Let me explain why the true cost of a refund is much greater than just the dollars you give back to the customer. Before we go into the specific costs, I need to explain how we view the difference between a refund and an exchange.
A return ≠ a refund!
A refund signals the end of a relationship
Before I get too far into all the associated costs of a refund, it's important to understand the high-level thinking. A return doesn’t equal a refund and not all return outcomes are created equally.
At Loop, we see a refund as the end of the customer relationship. The customer didn’t want an exchange or store credit, which means they’re likely taking that money to shop somewhere else. By requesting that refund, they’re signaling that something about the product or experience was off and they don’t want to continue the relationship with your brand.
A refund often signals the end of a customer relationship and that has a cost.
Many of the costs we’re going to talk about are ones you’ll never recoup since these individuals won’t become repeat or loyal customers.
The hidden costs of an online refund
Now that we know a refund is signaling the end of a relationship, we can evaluate the true cost of a refund.
There are many hidden costs associated with a refund. Without taking these into account, you’re not getting a truly complete picture of how much refunds are costing your business. Let’s take a look at the ones that have a major impact on your bottom line.
Customer acquisition costs
This one is pretty straightforward. When a customer refunds an order, you’re losing the acquisition dollars that you invested to get that person in the door.
So let’s say the average CAC for ecommerce brands is around $45. That means, with every refund, you’re not just losing out on the original value of the item. You’re also losing the $45 you spent to acquire that customer and now have to invest another $45 to replace them.
If you’re like most customer-focused brands, you probably offer free shipping on all returns. This means that, with every refund, you’re eating the shipping costs. And, unlike an exchange, you’re not retaining any revenue or preserving the customer relationship with a refund.
On the backend, there’s a ton of labor that goes into dealing with refunds (especially if you’re handling returns manually).
Depending on the state of the item you receive back, your team may have to return everything to inventory, repair or repackage the product, or even discard it completely. Because the nature of refunded items can be unpredictable, there’s a lot of labor and decision making that goes into the process.
Support, warehouse, and administrative labor costs are all associated with a return.
A refund signals the end of the customer relationship. This means that, in addition to all the other costs we mentioned, you’re also losing out on the future revenue that you could have been making if your customers had decided to stay with your brand.
While the exact opportunity cost depends on your brand’s customer lifetime value, the fact that a 5% increase in your customer retention rate can lead to a 95% increase in profitability is pretty cut-and-dry proof that keeping customers with your brand is the way to go.
The total cost of a refund
To make the idea more tangible, let’s attach some hypothetical numbers to these costs:
CAC = $45
Shipping = $7
Labor = $15/hour (assume 2 hours spent per return)
Returned item = $20
Because opportunity cost is challenging to calculate, we’ll leave that out of the equation for now.
This means that every return = $45 (CAC) + $7 (shipping costs) + $30 (2 hours of labor) + $20 (cost of the item assuming you don't resell it)
That is a total cost per refund of = $102
Total cost of a refund example
We know that the average ecommerce return rate is around 30%, and the average Shopify brand loses 80% of its returns to refunds.
So if you sell 10,000 items in one month, 2,400 of them will end up being refunded. If we use our total cost of a refund estimate above, this hypothetical brand is losing $244,800/mo in return costs and wasted acquisition costs.
That is a total cost of $244,800/mo.
But does this just end up being the cost of doing business? Not if you look at an exchange as a continuation of the shopping relationship.
Exchanges continue the relationship and retain profitability
Are exchanges any better? While you still have many of the same costs associated with an exchange, the main difference is that the relationship is continuing. This gives you an opportunity to recoup the costs in the future instead of chalking it up as a loss with a refund.
While you still end up paying the shipping costs and labor costs of an exchange (you can reduce this with an automated portal), you still have a customer. The acquisition costs are not lost in this scenario and you can still get a second, third, and fourth purchase from them.
An exchange continues the relationship and your CAC stays an investment in future value rather than a lost cost.
By shifting your mindset to focus on turning refunds into exchanges, you can minimize all the hidden costs that we discussed in this post. To learn how to reduce the number of refunds for your brands, just get in touch with our team.