By Roenen Ben-Ami, Chief Risk Officer, Justt
Friendly fraud continues to hurt merchant revenues. On average, reports indicate that one in five consumers knowingly submitted false fraud claims. And the problem only compounds with the prevalence of card-not-present payments. While online convenience certainly helps propel the e-commerce industry, it also increases fraudulent activity.
As a result, chargeback volume has skyrocketed. False disputes now contribute to $125 billion in annual chargeback losses for merchants worldwide.
But resolving disputes related to friendly fraud is a complex process. The entire chargeback system introduces several challenges that make fighting friendly fraud very difficult—and expensive.
Let’s discuss five primary chargeback issues merchants face when dealing with friendly fraud to help outline some possible solutions.
What Is Friendly Fraud?
Friendly fraud occurs when a consumer makes a legitimate purchase but repudiates the charge with their financial institution. Whether on purpose or by accident, the customer keeps both the bought product and money won in the chargeback dispute. The merchant who engaged in fair business practices must cover the losses of a product that resulted in no revenue.
Friendly fraud is different from true fraud, where an unauthorized user uses a stolen credit card to make illegal purchases. Instead, friendly fraud occurs when the cardholder knowingly or unintentionally misuses the chargeback system with false claims to their own benefit.
The standard fraud protection methods built into a physical card offer no protection from friendly fraud. Moreover, instances of friendly fraud increase with card-not-present payment methods, such as online shopping carts, phone orders, and recurring bill payments.
Friendly Fraud Disputes: 5 Difficulties Merchants Deal With
Friendly fraud occurs due to a confusing mix of reasons from cardholders making honest mistakes to shoppers intentionally trying to game the system. For many merchants, friendly fraud is difficult to assess, locate, and dispute, leading to high revenue losses.
Here are five common issues that merchants face when fighting friendly fraud chargebacks.
Friendly Fraud Issue #1: Distinguishing potential friendly fraudsters
First, merchants struggle to determine who might engage in friendly fraud and the intent behind the dispute itself, as many customers repudiate a credit charge with no ill-will. For example, a long-term priority customer could forget a purchase or might not recognize the shop name on their bill, leading to a chargeback. Alternatively, other consumers feel dissatisfied with a product and choose to file a chargeback with their bank instead of first contacting merchant’s customer service for a refund. In each case, the intention and origin of the dispute are varied, making it hard for merchants to assess.
Even advanced anti-fraud software solutions available to merchants today would have trouble locating potential instances of friendly fraud. Pre-transaction data does not always translate to friendly fraud at a practical level. Typically honest customers can initiate several false claims (even though the risk profile is minimal), while customers that appear likely to be dishonest can have a history of legitimate purchases before ever committing friendly fraud. Human behavior is not always straightforward, and that makes creating prevention methods for friendly fraud chargebacks difficult.
Friendly Fraud Issue #2: The loss of consumer trust
Relationships with valued clients can break down even as the consumer engages in the chargeback system honestly, leading to the loss of future sales. In addition, high volumes of chargebacks can create a negative reputation of problematic charges for a merchant, leading to a decrease in consumer trust. Whether this is reflected on review forums, word of mouth or in a Better Business Bureau rating, the public eventually finds out if a merchant has a chargeback problem. Merchants need to find a way to lower any instances of friendly fraud without the loss of valued customers.
Friendly Fraud Issue #3: Lack of coverage from anti-fraud solutions
While anti-fraud solutions with chargeback guarantees offer to cover the cost of fraud chargebacks, they do little to prevent friendly fraud. Chargeback guarantees provided by anti-fraud solutions are typically limited to disputes lost under fraud reason codes, not service reason codes. This means a significant percentage of chargebacks continue to cause losses for merchants.
Moreover, while those solutions cover the direct expense of some chargebacks, they still leave merchants responsible for chargeback fees and suffering from the reputational damage caused by chargebacks.
Friendly Fraud Issue #4: Refund abuse
To decrease instances of friendly fraud, many merchants implement a generous refund policy. A return incurs less expense when compared to the various unrecouped costs related to a chargeback. If a customer can return an item with ease, overall chargeback volume lowers.
But there is always a tradeoff between generous return policies and the occurrence of friendly fraud. While an open and robust return policy can limit disputes, refund abuse can increase in kind. Refund fraud is its own $25.3 billion problem for merchants, especially with card-not-present payment options. Customers can price switch, engage in price arbitrage, return stolen merchandise, and commit cross-retailer returns for illegal gain.
A robust refund policy is an excellent action step towards reducing friendly fraud, but it does not entirely solve the issue of friendly fraud chargebacks.
Friendly Fraud Issue #5: Variability in the dispute process
Lastly, merchants face the problem of variability in the dispute process both between card networks and between issuers. The card networks each have their own rules, arbitration systems, and reason codes that must be mastered by those handling chargebacks. But the level of specificity doesn’t end there. While the card networks set the rules for the chargeback process, card-issuing financial institutions must interpret them. Each of these financial institutions has its own preferences in terms of what and how evidence is presented.
E-commerce businesses now need a high level of expertise to best present relevant evidence to the various issuers. With several hundred issuers in the U.S. alone there is a significant level of expertise, time and effort needed to fight a single chargeback, with no guarantee of winning. To solve that issue, many merchants take on expensive chargeback dispute teams designed to fight friendly fraud. There are also opportunity costs, as business operations meant for revenue-building divert toward chargeback disputes.
Friendly fraud remains a primary driver of chargeback revenue loss for merchants. Some research suggests that as much as 86 percent of chargebacks are probable cases of friendly fraud. Moreover, the volume of chargebacks will likely increase with the growth of the e-commerce industry and convenient digital payment methods. Merchants need chargeback mitigation solutions, as friendly fraud should not become a standard business operating expense in a fair resolution system.
Merchants face several challenges that make the discovery, assessment, and resolution of friendly fraud difficult and expensive. But resolving friendly fraud is a complex issue and one not likely to be solved even with the most sophisticated pre-transaction anti-fraud technology. Moving forward, innovative, technological solutions that mitigate the problem of friendly fraud post-transaction and dispute revenue recovery are a necessary component of every merchant’s payment stack.