by Monica Eaton, Founder and CEO of Chargebacks911
Online retail has replaced the in-person shopping experience of sipping an Orange Julius while store-hopping and browsing through clothing, music, electronics, and any number of personal necessities or gifts. It’s no wonder over one-third of the world’s population has wholeheartedly embraced eCommerce, leisurely clicking here and there until they find exactly what they’re looking for. And despite the onslaught of new digital currency, the humble credit card remains the most popular method of online payment. But one nuisance has traversed from the old ways to the new: returning items that failed to satisfy.
Like all things in the digital era, consumers expect a quick and easy resolution devoid of resistance. Happy to oblige, banks have fast-tracked this process by allowing consumers to initiate chargebacks, obtaining lightning-fast refunds without giving merchants a chance to make things right. While the chargeback process was created to protect consumers, the quick-fix solution has led to misuse and abuse that incurs costs for all parties involved — consumers, banks, and merchants.
The Rise of Credit Card Fraud and its Financial Impact
In 1974, the Fair Credit Billing Act (FCBA) was passed into law to protect the increasing number of cardholders in the United States from unfair billing practices. It granted consumers the right to dispute charges with their credit or debit card issuing banks to reverse transactions, also referred to as “chargebacks.” Chargeback rights apply to various situations, such as unauthorized charges, billing errors, undelivered merchandise, misrepresented goods or services, or fraudulent activity.
In the decades following the FCBA’s passing, credit and debit card fraud has continued to rise in step with the wide-sweeping adoption of card use, pummeling consumers, banks, and merchants financially. Recent studies reveal alarming statistics regarding the monetary impact of fraud in the U.S, with card-not-present fraud leading trends that outpace transaction growth in the same genre. In 2022, 65% of cardholders in the U.S. reported being victims of fraud, with nearly half experiencing fraud multiple times, costing consumers $8.8 billion in that same year, a 44% increase from the previous year.
This financial burden, however, is not confined to consumers. The payments industry as a whole is expected to sustain damages exceeding $206 billion in 2023, much of which is a result of first-party fraud, otherwise known as “friendly fraud.”
Why Is Friendly Fraud So Common?
What many people don’t realize is that the majority of chargebacks, up to 75%, are not the result of third-party criminal fraud—such as identity theft or stolen card numbers—but rather first-party fraud, dubbed “friendly fraud.” First-party fraud is committed by the cardholder themselves, and includes the misuse and abuse of the chargeback process. This happens when cardholders unknowingly or knowingly exploit this protection mechanism.
For example, one of the most common instances of friendly fraud stems from unrecognized billing descriptors, where consumers don’t immediately recognize a transaction on their card’s billing statement and assume criminal fraud has been committed. They quickly contact their bank to report the transaction as fraud and get their money back. Due to the arduous process involved in rectifying an invalid chargeback, the majority of these claims are written-off by either the merchant or their bank as a cost of doing business.
Chargeback misuse escalates into abuse when virtual shoplifters game the system to get something for free, sometimes double-dipping by requesting a chargeback from their bank and then requesting a refund from the merchant without returning the merchandise, causing the retailer to refund the fraudster’s money twice.
A telling survey revealed that 23% of consumers confess to intentionally disputing purchases as fraud despite having received a product or service that they were completely satisfied with.
Negative Consequences for Merchants, Banks, and Consumers
Friendly fraud has negative consequences for all parties involved, with merchants suffering the most substantial financial losses. It is estimated that chargebacks will cost merchants over $100 billion in 2023. To put into perspective the associated costs of invalid chargebacks inflicted on merchants, resolving every $1 of fraud in dispute costs merchants $3.75. This is in addition to compounded losses from lost sales, unreturned merchandise, chargeback fees, and customer loss.
