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Handling Refunds and the linkage to Ratings and Reviews

This is a general guide on post-pandemic business management.

Refunds are a thorny issue. There are various reasons why a customer might want a refund. It is a normal part of most businesses. In retail, refunds range between 4% and 8% of sales, and these are normal depending on the type of retail trade the business undertakes. In services, refunds are less common. For long-term products such as construction projects, refunds are unheard of unless something goes awfully wrong.

How is the post-pandemic business manager supposed to deal with refunds? Do you put a flat “No Refunds” policy? Do you craft a very generous refund policy? First, we need to peek into the future and see if the environment around refunds has changed.

The post-pandemic environment is reviews and ratings-based

For most products and services, you will not escape being rated online. Before the pandemic, consumers and B2B customers were increasingly making use of online ratings as guides before making a purchase. Post pandemic, this is spreading to products and services that are not offered online. Consumers are googling what other consumers say about the place they want to physically visit. If ratings are low and negative complaints are abundant, consumers stay away.

This trend will continue and will eventually cover almost all products and services offered on the earth. For now, rating services are in silos and are industry-based. Those in travel make extensive use of Trustpilot, for movies, we use 1MDb, for general complaints, we use Hello Peter, and so on and so forth. In the future, there could be one giant rating service for everything. And your business cannot escape that.

How does this connect to refunds? Unhappy clients are probably going to post their unhappiness on the rating service websites and social media. They are also going to demand a refund. Not honoring their refund request will throw the business into a position where it has to defend itself on social media, which it can successfully, but for the rating service, the business will not be able to defend itself. If it is standard practice not to honor refunds or if the refund policy for the business is too tight, the business will be faced with a lot of negative reviews and low ratings. These affect the ability of the business to generate revenues in the future and sustain operations.

Higher ratings and positive reviews lead to higher sales. Higher sales mean a lot of people will review. If the product is good, the reviews will be positive, which in turn leads to higher sales. It's a self-reinforcing positive feedback loop.

Bad reviews and ratings lead to lower sales. Lower sales mean fewer people will rate and review your product or service. Of those fewer people, the ones that are likely to rate and review are the ones that have had a bad experience. This leads to an overrepresentation of bad reviews, which leads to lower sales. It is a self-reinforcing negative feedback loop.

The problem here is that, when the number of ratings and reviews is low, there is a tendency for negative reviews to be overrepresented due to the default human nature of not reviewing or commenting if the product is good whilst finding the energy to review if the product is disappointing. When the number of ratings is high (due to higher sales transactions) positive reviews start to weigh in heavily and dilute negative reviews.

Mishandled Refunds = Review Nightmare

The above discussion implies that all refund requests should be handled with care due to their backlink to reviews. A client that requests a refund will have extra energy to spoil your reviews which messes with your ability to generate future business.

It wasn't always like this. In the pre-pandemic world, before everything was on the internet, a business could get away with mishandling a refund. The aggrieved client would only spread the word around his or her circle of influence and that is that. The new connected world connects almost everyone. Review sites ensure that a bad review is noticed by anyone who wants to, irrespective of circles of influence.

Almost every business should have a refund policy that allows for refunds regardless of the product or service being sold. Competition and connectivity demand so. Clients will increasingly avoid buying from businesses that have a “no refunds” policy.

Refund Policy Settings

Striking a balance between a Loose and a Tight refund Policy is a delicate art. A loose refund policy exposes your business to opportunists. A refund policy that is too tight drives potential customers away.

The business manager must play with the settings over time in order to strike the right balance. If refunds are too high as a percentage of sales, the refund policy might be too loose. If refunds are too small yet customers are complaining, the refund policy might be too tight. There are other factors that feed into the equation that determines the level of refunds.

If refunds are too high, it could as well be due to any of the following factors:

  • Bad product/service
  • Aggressive selling (extraordinarily high conversion rate)
  • Force Majeure (Act of God)
  • Growing IRIA black hole swallowing the business

Bad Product or Service

No matter how hard you try to sanitize the front end of the business with clever marketing, artificially boosting ratings, weeding out of bad reviews, and cleaning up the image of the company online, among other gimmicks, a fundamentally bad product or service will always catch up with you. Clients will always demand refunds. A high ratio of refund to sales is usually a result of a bad product or service. If the company is not refunding in cash, the number of returns for swaps and credit notes as a percentage of sales would be indicative of the same problem.

Aggressive selling — insanely high conversion rate

A high refund as a percentage of sales ratio could be a result of aggressive selling. This is a case of driving your salespeople too much that they go out there and successfully convert every lead into a customer. The conversion rate will be typically very high. But that is countered by an unusually high prevalence of refunds. Think of this simply as some vendor at the fruit market who is very persuasive to the extent that he convinces people who want to buy apples from the next stall to buy bananas from his stall instead. Some of those who buy his bananas instead of apples will take the first bite and find his bananas not pleasant at all and return the rest of the bunch for a refund. These customers never really wanted to buy bananas in the first place, but they were convinced that bananas are better than apples and that's exactly what they need. This could be viewed as a problem of over efficiency of the sales and marketing department.

Generally, not all people are going to like your product or service. That is natural, and that is okay. Thus, conversion rates are not supposed to rise above a certain level for any industry. When you try to make sure that everyone buys your product whether they like it or not, you invite trouble. They are going to try your product and they are not going to like it, true to their nature. They will press the refund request button and possibly give you a bad review.

