The $25 Billion Problem and How to Combat It
While merchants are left to carry the brunt, this is an industry problem requiring collaboration
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First party fraud, also known as chargeback fraud or friendly fraud, occurs when a customer files a dispute on a legitimate transaction, essentially disputing a charge they knowingly made.
This can happen for various reasons, such as buyer's remorse, confusion about the purchase, or even intentional deceit to get free goods or services.
Friendly fraud is a growing problem for online merchants, Verifi sharing that Visa’s internal reporting revealed it accounts for up to 75% of all chargebacks.
The impact of friendly fraud is significant.
According to a report by National Retail Federation, merchants are expected to lose $25 billion in a year from friendly fraud.
In addition to the direct financial losses, merchants also face increased operational costs, damaged reputation, and potential penalties from payment processors for high chargeback rates.
In this article, we will explore the opportunities merchants have in combatting friendly fraud by analyzing dispute causes, categorizing dispute reasons, and distinguishing between incorrect dispute classification and false claims.
We'll also discuss best practices and actionable steps merchants can take to mitigate the impact of friendly fraud and protect their revenue.
A Multi-Pronged Approach to Friendly Fraud
Before we dig into how merchants can protect their revenue from friendly fraud, one important thing to call out is that the industry, as whole, must combat friendly fraud with the same dedication towards preventing third-party fraud. Full collaboration among merchants, financial institutions, and card networks is crucial to develop effective strategies, share best practices, and implement robust solutions to address this escalating issue.
While not exhaustive, here are crucial areas to focus on in combating friendly fraud:
Issuers:
Customer Experience vs. Compliance: Find the right balance when tightening security measures to avoid friction for legitimate customers.
Dispute Intake Improvements: Streamline processes to promptly identify and address valid claims, reducing the incentive for false disputes.
Regulation E/Z Adherence: Ensure internal practices are fully aligned with these regulations to minimize vulnerabilities.
Card Networks:
Continued Rule Refinement: Network efforts (like CE3.0 and First Party Trust) to evolve rulesets to address friendly fraud.
Merchants:
Clear Customer Communication: Proactive, transparent policies regarding returns, refunds, and billing descriptors can prevent misunderstandings.
Process and Experience Improvements: Optimize purchase flows and customer support to address pain points that lead to disputes.
Industry Collaboration:
Shared Best Practices: Establish industry-wide standards for communication and consequence management regarding fraudulent behavior and dispute process abuse.
The Unique Challenge of Friendly Fraud
While third-party fraud certainly poses a threat, it's first-party fraud that can be the most insidious. Unlike third-party fraud schemes where stolen or fabricated identities are used, first-party fraud involves a customer intentionally misrepresenting information about themselves. These are not accidental errors – this is a customer knowingly providing incorrect details for their own benefit.
This type of fraud can be very difficult to identify and even harder to prevent with traditional methods.
Why Current Fraud Modeling Isn't Enough
Fraud monitoring and machine learning models work wonders with third-party fraud. They can detect inconsistencies in identities, flag anomalies in transaction patterns, and even identify the usage of synthetic identities. Unfortunately, these same tools fall short with friendly fraud.
The crux of the issue is that the information the first party fraudster provides is, on the surface, legitimate and consistent. Traditional models designed to detect out-of-the-ordinary behavior can't always pick up subtle manipulations employed in first party fraud.
This highlights the importance of going beyond straightforward data checks when it comes to friendly fraud. Businesses need to invest in deeper analysis and investigative techniques to spot the red flags that indicate someone is trying to game the system.
To effectively combat friendly fraud, businesses must take a proactive, data-driven approach. This involves thoroughly analyzing dispute data to identify patterns in customer dispute reasons and pinpointing the root causes of friendly fraud.
By gaining insights into the specific triggers and motivations behind illegitimate disputes, merchants can implement targeted strategies to prevent them from occurring in the first place.