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Fraud, Chargebacks, And How They Affect Your Online Business

06th April 2011
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Online merchants all over the world have to deal with fraudsters who are trying to steal their products or services through bank or credit card fraud.

When a purchase has been made by a customer, and you have received the so-called "authorization" from your credit card processor, it would seem logical simply to deliver the purchased items. Unfortunately, that is not true.

Never forget that the "customer" may well be a fraudster who has entered other person's payment credentials attempting to purchase the product or service with someone else's money. The victim whose bank card has been used for such fraudulent payments will file a claim to his/her bank to have the illegally withdrawn funds returned to his/her account. This return of funds becomes a chargeback to the merchant whose product was stolen by illegal use of the bank card.

Banks initiate chargebacks to merchants after receiving documentation from cardholders that specific transactions were fraudulent. Funds are then withdrawn from the seller's merchant account to be returned to the cardholder. In this way banks and payment systems protect customers from unscrupulous online sellers and unauthorized use of their bank cards. In addition to reversal of fraudulent payments, online merchants are assessed an additional fee by their own processing banks.

Although it is the online merchants who pay very high fees to credit card processors and banks, these companies offer no protection or assistance to merchants, who have had their products or services stolen. Instead, the banks add insult to injury by adding the chargeback fees which increases sellers' losses. Automatic detection software offered by banks and card processors is ineffective; e.g., it notifies sellers of multiple card attempts long after the merchant has already identified that issue.

The biggest danger is that if a company's business results in a large number of chargebacks during some arbitrary period of time, its bank or credit card processor may refuse to accept bank card payments to the merchant. You, the online merchant, are then out of business.

For these reasons, we recommend verifying bank card payments before completing any online purchase order. The person(s) responsible for this process should be fully aware of how important verification of online payments is to the success and even the survival of your online business. It is essential to pay close attention to all orders paid using bank cards or via PayPal so that ordered products and services are provided only to genuine customers.

For specific recommendations, please see our article "How To Avoid Fraudulent Credit Card Chargebacks".

Below are some statistics which we have collected over the past 5 years from our clients. Data is based on an analysis of 16,793 transactions.

6.17% (1048 of 16973) orders were flagged as suspicious and customers were requested to provide copies of identification documents.

Over 46% (486 of 1048) of suspicious payment attempts turned out to be fraudulent. Among them is a minor portion of genuine customers who refused to send copies of documents as a proof of a valid transaction. Some of those clients later emailed to explain their refusal; however, most of those who did not respond to verification requests are definitely fraudsters who were using stolen bank card data.

Nearly 2% of orders (11 of 562) for which copies of identification documents were sent still resulted in chargebacks. This group includes fraudsters who have physically stolen somebody's bank card and/or its photo image and so-called chargeback fraudsters. The latter type of thief may pay for their order and receive the ordered product (mostly intangible such as software or media files) but then request a chargeback claiming they did not order that product, and that their bank card must have been fraudulently used by a third-party "hacker". A reliable way to counteract such behavior is to store information about access to the purchased products. If a seller has solid proof of such access, he can win a counterclaim against such chargeback fraudsters.

0.67% of orders (107 of 15925) were shipped without verification requests to customers, who later turned out to be fraudsters. Such fraud cases are very difficult to battle, because these transactions look very similar to those of genuine customers. As experience is gained from processing more and more payments, this type of chargeback steadily declines. From our perspective, this is a cost incurred as an inevitable consequence of our loyalty and service to our genuine customers.

As a final note to the above statistics, I would like to point out that, without payment verification in place, there would have been 604 chargebacks in the same period. That equates to 3.56% of the total number of orders paid using bank cards (16,973), and would have been five times as high as the actual percentage of chargebacks 0.7% (118 of 16,973).


This article was written by Mr. Vladimir N.Tuporshin, founder of WebAsyst and several other software development companies during a successful career spanning more than 20 years. Sign up for free online versions of his practical and useful applications which can help you manage your business effectively.
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