Web Merchants See Fraudulent-Order Rate Fall, But the Good News Comes at a High Cost

Online merchants made some progress last year against fraud, but the fight is becoming more and more expensive for them in terms of both dollar losses and operational costs, according to a report issued on Tuesday.

Indeed, the news for e-commerce sellers is mixed at best. While fraudulent orders as a proportion of all orders dropped from 0.9% to 0.6% last year compared to 2010, dollar losses as a proportion of revenue actually climbed for the first time since 2004, reaching 1% or $3.4 billion. That’s according to an annual survey of e-commerce merchants conducted last fall by CyberSource Corp., a fraud-management and transaction-gateway provider for online retailers and a unit of card-network giant Visa Inc.

That 0.6% fraudulent-order rate is the lowest this survey has found in its 13-year history, but merchants told CyberSource they’re working harder than ever—and not necessarily with bigger budgets—to achieve those results. Overall, 82% of respondents expect their budgets to stay flat or actually decrease in 2012. “Their budgets are relatively fixed,” notes Doug Schwegman, business leader for market intelligence at CyberSource. “Their basic problem is not so much a fraud problem but a cost problem.”

This problem can only grow worse as online merchants sell more. That’s because in many cases they still depend on a highly effective—but also expensive—process called manual review to suss out fishy orders. Because manual review depends on human intervention, it becomes more and more costly as sales grow and suspect orders pile up.

At the same time, in a trend known as “clean fraud,” cyber thieves are becoming increasingly effective at dressing up their orders to evade initial screens, requiring merchants to review more orders. In 2011, the survey found the percentage of orders sent to manual review had increased for the first time in years. Because of this and an e-commerce market growing at double-digit rates, “on average a merchant doing manual review probably saw 30% more orders in 2011 than in 2010,” estimates Schwegman.

Overall, some 75% of surveyed merchants said they performed manual review last year, up from 72% in 2010. Because fraudsters are more effective at entering orders to evade reviewers’ criteria, some 6% of orders sent to manual review in 2011 turned out to be fraudulent, up from a 4%-to-5% historical trend. And an overwhelming majority of orders received in manual review—some 75%–wind up being accepted. “Human beings aren’t a perfect defense,” notes Schwegman.

For the first time, CyberSource asked merchants about fraud in their mobile channels—through both apps and browsers optimized for mobile devices. A little more than a quarter of respondents said they have invested in mobile commerce, and of those who said they track fraud in this channel, most said fraud is the same as or lower than that they experience online. But Schwegman cautions that it’s early days for mobile. “As that channel grows, more fraudsters will test it to see what the easy pickings are,” he says.

Among other salient results from the study, which garnered responses from 325 online retailers accounting for $81 billion in annual sales, or almost one-quarter of the e-commerce market:

–As might be expected, retail sectors selling high-value, fencible products tend to attract the most fraud. Consumer electronics saw the highest rate of fraudulent orders, at 1%, followed by apparel/jewelry and household/general merchandise, at 0.7%. Digital goods, however, also sustained a 0.7% rate.

–Orders from overseas continue to be risky, with a 2% fraudulent-order rate.

–As found in previous CyberSource surveys, merchants resolve most fraud cases with credits to affected customers rather than through chargebacks. In 2011, credits were issued in 59% of cases.

–Merchants on average challenge 56% of all fraud-coded chargebacks, winning in 27% of the cases.