Online Fraud: How Bad is It?

Fraud on the Internet is taking its toll on e-tailers, who are getting not only hit by Internet fraud, but also by the credit card companies, according to the Gartner Group.

Gartner surveyed more than 160 companies, and found that 12 times more fraud exists on Internet transactions and that e-tailers are paying credit card discount rates that are 66 percent higher than traditional retailer fees. Moreover, Web merchants bear the liability and costs in cases of fraud, while credit card companies generally absorb the fraud for traditional retailer, as long as the retailer follows procedure and saves the signature on the receipt.

The e-tailers surveyed by Gartner said their average credit card discount rate was 2.5 percent, plus about $0.30 per transaction. The same average for traditional is about 1.5 percent plus $0.30 per transaction. This means a merchant may pay credit card processors $2.80 for selling a shirt online, but pay only $1.80 for the same transaction in a physical store. E-tailers also pay about four times more to resolve and process chargebacks than retailers do. On top of all this, e-tailers must pay for Internet payment gateways and fraud detection, which can add another $0.50 and fraud detection, which can add another $0.50 cents to each transaction. Meanwhile, Gartner reports that credit card companies have failed to offer e-tailers a cost-effective solution for fraud prevention.

“There is no incentive for a credit card company to break this unfair fee structure for e-tailers,” said Avivah Litan, research director, Gartner Financial Services. “However, the credit card issuer that is bold enough to lower the fees online could create a real competitive advantage on the Web and possibly gain early market share among e-tailers and Internet shoppers. In the meantime, several savvy startup competitors are giving e-tailers alternatives to credit cards, such as processing that accesses bank accounts directly via closed-loop systems. At the current rates, those firms could give the card companies a run for their money.”

As for the other side to the story, according to ActivMedia Research, fraud is actually only perceived to be a substantial problem at 3 percent of all Web sites that responded to ActivMedia’s study “Real Numbers Behind E-Transactions, Fraud & Security.” According to the study, online fraud rates are often less than offline fraud rates.

“Online shopping gets a bad rap in the press, but most of the stories reported are anecdotal tales of companies that haven’t put successful defensive measures in place,” said Harry Wolhanlder, VP of Market Research at ActivMedia. “Web businesses running proper screening of customer information are suffering very little, with average fraud losses held to just over 1 percent. Fraud control is clearly possible online, although many companies do not implement stringent screening and prevention measures. The specific types of products sold online may impact fraud levels more than the marketing channels through which they are sold.”

ActivMedia’s research indicated the 75 percent of Web sites experience no online fraud losses, and only one in 25 has more than 5 percent of revenues lost to fraud. Fraud is more widely experienced by the same vendors through offline sales channels than through online channels. When companies reported both online and offline losses for comparable products sold through traditional channels, exposure is slightly higher though offline marketing channels than it is online.

The study also reports that losses can be controlled effectively online through screening measures and policies. Companies that decline sales due to Web-based real-time screening methods turn away an average of 4.5 percent of expected orders in efforts to control fraud. Screening procedures in place at more than half of the sites that view fraud as a problem include requiring full order address and phone number to process order; insist on advance payment prior to shipping; manually validate/verify credit card offline; and send email to validate order before processing.

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