In the 1980s, there were approximately 2,500 shopping malls in the U.S. There are only about 700 malls left, and experts predict that number will drop to 150 in the next ten years. Their brightly colored storefronts, ornamental fountains and gleaming escalators have been gradually replaced by the incredible ease of online shopping from anywhere at any time, away from crowded parking lots and long checkout lines. And despite the plethora of digital payment methods, cards are still king in e-commerce.
With one-click checkouts and expedited deliveries, consumers expect equally swift and hassle-free resolutions when they have issues with their purchases. Needless to say, chargebacks have evolved to offer a quick-fix solution for an increasingly impatient consumer population. And while chargebacks are essential to consumer protection, their misuse and abuse impose significant costs on all stakeholders involved — consumers, banks and merchants.
Credit Card Fraud, By the Numbers
There is a record-high number of card holders in the United States, with the average cardholder owning at least three, finder.com reported in February. Created in 1974 through the Fair Credit Billing Act, the concept of a “chargeback” was brought to life with a mission to provide consumers the right and mechanism to dispute illegitimate card charges and get their money back. In short, chargebacks help ensure a safe environment that encourages card use without fear of being responsible for fraudulent activity.
Between 1974 and today, much has changed in the way buyers and sellers interact with cards. Decades ago, chargebacks were an indelible statistic for fraud — a perpetrated crime against the consumer, whether stemming from the merchant or from a third-party criminal. Today, however, the word “chargeback” is closely associated with criminal fraud, but the reality is anything but.
The leading cause of chargebacks is no longer an illegitimate charge intentionally aimed at defrauding consumers; it is an unrecognized charge that is innocently mistaken by a consumer, or a misidentified threat triggered by poor underlying data.
With growth rates of more than 20% per annum, the trajectory of chargebacks will continue to surpass e-commerce, as a result of two primary factors: The continued dependence on cards as the only payment method that offers global, bona fide chargeback rights to consumers, and the lack of exchanged transaction data amidst evolving technology and consequential consumer behaviors/expectations
The growth of card use and subsequent card disputes have led to increased efficiencies that dramatically improve the consumer experience — and have forever changed expectations and behaviors. The act of filing a chargeback has become a one-click convenience — not an investigative criminal claim, as it was originally designed. But the definition of this incident has not been updated since its birth in 1974. A chargeback is still a permanent black mark against any merchant, a fraudulent statistic that carries negative consequences, and a metric used for compliance reporting — despite the prevalence of “friendly fraud,” a type of chargeback that was in fact filed on a legitimate transaction.
It’s not surprising that, as a result, card fraud is the most common type of fraud in the U.S. This type of fraud is easily reported as chargebacks, but not easily deciphered.
The Federal Trade Commission reported that fraud in 2022 culminated in a loss of $8.8 billion for consumers, a 44% increase from the previous year taken from a portion of identity theft-related claims, according to CNBC in March. However, if we factor in chargeback abuse and its impact on all entities involved in a given transaction, this number is closer to $250 billion when considering the total loss that occurs when chargebacks are assessed against legitimate transactions, as Chain Store Age reported in January.
When Fraud Is Friendly
While outright third-party fraud, like identity theft, is all too common, up to 75% of all chargebacks stem from first-party misuse, or “friendly” fraud, where consumers (or their banks) mistakenly or intentionally abuse the chargeback process. It’s an issue Visa, for one, has told businesses it is addressing. Many consumers are unaware that they are engaging in a form of fraud that costs retailers billions of dollars each year.
For instance, if someone forgets they spontaneously bought something online or doesn’t recognize the name of a vendor they ordered from, they may jump to the conclusion that their credit card information has been stolen and immediately contact their bank to report a case of fraud. Ironically, they are unwittingly committing the fraud themselves.
Customers can be dissatisfied with a purchase for any number of reasons, but rather than take the chance that a merchant might deny their refund request, they rely on their bank to provide an instant solution. This “competition for convenience” exposes a growing educational gap in what this protection mechanism is designed to support and, consequently, increases opportunities for exploitation. Friendly fraud also occurs when customers dispute a valid purchase through their financial institution with the intent to get merchandise for free, a term the industry has coined as “cybershoplifting.”