Another factor contributing to the rise of friendly fraud is convenience. When given the choice, consumers would rather report and resolve transaction disputes in one easy phone call, which is exactly what many issuing banks offer. In fact, a Chargebacks911-led consumer survey found that 87% of respondents contact their bank rather than the merchant to resolve a dispute because banks offer faster resolutions and are typically more understanding.
While cardholders may be appeased, many consumers are unaware that contacting their bank instead of the retailer has far-reaching effects—including on the consumer themselves. Chargeback misuse and abuse triggers increased prices on goods and services to offset shrinking margins and burdens borne by the merchant, causing consumers to suffer more restrictive policies from merchants. Additionally, cardholders who file excessive chargebacks may also become blacklisted by certain merchants and face unexplained transaction declines from their bank.
Breaking the Cycle: Revolutionizing Chargebacks
While banks have a responsibility to protect their customers and themselves from fraudulent activities, the prevalent practice of filing chargebacks as a first resort perpetuates a harmful cycle. Breaking this cycle requires a revolution in the way merchants, banks, card networks and consumers think about chargebacks.
One report suggests that 80% of chargebacks could be prevented if consumers contacted the merchant first to address their concerns, so for merchants looking to compete with the convenience of a cardholder’s bank, it’s important they prioritize customer-centric strategies. Emphasizing transparency and having customer support readily available can make customers feel comfortable approaching them first to resolve any issues. Merchants should also have terms, conditions and return policies clearly stated to avoid miscommunication. Lastly, merchants should provide tracking numbers for shipments and provide customers with updates on potential delays. This can provide customers with peace of mind on their purchase and help merchants avoid chargebacks filed due to shipping issues.
While improving practices and standards for merchants is absolutely recommended, without similar consideration taken on the other side of the coin, the idea that merchants alone can change the tide is ill-conceived. If the goal is to resolve this problem, we must address the cause—not the symptoms—of chargebacks. At a high level, this involves three areas of concern:
- First, as an industry, we must confront the unfair bias of current regulations that consider merchants guilty until proven innocent, and treat all chargebacks as equal when in fact there are many nuances. Today, chargebacks serve as just a reprimand to merchants where even if proven invalid, merchants and banks still suffer a penalty. Chargebacks should only carry a compliance statistic if the chargeback is found to be valid and not friendly fraud.
- Second, merchants and banks should be incentivized to exchange more information about the charge, especially for card-not-present transactions where “unrecognized charges” account for the majority of disputes. Fear of compliance fines, administration costs and reputational harm is driving write-offs and reducing incentives to exchange chargeback information between merchants, banks and card networks, which today is the only way to identify and avoid rewarding friendly fraud behavior. To reduce costs and success in creating a sustainable model, merchants and financial institutions should have access to workflow automation tools that help exchange data in real time.
- Third, consequences must exist equally and without prioritizing the needs of cardholders above merchants. There is currently no direct consequence to those who commit friendly fraud or first-party misuse, which encourages repeat behavior and further deters viable solutions. Similar to how credit scores were developed to help monitor and restrict financial loss while advocating for productive consumer behavior, chargeback abuse incidents should carry a similar penalty that is instituted as an industry mandate to ensure new standards are maintained and not just sanctioned and siloed.
Bottom line, when merchants and banks write off invalid claims without addressing them, valuable feedback is lost, further reinforcing counterproductive behavior. Allowing fraudulent chargebacks, such as first-party fraud, to go unaddressed is unfair to merchants, banks, and consumers themselves. But this also deprives stakeholders of constructive feedback that can inform better decisions, reduce unnecessary declines, and prevent future fraud and disputes. Resolving this problem through removing bias, siloes, and improving collaboration will not only redefine chargebacks, but help ensure economic integrity and sustainability for us all.
Monica Eaton is the Founder and CEO of Chargebacks911. Chargebacks911 is the global leader in chargeback and dispute remediation technology. As a provider and supplier to financial institutions and merchants, Chargebacks911 safeguards more than 2.4 billion transactions per year on behalf of its clients in 87 countries around the world.