Fraud Programs – Doing More Harm Than Good?

U.S. merchants had an astounding $9 Billion in payment card fraud in 2015, a number that continues to grow at an increasing rate year after year.[1] In a retail climate that that faces increasingly tighter margins, higher operating costs, and intense competition from low cost, online only retailers, fraud losses are a major pain point for organizations, especially for their bottom line.  In efforts to thwart fraudsters, especially in card not present environments (i.e. orders via mobile and web platforms), organizations have begun designing and implementing fraud monitoring programs. These programs may include a combination of both internal controls and 3rd party fraud management solutions to reduce the impact of card fraud. Unfortunately, many of these fraud solutions are more successful at turning away good customers than preventing the bad actors. Why is it that the good customers are getting turned away, but the fraudsters still manage to get through?  Our experience has shown that a disconnect between organizational goals and the process for achieving those goals may be to blame – leading to unintended outcomes and higher fraud costs.
Fraud solutions have a large thorn in their side, namely false positives. A false positive occurs when a fraud management tool or program incorrectly identifies a good customer as a fraudster and declines a transaction. The transactions that most fraud solutions target are a small subset of total chargebacks, which is an even smaller subset of all transaction volume. All of this leaves a lot of room for error when assessing transactions for fraud. Estimates range between 1-10% of chargebacks are the result of criminal fraud, the type of fraud that most fraud solutions target.[2] Therefore, only a small amount of transactions should be declined by a fraud solution. Yet in 2014, an estimated $118 billion in valid sales were incorrectly declined due to fraud solutions; 13x more than amount of payment card fraud that merchants incurred.[1] For e-Commerce/m-Commerce merchants the false positives problem is only getting worse – false positives jumped from 25% to 35% of declined transactions from 2015 to 2016.[3] It is evident that the rate at which the industry declines transactions is doing more harm than good. While false positives are an immediate concern, the long-term impact of false positives is often overlooked.
Customer experience is a key driver for sales, and poor experiences can have a devastating effect on consumer behavior. Approximately 26% of declined cardholders reduce their spending at a merchant following a decline, and 32% stop shopping at a merchant entirely (for e-Commerce transactions 66% of cardholders reduce or stopped patronage at a merchant).[1] As a customer, having a transaction declined is an embarrassing experience that causes many to leave a merchant altogether. Not only are false positives killing over 13 good sales to every fraudulent transaction, the negative customer experience has a significant impact on future sales. It is clear that false positives pose a great risk to the industry; luckily, there are some tools and tactics that merchants can adopt to help reduce legitimate fraud and minimize false positives.
Manual reviews have become an industry standard for big box retailers to lower false positives on eCommerce transactions, however, it is a costly and time-consuming solution. There are alternative approaches that are easy to implement and can be applied to merchants that can’t afford the time to perform manual reviews. The first is ensuring that any data modelling or transaction scoring models are trained on lowering false positive rates rather than lowering fraud. In addition, creating control groups to analyze the true rate of false positives will help organizations understand the harm they are causing and react appropriately. Rather than outright declining potentially fraudulent transactions, utilizing additional customer verification methods such as two-factor authentication or customer specific knowledge may reduce false positive rates. These tactics along with a shift in organizational fraud objectives will help merchants cut back fraud without reducing sales.
As an industry, the underlying goal of fraud programs needs to be re-evaluated. Simply looking at losses due to chargebacks and determining that number needs to be reduced is ineffective. In other words, fraud teams that have been established with the sole goal of reducing fraud will reduce sales even more than fraudulent transactions. When the primary goal is to reduce fraud, the solution will include a rampant rate of false positives that will have a significant effect on a merchant’s bottom line today and in the future. Progressive fraud solutions must possess a more holistic view of fraud as it relates to the business; the goal of fraud prevention being profit maximization for the organization. Combining a shift in organizational fraud goals and various methods to reduce false positives, the unintended consequences of fraud solutions, false positives, will be minimized.
If you would like to learn more about managing fraud at your organization, including how to best protect against false positives, you can reach Danny Omiliak at [email protected].

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