Retailers Should Brace for More Fraud After a Lull in Losses, Study Says

The good news: merchants’ total losses from fraudulent transactions are down. The bad news: losses are likely to rise. More bad news: fraudsters are taking a liking to alternative and mobile payments.

Those are some of the key findings from the third annual “LexisNexis True Cost of Fraud” study sponsored by content provider LexisNexis Risk Solutions and conducted by Javelin Strategy & Research. The newly released study attempts to quantify retailers’ acknowledged fraud losses in addition to resulting costs such as expenses for replacing or redistributing lost or stolen goods, fraudulent transactions for which the company was held responsible, and any fees or interest they paid to financial institutions as a result of fraud.

The study’s data came from 1,006 fraud-control executives surveyed online in May and included representatives from companies of various sizes and industry segments. Its so-called fraud multiplier came in this year at 2.3, which means merchants actually pay $2.33 in total costs for every $1 in fraudulent transactions. The multiplier was 3.0 in last year’s study and declined because total retail sales rose while fraud rates reported by financial institutions, merchants, and consumers fell, according to the study.

But hold the celebration. “We think we’re in a bit of a lull, the calm before the storm,” says James Van Dyke, president and founder of Pleasanton, Calif.-based Javelin. Looming on the horizon are the storm clouds of a weakening economy, which Javelin says is correlated with higher fraud, and fraudsters’ propensity to find weaknesses in payment systems, including those supporting electronic and mobile commerce. Further, after a quiet 2010, early 2011 was marked with some huge data breaches, including those of Sony Corp.’s gaming sites and Alliance Data Systems Corp.’s Epsilon marketing subsidiary, the full effects of which may be yet to be felt.

Jim Rice, director of market planning for retail and e-commerce markets at LexisNexis Risk Solutions, also notes that the average value of a completed fraudulent transaction was $122 in 2011 versus $91 in 2010. That means that while there were fewer fraud attempts, the attempts were more effective. “The fraudsters are becoming very sophisticated in their fraud schemes,” Rice says.

Retailing sectors with the highest fraud multipliers were toy and hobby merchandisers, 3.4, and hardware and home-improvement stores, 3.3. The former often sell faddish items and DVDs and other high-demand electronic goods while the latter also have a wide variety of items fraudsters also can easily turn into cash, according to Van Dyke.

Meanwhile, respondents reported 27% of their fraudulent transactions came through alternative payment methods, up from 20% in 2010. Comparable numbers for other payments in 2011 and 2010, respectively, were checks, 40% and 46%; debit cards, 18% and 30%; and credit cards, 65% and 66%.

Plenty of small merchants accept alternative payments: 31% of such merchants take PayPal, 5% Google Checkout, and 4% other alternatives, but they’re more likely to sustain fraud losses on alternative payments than are large merchants. Small merchants said 31% of their fraudulent transactions came from alternatives versus 15% reported by large merchants.

That differential is largely the result of more small merchants taking alternatives and more consumers shifting to them, but merchants, especially small ones, are paying for their inexperience in flagging fraudulent transactions coming through the newer payment channels. “Whenever you get a lot of shifts going on, criminals are going to exploit that,” says Van Dyke.

Only 4% of the responding merchants accept mobile payments, up from 1% last year. But with all the development around mobile payments by card networks, processors, wireless phone providers, and tech companies, mobile acceptance and mobile fraud are sure to grow. Tellingly, only 21% of merchants in the study viewed mobile contactless payments as “not all risky,” by far the lowest ranking among five types of mobile payment methods that include bill to mobile phone, text message, mobile application and mobile Web browser.

The sampling error of the merchant panel was plus or minus 3.1 percentage points at the 95% confidence level. Javelin supplemented the merchant data with interviews with financial-institution executives as well as data from fraud victims based on a survey of more than 5,000 U.S. adults.