The business impact of fraud
June 24 2020
by Jordan McKee
Fraud is most often associated with losses. While losses are a major consequence, they're only part of the overall impact that fraud has on a business. In this report, we discuss the broader business implications of fraud, supported by findings from 451 Research's recent Customer Experience & Commerce, Merchant Study 2020.
The 451 Take
The initial reaction to fraud is often to focus on losses. This mentality fails to recognize its overall impact. Fraud has far-reaching consequences that inevitably jeopardize all areas of a merchant's business. To effectively mitigate the direct and indirect financial burden of fraud, it's imperative to understand the totality of the diverse implications that stem from it. Successful fraud-prevention strategies require a holistic approach targeting not only losses but also customer experience, operational and topline impacts.
Fraud: More than meets the eye
Given the direct and often severe consequences of fraud, it comes as little surprise that fraud reduction registers as the top commerce and top payments initiative for merchants, respectively. We also find that merchants have ranked fraud prevention as a top three area of technology investment for their business. While many are quick to trace this back to the financial losses associated with fraud, there is a much broader impact at hand. As shown in the figure below, losses, while serving as the top fraud concern among merchants, are only one component of the extensive impact that fraud has on a merchant.
The Business Impact of Fraud Is Multi-faceted
451 Research's Customer Experience & Commerce, Merchant Study 2020
The impact of fraud is multi-faceted and inevitably creates implications across all areas of a merchant's business. The most pertinent consequences include:
Financial losses are the most obvious impact of fraud, and often the first metric to capture executives' attention. While losses seem straightforward in theory, merchants must take into consideration the broader costs beyond the merchandise itself. Additional sources of losses stemming from fraud include chargeback fees, along with the transaction-processing fees and shipping costs associated with the fraudulent purchase. At worst, merchants that experience fraud spiraling out of control can see their processing rates increase, resulting in a perpetual drag on the bottom line.
Merchants must also be cognizant of other growing loss vectors. Returns abuse has become an expanding financial problem for many merchants, resulting in merchandise that must be disposed (e.g., due to damage or seasonality), or requiring a significant margin sacrifice to be resold. Similarly, promotion abuse can create needless margin erosion when existing customers take advantage of things like new user discounts. Account takeovers have also become increasingly problematic (especially in verticals like travel and hospitality) and have a direct financial consequence in the event that a depleted rewards account must be replenished.
Fraud – and more specifically, the measures put in place to prevent it – can have an extensive impact on the customer experience. Fraud-prevention measures that are too restrictive can cause friction for legitimate customers, impeding their path to purchase and resulting in cart abandonment. Similarly, fraud controls that are too tight can result in false-positive transaction declines. Finding the right balance continues to prove problematic for online merchants, with less than one in four stating that their approach to fraud effectively balances prevention with the customer experience.
On the other end of the spectrum, merchants that fail to take the necessary steps to protect their customers can face difficultly in establishing trust. Consider that 51% of respondents to our Connected Customer, Consumer Representative, Q4 2019 survey indicated that 'trust in the merchant's reputation' influences their decision to save their payment information with an online merchant. At worst, failure to establish trust can result in irreparable damage to a merchant's brand and reputation. The same survey revealed that 'avoiding organizations or services I don't trust' is the top way consumers say they protect the privacy and security of their personal data online.
The operational impact associated with mitigating and addressing fraud can be extensive. At the top of the list are the costs associated with antifraud technology. The traditional approach to addressing fraud has been to layer an array of independent fraud-prevention tools and systems on top of one other, each with its own set of capabilities. The result is a disjointed fraud stack, often characterized by redundancies and cost inefficiencies. Platform approaches that have come into the market in recent years have sought to address this.
The operational burden stemming from fraud also includes compliance requirements. The Strong Customer Authentication requirements necessitated by PSD2 in Europe, for instance, have resulted in a complete upheaval of the checkout flow for most online merchants. Underpinning each of these concerns are the resources that must be committed to fight fraud. Merchants have historically employed sizeable teams of risk analysts to write and adjust fraud rules and investigate chargebacks. Fraud platforms rooted in AI and machine learning, along with chargeback automation offerings, can help alleviate headcount requirements or allow staff to be reallocated toward more strategic initiatives.
Fraud is often viewed in the context of the bottom line. However, among the most underrecognized consequences is the near- and long-term impact it can have on topline revenue. There is often an opportunity cost associated with fraud prevention. Approaches that burden legitimate shoppers can be a conversion killer and put customer lifetime value in jeopardy. Similarly, dialing back return policies and new customer promotions as a result of fraud inevitably harms relationships with the good shoppers that those policies were first intended for. We have also seen merchants avoid new revenue opportunities, such as entering a new geographical market, due to concerns over fraud risk.
Another long-term, topline impact is the prolonged increase that merchants may experience in their decline rates if their chargeback ratio begins to spike, even temporarily. This occurs as card issuers raise their guard and become increasingly conservative about the transactions they approve. Merchants with high chargeback rates may also see an increasing percentage of their overall sales held in reserve by their acquiring bank as a security deposit to cover potential fraud disputes.