Published November 04th, 2016 by

Friendly Fraud: A Costly Revenue Drain

eCommerce is big business—consumers spend hundreds of billions of dollars each year in the U.S. alone, and that total grows with each new year. That’s good news for online merchants, but the growth in popularity of eCommerce also has a down side.

As research suggests, more than 80% of all chargebacks could be unjustified. It’s a practice called “friendly fraud,” and it may cost merchants as much as $40 billion annually.

What is Friendly Fraud?

To understand friendly fraud, we must first explain the chargeback process.

Chargebacks were originally introduced decades ago as a form of consumer protection, when the use of credit cards was still a relatively young practice. It’s essentially a forced bank refund; if a cardholder believes a transaction to be fraudulent, U.S. law allows that cardholder to dispute the transaction by requesting a chargeback.

Chargebacks insure cardholders against loss resulting from criminal fraud or merchant error, but more often than not, customers abuse the process by requesting chargebacks prematurely. This is what’s known as friendly fraud, referring to the fact that everything about the transaction appears legitimate, but the merchant ultimately loses anyway.

Friendly Fraud is a Serious Problem

Friendly fraud is less cut-and-dry than other forms of eCommerce fraud. Essentially, friendly fraud can be defined as a chargeback filed without the cardholder or issuer first performing the necessary step of attempting to resolve the dispute through the merchant.

While this seems fairly innocuous, chargebacks are a big problem for online merchants. The practice is alternately referred to as “cyber shoplifting,” because even if the customer sees what they’re doing as harmless, they are still getting something for free at the merchant’s expense. As Chargebacks911 COO Monica Cardone explains:

“Cyber shoplifting increases costs for the merchants. With this type of activity, the merchant loses the cost of the merchandise in addition to the transaction value and fine or fee associated with the chargeback. It also increases their liability and payment processing risk: if a merchant receives too many chargebacks (regardless if they are due to cyber shoplifting or friendly fraud), they may lose their ability to process credit cards and be liable for significant fees and fines.”

According to proprietary research by Chargebacks911, just 14% of customers who filed a chargeback contacted the merchant before doing so, and only 25% of customers contacted the merchant after filing. Additionally, 81% of cardholders who have filed a chargeback admit to doing so out of convenience—they simply didn’t have time to contact the seller, and going to the bank for a chargeback seemed like an easier option.

Can Anything Be Done About Friendly Fraud?

The rules regarding chargebacks were originally drafted more than forty years ago; as such, the system has not kept pace with the development of new technologies. Friendly fraud thrives in the absence of adaptation.

There are a number of changes the industry will need to make in order to stand up against this problem. For example, issuers and card networks will need to take a more adaptive response to chargeback arbitration, combining human intelligence and machine learning. In addition, the industry will need greater standardization of methodology in order to ensure that regulations are applied evenly by all parties in a chargeback dispute.

In the meantime, merchants must adhere to business best practices to insulate themselves against friendly fraud. For example, merchants can reduce the likelihood that customers will turn to a chargeback instead of requesting a refund through customer service practices. Providing 24/7 live service across multiple different channels, and answering all phone calls within three rings encourages customers to use proper channels rather than request a chargeback.

In addition, employing criminal fraud prevention techniques, such as requesting CVV code verification and deploying 3-D Secure, can have a big impact as well. As Build the Store found Erik Van Riper commented:

“One thing that we insist on for any credit card transaction is that the billing address matches the credit card billing address. The shipping address can be different, but we insist that at least the knowledge of the billing address is there, and correct.”

Take Action Now

Drastic action will be necessary in order to make friendly fraud a thing of the past. Banks, merchants, card networks and processors will need to work together to mitigate the risk; otherwise, the problem will only continue to get worse.

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