‘Friendly Fraud’ Grows Worse, But Chargebacks Winnable, Expert Says

A problem the electronic payments industry calls “friendly fraud,” which has long dominated chargebacks for online sellers of digital goods from songs to software, is getting worse for these merchants, according to the top executive of a payments processor specializing in this market. Gene Hoffman, chairman and chief executive of San Mateo, Calif.-based Vindicia Inc., says fighting chargebacks has become more important for online merchants selling games, movies, music, software, and other downloadable goods because consumers are becoming more brazen about buying such products and then repudiating the sale. Commonly classified as “friendly fraud,” such repudiation accounts for about 70% of all chargebacks sustained by digital-goods merchants, compared to around 20% for e-commerce catalog merchants, Hoffman estimates. The bulk of the remaining chargebacks represent so-called true fraud, where a criminal buys merchandise with stolen cards. Initiating a chargeback on a digital-goods sale has become a perverse budgeting tool for some consumers. “People have learned they can do this,” Hoffman says. “The recidivism has gotten stronger.” He notes that a sort of “post-Thanksgiving chargeback rush” has developed in recent years, in which some consumers charge back sales in the days after the November holiday to help pay for planned Christmas purchases. “You can watch the seasonality of chargebacks now,” he says. With the problem growing more acute, merchants are under more pressure to challenge chargebacks. But the conventional wisdom among online sellers of digital goods has long been that they can't successfully win these challenges, since proof of delivery is hard to establish. Indeed, Hoffman says, many sellers don't bother, figuring the cost isn't worth it when they could make up the loss on the margin they'll earn on the next download. But with the right approach, merchants can win back a substantial sum they're now leaving on the table, he argues. “It's a massive myth that you can't win a friendly-fraud chargeback on an intangible good,” Hoffman says. Indeed, merchants can achieve win rates between 65% and 85% according to results seen by Vindicia, which sells a hosted payment-processing system for digital-goods sellers. A former chief executive for an online music vendor, Hoffman says they key is to demonstrate that the customer conducted the transaction on the site. “You have to show utilization, that the customer logged in from an IP address that makes sense,” he says. Such an IP address would be one that matches the known address of the customer, for example. Such challenges will reduce chargeback rates over time because customer-service representatives at issuing banks will become more inclined to question customers more closely and less inclined to pass through the disputed transaction, Hoffman argues. Five-year-old Vindicia, which handles chargebacks on behalf of some of its 30-plus clients, processed 120,000 of these items in its peak month last year. Overall, it handles more than 200,000 transactions a day. Its CashBox billing product is integrated with Chase Paymentech Solutions LLC, First Data (Nashville), and Litle & Co. Users pay a fee amounting to what Hoffman calls a “small” percentage of the transaction, with a cap. On chargebacks, Vindicia collects 10% of what it recovers on clients' behalf.