(November 14, 2007) Online fraud rates are holding steady but the cost of fraud is going up as e-commerce grows and companies hire more people to weed out suspect orders, according to CyberSource Corp.’s 9th annual e-commerce fraud survey. The merchant processor and risk-management firm’s recent survey of 318 American and Canadian retailers that sell on the Internet found merchants this year are manually reviewing on average 27% of orders, up from 23% in 2006, and are hiring more people as a result. And the size of the average fraudulent order in 2007 is running at $200, up 67% from $120 in 2006.

The overall loss picture is a mixed bag. CyberSource estimates Internet merchants will lose about $3.6 billion in revenue this year to fraud, an increase of about 16% from $3.1 billion in 2006 but in line with sales growth. That means the dollar-loss fraud rate is holding steady at 1.4%. But the percent of accepted orders that turn out to be fraudulent is running at 1.3% this year, up from 1.1% in 2006.

Small and medium-sized e-commerce merchants in particular are doing more manual reviews than their larger cohorts. The smallest merchants, those with under $500,000 in annual online sales, are reviewing 43% of their orders; those in the $500,000 to $5 million cohort are reviewing 45%, and those with $5 million to $25 million in Web sales are reviewing 40%. In contrast, merchants with more than $25 million in annual online sales this year are reviewing 14% of their orders. The above figures are for merchants that do manual reviews. In all, some 82% of e-commerce merchants perform manual reviews, up from only 48% in 2001.

“It could be that fraudsters are focusing on smaller or medium size merchants, since larger merchants have more [fraud-fighting] tools,” Doug Schwegman, director of market intelligence at Mountain View, Calif.-based CyberSource, tells Digital Transactions News. “The fraudulent order rate has gone up a little bit in those-sized bands.”

Merchants this year are accepting 75% of their manually reviewed orders, up from 66% in 2006. Schwegman estimates the average cost of reviewing an order manually is close to $1. That adds up in light of the mean number of orders a reviewer handles—32 per hour, up from 29 in 2006. Some 67% of manually reviewed orders clear in a day or less.

Rejection of valid orders in the name of fraud control continues to be a drag on Internet merchants’ bottom lines. Merchants in 2007 on average automatically or manually reject 4.2% of orders on suspicion of fraud, up slightly from 4.1% in 2006. But for every actual fraudulent order, merchants are rejecting 3.2 more as suspicious. According to CyberSource, if just 20% of those rejected orders were valid, the lost sales would total $20 billion. Wide variations in rejection rates within some industries such as consumer electronics, despite overall stable fraud losses, show merchants haven’t yet perfected the art of separating the good from the bad, according to Schwegman.

Chargebacks, especially on credit and debit card transactions, account for not even half of fraud losses. Formal fraud chargebacks represented only 44% of fraudulent orders. Merchants became aware of the majority of fraud through other channels such as direct customer notification, and handled the other 56% of fraudulent orders through credits issued to such customers. Merchants on average challenged 47% of their chargebacks and won 40% of the time, the survey says.

U.S. and Canadian merchants say orders originating outside their countries are 2.8 times more likely to be fraudulent than domestic orders. Nonetheless, some 60% of the polled merchants accept international orders, about even with last year.

In all, CyberSource says e-commerce merchants will spend $780 million this year fighting fraud, up 18% from an estimated $660 million in 2006. Some $406 million, or 52% of the 2007 figure, is for order-review staff, the rest is for software and other fraud-fighting tools. Merchants increased their personnel spending by 34% from an estimated $304 million last year due to the higher volume of manual reviews.

The survey, commissioned by CyberSource and conducted online by Austin, Texas-based Mindwave Research between Sept. 13 and Oct. 1, polled merchants with about $50 billion in total online sales representing 19% of the e-commerce market. Respondents were managers with significant or ultimate decision-making responsibility for fraud control. The major findings have a margin of error of plus or minus 5% at the 95% confidence level, Schwegman says. The statistical validity of some data, however, is lower because of the low number of responses to some questions.