Chargeback misuse gives way to abuse when consumers engage in online shoplifting. A 2022 Sift survey, reported in The Ascent, a Motley Fool Service, found that 23% of consumers admitted to deliberately reporting legitimate retail transactions as cases of fraud when they actually received and were happy with their purchases.
Who Pays the Price for Friendly Fraud?
Friendly fraud affects all parties involved. As Insider Intelligence discussed in an article last December, resolving each $1 of fraud dispute costs merchants $3.75, with compounded losses in revenue from voided sales, unreturned items, chargeback fees and lost customers. Banks issue chargebacks to satisfy their cardholders and to comply with federal regulations, which leads to billions of dollars in penalties and losses, many of which may be unnecessarily imposed. Consumers face higher costs and stricter policies due to excessive chargebacks. And business owners who receive too many chargebacks may lose their payment processing privileges. This undermines commerce confidence and perpetuates a harmful cycle that affects every stakeholder in its path.
That said, the price of chargebacks is not solely measured by dollars. With banks and businesses now competing for convenience when resolving transaction disputes, emerging roles and processes have blurred the responsibilities of merchants and financial institutions, forming misaligned cost structures and operating procedures. Consumer banks, for example, have shifted from simply protecting their cardholders from fraud to offering a concierge-like service — transforming their traditional support model to a one-stop-shop consumer resolution center, with the expected obligation to assist their customers with virtually any purchase question or issue (e.g., inquire via chargeback).
The cost of this growing transformation is significant, and equally the most difficult to disrupt. Short of a wide-sweeping mandate that forces a structural change, expectations will continue to transform to new standards, with rising costs being an unfortunate byproduct. As Payments Journal pointed out even several years ago, 80% of chargebacks could be avoided if consumers contacted the retailer first.
Chargebacks Should Not Be Defined Solely as ‘A Cost of Doing Business’
Despite the temptation businesses may have (due to the arduous process that embodies chargebacks) to assign a P&L line item and attempt to increase their revenue to compensate, failure to thoroughly address chargebacks will only ensure increasing costs and liabilities.
To help manage the growing impact of chargebacks and disputes, chargeback management systems and remediation technologies provide workflow automation that can dramatically improve efficiencies related to the facilitation of exchanging chargeback-related data. These tools support the needs and resources financial institutions and merchants require, to proactively interpret and respond to chargebacks.
Considering that up to 75% of e-commerce chargebacks are the result of friendly fraud — and, if left undetected, more than 50% of consumers will attempt this offense again within 60 days — the numbers don’t lie.
Bottom line, the review and exchange of chargeback-related information is not only important but vital for the following reasons:
- Financial institutions may be obligated to review this information, but with improved tools, can more easily utilize their insight to improve compliance and provide helpful feedback to their customers.
- Merchant processing banks should encourage feedback be provided by their merchants on every chargeback case. Not only does this practice ensure chargebacks are being properly addressed to avoid continued issues from the same customer, it helps reduce incidents of friendly fraud.
- Merchants should proactively address chargebacks, to help determine the originating source, and take action where necessary. Promptly responding to chargebacks also increases authorization rates, providing necessary feedback that fuels fraud-filter rules and machine-learning models.
When merchants and banks dismiss or write-off invalid claims like friendly fraud as a cost of doing business, it prevents the exchange of valuable feedback; reinforces financially and reputationally damaging consumer behavior; and misconstrues the responsibilities of merchants, banks and consumers. Proactive chargeback feedback and remediation is crucial to combat the surge in friendly fraud, gather insights for better decision-making within the payments industry, reduce false declines and, moreover, prevent future disputes to help ensure a more sustainable and secure environment for both buyers and sellers.
Monica Eaton is the founder and CEO of Chargebacks911, the global leader in chargeback management and remediation technology. As a global provider or supplier to financial institutions and companies, Chargebacks911 helps safeguard more than 2.4 billion transactions per year on behalf of clients in 87 countries around the world.
Did You Know: Twenty-three percent of consumers admit they’ve called their bank and claimed a legitimate purchase was a case of fraud to get free stuff. Banks refund their money back to their account as a chargeback. This kind of friendly fraud will cost merchants more than $100 billion in 2023.
Up to 75% of e-commerce chargebacks are the result of friendly fraud — and, if left undetected, more than 50% of consumers will attempt this offense again within 60 days.
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