The chart above shows average conversion rates by industry. Data is from Ruler Analytics. The conversion rate for calls for the travel industry is at 4%. At the extreme end for travel, the email conversion rate is generally agreed to be around 18% (this is not shown on the chart above). If your travel business has conversion rates that are way above the extreme of 18%, you could be suffering from sales and marketing over efficiency, which could then create an unusually high refunds problem.

Force Majeure

The pandemic is a perfect example of this. It unleashed a wave of refunds across industries. The unusually high refunds were forced by the pandemic called COVID-19. Other pandemics that are localized such as hurricanes, strikes, et cetera can force a wave of cancellations and refund requests.

The so-called Acts of God are increasingly becoming common. The post-pandemic era, with global warming out of control, social unrests on the way, et cetera, could witness an increasing occurrence of these Acts of God. The post-pandemic business manager should manage the business with an acceptance of the frequency of occurrence of the events. He or she should deem the occurrence of a Force Majeure event within his lifetime, as an eventuality, not a possibility. He should be prepared for a scenario whereby he has to refund 70 to 80% of his clients.

Growing IRIA Black Hole

Income received in advance (IRIA) was covered in an earlier article. This is a liability. It is the maximum potential size of refunds. In the most extreme case, all of the income received in advance would have to be refunded to clients.

When business managers dip their fingers into IRIA and use those funds before they have earned them, they create a financial hole which is like a black hole. The hole typically grows over time and becomes large enough to swallow the business.

When a business gets to this stage, where the IRIA becomes a giant black hole, it fails to deliver products and services that it used to deliver easily, because cashflows become crippled. It fails to pay suppliers in time. It might fail to pay employees in time, so the employees render bad service to clients, etc. The business might also fail to honor a couple of refunds, which fall within the normal range (say 4–8% of sales). This leads to bad reviews and ratings, as well as noise on social media. All these pressure points lead to a wave of refund requests from jittery clients. This leads to an unusually high ratio of refunds as a percentage of sales because sales (the denominator) stagnate or decline whilst refunds (the numerator) rises.

The above scenario typically doesn't end well because it is a self-reinforcing negative feedback loop. It usually requires a sizeable loan to plug the IRIA black hole and escape the loop.

What to do if you are caught up in a Negative Self-reinforcing loop

If you are a business manager, whose business is caught up in a negative self-reinforcing feedback loop caused by an IRIA blackhole, the best that you can do is to source funds that can close the hole, as described above. This is not something that every business can do, because capital is generally scarce and investors generally run away when they see the state of the balance sheet, with huge unfunded liabilities. You have to save yourself.

At this point, it is too late to be the Best Samaritan. You are a bad steward. Now is not the time to build trust. Now is the time to save whichever trust you can save (i.e., you cannot save it all) and save the business (i.e., remain with a cash flow to fund operations).

Managing a wave of refund requests:

  • Be careful not to destroy your business, don't honor all refund requests at once. It is too late to do so, you don't have the capacity. Spread them across time. Advise clients that you have received their refund request and you will honor it in two weeks' time based on your “pay-runs” or some other reasons.
  • Come out in the open for the big clients with big refund requests. They need to know. Talking things over might help them understand your cash flow problems and will buy you the time needed to recover.
  • Try to negotiate for swapping of products, postponement of transactions, and other arrangements that do not involve you paying out cash.
  • Honor refund requests from the most vocal clients.
  • Honor all small refunds first and negotiate with clients for larger refund transactions. You don't want a lot of trouble from 100 guys that you owe $10 each (i.e., a total of $1,000) whilst you have refunded one guy you owed $1,000.
  • Intentionally develop a very complicated and frustrating refund process with all sorts of documents to be filed just to delay the pay-out process (i.e., take a leaf from the insurance companies). This helps in smoothening the cash flow and buys you time.
  • Avoid refund-related lawsuits, they eat into your time and your cash balances. If the refund request is reasonable, acknowledge liability earlier before matters go to court.

If you are caught up in a negative feedback loop that has nothing to do with the IRIA black hole, you are in a good position to overcome. You need to find one point you can address that breaks the loop. You can choose to address the quality of the product. Improving quality increases sales and reviews.

You can choose to increase sales if the quality is reasonable. Promotions, discounts, and other forms of under-pricing can get you the volume of sales that you want and break the cycle. Higher volumes will bring more ratings and reviews, which bring in more positive reviews.

You can choose to focus on the reviews first. Follow up with buyers if you are in a position to do so. Kindly ask the happy clients to rate and review. Remember the default asymmetry in rating behavior (happy customers don't usually rate and review whilst the unhappy ones are trigger-happy to downvote, downrate, and give bad reviews). If you don’t ask your happy clients to review, they don't review. If you ask them, they might review and thus dilute the prevalence of bad reviews, thus giving you a chance to break from the negative self-reinforcing feedback loop.

Wrap -up

Overall, reviews and ratings are connected to refunds. Refunds are a balance sheet item. For businesses that involve IRIA, refunds are connected to IRIA since the entire IRIA can be a refund. Managing the balance sheet entails managing all of these items together. There are way too many moving parts. They cannot be managed in isolation.




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Ryan Gosha

Ryan Gosha

Financial Analyst, Cloud Accountant, Citizen Data Scientist, FPL Boss

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