The history of retail is also the history of evolving patterns of fraud. Human nature being what it is, there are always individuals who try to cheat the system and get something for nothing. In recent years, retail fraud attempts have grown most dramatically in card-not-present transactions, thanks to the rise of e- and m-Commerce and the introduction of security chips in physical cards.
Merchants tend to respond to rising fraud risk in two distinctive ways: investing heavily in set-and-forget fraud prevention, or rejecting any transaction that seems questionable. Both strategies have failed.
Fraud leads to increasing expenses (every $1 of fraud now costs merchants about $3.13 in fees, interest, merchandise replacement and redistribution) while continuing to consume a larger share of revenue (in 2019, fraud cost the average retailer 1.86% of annual revenue, compared to 1.8% in 2018 and 1.47% in 2016). Attempting to reduce fraud risk by imposing overly tight acceptance parameters comes with an even greater opportunity cost, as false-positive declines cost the retail sector $118 billion in lost sales annually — 13 times the rate of actual completed card fraud ($9 billion) — and customers who have been declined by a retailer typically go elsewhere and never return.
E- and m-Commerce were supposed to be the great equalizer, but small and midsized merchants have been hardest hit by these trends, as they are unable to match larger companies’ spending on expensive fraud-fighting tools (about $4 spent for every $1 of fraud committed), and are forced to combat fraud primarily by not approving questionable transactions. The problem with this approach is that many of those ‘questionable’ transactions come from legitimate customers. By false positively declining them, merchants damage their brand’s reputation and send potential customers to competitors that do a better job of not mistakenly declining transactions.
The Unsustainable Cost Of The Fear Of Fraud
The e-Commerce fraud problem actually masks a much larger fear of fraud problem, and this fear of fraud is crippling profitability.
While most organizations carefully track their fraud rate, many don’t know their approval rate or consider how the two relate. Reducing fraud by throttling legitimate transactions is short-term thinking: it puts undue pressure on profit margins, reduces sales revenues and the number of good transactions accepted and negatively affects customer loyalty and brand reputation.
Retailers are understandably protective of their bottom line, but in their single-minded focus on keeping fraud rates low they end up rejecting a high volume of good transactions. Actions taken to protect the business wind up negatively impacting the brand and hindering profitability. Vesta estimates that over the next five years, companies will turn away more than $130 billion in good, clean revenue in their effort to avoid fraudulent chargebacks. Meanwhile card-not-present fraud is growing at twice the rate of e-Commerce sales.
At what point will lost revenues tip the balance, overwhelming merchants’ ability to support fraud-prevention expenses and causing well-intentioned retailers to shutter their cyber doors as they lose the fight against the fear of fraud?
A Shift In Perspective
Most retailers have no idea how much revenue they are turning away through their fear of fraud. A shift in perspective is needed.
If a business wishes to achieve zero fraud, there is an easy way to accomplish that: simply do not approve any sales transactions. If a retailer intends to build a profitable, growing business, however, fraud avoidance needs to be balanced by an effort to increase customer numbers and revenue.
Maintaining a low rate of fraud is laudable, but not at the cost of suppressing too much revenue or alienating too many potential customers. Merchants must be actively aware of this dynamic and pay greater attention to their approval rate as well as their fraud rate.
Fraud is real, and merchants cannot control its growth; however, they can control how they react to it. It is time for merchants to step back from fear-based practices and start putting their focus back where it belongs, on growing their businesses.
Ron Hynes, CEO of Vesta, is a 20-plus-year payments industry veteran with a successful track record of leading high-growth payment businesses and growing and scaling payment solutions for a variety of established and emerging fintech companies. Prior to joining Vesta, he served as CEO of UniRush, where he led the turnaround and eventual sale of the company and its RushCard business to Green Dot. Previously, he spent more than eight years in senior leadership roles at Mastercard — four of them running the company’s global prepaid business, where he led strong revenue and market share growth.