Online Fraud Rate Drops, But ‘Cleaner’ Fraud Poses a Bigger Threat

Good news for online merchants: In 2010, for the second year in a row, fraud losses expressed as a percentage of revenue went down. They came to 0.9%, down about $600 million from 1.2% in 2009, according to the latest research from CyberSource Corp., a unit of Visa Inc. that provides transaction-gateway and fraud-management services to Internet merchants.

Also, according to the company’s 12th annual online-fraud study, which was released on Tuesday, e-commerce retailers are disputing more chargebacks, winning a high percentage of those disputes, and accepting fewer orders that later turn out to be fraudulent.

But the war on online fraud is far from over, experts caution, pointing out that cyber-criminals probe relentlessly for weak links in any e-commerce chain. Merchants “can’t rest on their laurels,” Doug Schwegman, director of customer and market intelligence at Mountain View, Calif.-based CyberSource, tells Digital Transactions News. “If they did, the fraud rate would go up.”

For one thing, fraudsters are getting cleverer about the way they dress up bogus orders so the transactions can evade merchants’ detection routines. This can include lower dollar amounts and other characteristics that criminals know are less likely to trigger alarms. Some 52% of merchants told CyberSource that fraudulent orders are, so to speak, cleaner than they were a year earlier, up from 48% in the previous survey. Fighting such fraud “is a little harder than it was a year ago,” notes Schwegman.

Though it’s hard to measure, friendly fraud—where consumers later try to repudiate orders they actually placed–also appears to be increasing. This is especially troublesome for digital-goods merchants, since they have a tougher time proving delivery, Schwegman says.

And fraud originating overseas, but affecting U.S. e-commerce retailers, continues to run rampant. More than half of merchants accept international orders, and for these sellers such orders constitute on average one-fifth of all of their orders.

But transactions from overseas continue to be much riskier, overall, than those from North America, with 2.1% of all orders accepted later turning out to be fraudulent, little changed from 2% in 2009 and more than twice the domestic rate (0.9%). Still that’s an improvement from the 4% registered in 2008. (The comparison of international to domestic fraud rates relies on measures of actual numbers of transactions, rather than dollar volume).

Still, considering that most online merchants are combating fraud with little or no increase in budgets, they’re doing a creditable job, says Schwegman. “They’re finally seeing a payback on all their investments in training and tools,” he says.

Consider the basic job of stopping bogus orders before they can do any damage. U.S. and Canadian merchants rejected 2.7% of incoming orders on suspicion of fraud, up only slightly from 2009. But merchants also kept a lid on the number of accepted orders that later turned out to be bad, as indicated either by a fraud-coded chargeback or issuance of a credit to a customer who says he didn’t place the order. This percentage leveled off at 0.9% for all online merchants, down from 1.3% as recently as 2007.

The process of manual review of orders, widely considered inefficient because of its cost, played a bigger role in stopping bad orders last year. Of all orders reviewed by humans, some 4% later turned out to be fraudulent, an improvement from 6% in 2009. The same was true on a dollar basis, with dollar volume manually reviewed and turning out to be fraudulent dropping to 4% from 6%.

Merchants are also challenging more chargebacks and succeeding with a significant number of those challenges. According to the survey, they disputed 55% of all fraud-coded chargebacks last year, up from 53% in 2009 and less than half a few years ago. Of those cases they re-present, merchants are winning 41% overall. This success rate rises to fully 79% for merchants with between $5 million and $25 million in revenue. “The win rates are pretty good,” says Schwegman.

For its latest study, CyberSource researchers took responses last fall from 334 online merchants, down slightly from 352 in 2009.