The growing problem of online disputes explained

Sift’s latest quarterly report describes how the growing problem of real and fraudulent online disputes threatens many a bottom line. Q4 2022 Digital Trust & Safety Index: The rising risk of online disputes can be downloaded here.

Brittany Allen sees a rising risk from online disputes. Allen, Sift’s trust and safety architect said dispute rates rose 35% between 2022’s first and third quarters. That’s an ominous development because chargeback disputes typically follow a transaction for as long as three months as they go through the system and are applied.

Given the busy shopping season happens in the last six weeks of the year, the fact that disputes rose after the 2021 shopping season chargebacks were processed doesn’t bode well for 2022.

Brittany Allen headshot
Brittany Allen

Disputes are more frequent, expensive

In some ways, this was predictable, given layoffs, tighter budgets, inflation, and fears of a recession, she said. Folks need to free up some credit to deal with necessities.

But companies need to do the same thing as they cut costs and plug revenue leaks in the downturn. Chargebacks pose a unique risk because they are unpredictable and easily exploitable. Merchant Fraud Journal predicts the merchant chargeback tab will surpass $100 billion this year.

Disputes are expensive. Merchants are liable for card-not-present purchases by default and automatically lose the transaction amount when the dispute is processed.

For every 2022 dollar lost to fraud, American retail and e-commerce merchants will lose $3.75, a figure 19.8% higher than it was in 2019. Additional chargeback fees can cost the merchant $40.

“Breaking down the true cost of chargeback processing fees between 1%–4%, covering the cost of data transmission, the chargeback itself, and coverage against chargeback exposure for the processor,” the report states. “In the event the merchant doesn’t win the case. They’ll also lose the cost of the product or service, time and labor expenses, and any associated shipping fees. If disputes are unchecked, payment processors could even issue fees and restrictions on merchants with a chargeback rate of over 1%.”

See also:

Fintech is a top dispute sector

Fintech is one of the most vulnerable sectors for disputes. It ranks third behind digital goods and services and retail. (The top three most disputed purchases are clothing (21%), subscription services (19%), and electronics (18%).) These sectors are especially vulnerable because they have access to little physical evidence such as shipping address or proof of delivery.

And most of those disputes are fraudulent. Between January and September of 2022, 71.5% of disputes were deemed fraudulent. More people aren’t shy about it, as 23% of those who disputed a purchase in a recent survey admitted to first-party fraud. 

Allen suspects that rate is much higher.

“It shows how much that system can be leveraged against a merchant and by the consumers,” Allen said. “That’s also why some changes are coming down the pike for how the chargeback disputes will work.”

A new sheriff is coming to town

Allen was referring to Visa’s Compelling Evidence 3.0 changes that came into effect in April. They provide the acquirer with more options to further remedy the dispute instead of supplying compelling evidence that could be further disputed.

As the industry catches on, so do the scammers. They now use non-fraud codes in combination with fake excuses like never receiving the order to try and fool companies. 

Allen cited the example of a cryptocurrency exchange that allows investors to purchase crypto with credit cards. Criminals use a physical good fraud code which forces the exchange to provide physical proof of delivery. The exchange, guilty until proven innocent, must explain they do not provide material goods. This tactic relies on bank fraud review staff only having up to a minute to review each case, which is on a high average side. The deeper it’s hidden, the more likely the strategy will work.

If this wasn’t enough, the market must contend with friendly or first-party fraud, which occurs when the legitimate purchaser lies to get their funds back.

Some surveys estimate it’s between 20 and 40% of all chargebacks. Those with solid fraud detection systems, where few cases get through, can have such cases represent up to 90% of all cases.

Increased consumer awareness as a deterrent

Better consumer awareness of how the chargeback process works could be the best deterrent. That is because the process is sloooooow, Allen explained.

  1. Cardholder issues dispute with issuing bank.
  2. Goes through issuing bank card network
  3. It goes to the merchant’s bank
  4. It goes to the payment processor
  5. Merchant response

If there is any disagreement, the process repeats. Allen’s seen cases lasting a year. Because they lack effective solutions and spare time, many businesses know they have a poor chance of victory. They don’t bother fighting.

Brand damage among a merchant’s risks

Merchants are in a tough spot no matter what they do. If they fight fraud, it takes time while sometimes giving little chance of success. If they don’t fight, they’re an easy mark. 

Should a legitimate customer be victimized by fraud, the brand suffers reputation damage. Five out of six consumers who filed a dispute said they would be less willing to buy from that brand if they had to file a purchase dispute due to fraud. Of that 83%, 35% said they will never buy from that brand again.

If the chargeback takes too long to be resolved, there is a significant risk of customer loss. Half of the consumers said they’d abandon a brand if their dispute wasn’t resolved within 30 days.

“That is really tough for merchants because the delay is not going to be completely something that they can control,” Allen said.

“I had numerous experiences from my time as a merchant where I would be talking to a customer, and they had filed a chargeback dispute. And they would say, ‘I’m in the right.’ If I agreed with them, I would say, ‘yes, you are in the right, and if you hadn’t filed a chargeback, I could refund you today. Now, all that I can do is accept the chargeback, which just means the merchant agrees with it and agrees to return the funds. It’s going to take anywhere from 30 to maybe even 75 days for that to go back through the system and for you to get the refund, and there’s literally no other thing I can do.’

“I would even show them if I hit refund. It won’t work because there’s an open dispute. It’s not well-known how that process works. If I was to talk to just like a person who’s filed a chargeback, I bet they couldn’t describe to me how that process works or how long it takes.”

Current and possible future options

Some merchants have adapted by widening the return windows for physical goods, Allen said. When asked about universal identities, she said that lack of anonymity could allow companies to refuse future purchases or to make it harder to open a new account.

For higher-value items like plane tickets, many could be deterred from gaming the system if it means losing access to their regional carrier.

Scammers employ multiple methods

Merchants also contend with fraudsters who abuse refund and return policies. They know who doesn’t closely check their returns.

“In some cases, what they’ll do to successfully get refunded is take an envelope and put the tracking or label on it,” Allen said. “That can then be scanned in and show that it was successfully delivered back to the merchant’s warehouse, but it is a paper envelope with nothing in it. 

“And they were supposed to be returning a coffeemaker, and they’re kept that coffeemaker and are going to resell it. But that one little piece of paper makes its way to the merchant’s warehouse and gets scanned as accepted. Then they get their money back, so they take advantage of the fact that companies can’t handle the volume of returns.”

  • Tony Zerucha

    Tony Zerucha is a long-time contributor in the fintech and alt-fi spaces. A two-time LendIt Journalist of the Year nominee and winner in 2018, Tony has written more than 2,000 original articles on the blockchain, peer-to-peer lending, crowdfunding, and emerging technologies over the past seven years. He has hosted panels at LendIt, the CfPA Summit, and DECENT's Unchained, a blockchain exposition in Hong Kong. Email Tony here.

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