories, more items can be lost or damaged. As Target grows its e-commerce business and pickup and delivery options, there’s more room for error as merchandise moves around.
“Target is not always the best at managing its own inventory. It does tend to have a lot of out of stocks at stores, it does tend to have a supply chain that’s quite fragmented and it’s very easy for things to be misallocated and mis-accounted for within that,” said Saunders. “I’m sure bundled in with their number there’s a lot of things where Target has just lost stuff, broken stuff, put stuff in the wrong stores, put it in the wrong location, can’t find it.”
In response, Target said its shrink numbers vary widely by location and do not correlate with inventory levels. The retailer said it sees a relationship between levels of shrink and stores with higher safety and crime incidents, rather than overall levels of inventory in a store.