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Chargeback Fraud and Cyber Shoplifting Explained

Online merchants are facing a problem that threatens to cost them as much as $190 each time it occurs. Chargeback fraud, a dreaded ecommerce scam, affects more than 75% of merchants. Worse, they lose $3.75 on average for every $1 of chargebacks. While it might seem victimless to some perpetrators, it can have devastating effects on businesses. Here’s how it happens, how to spot it, and the best ways to prevent chargeback fraud.

What is chargeback fraud?

Chargeback fraud is when a consumer claims a transaction was fraudulent and requests a refund, known as a “chargeback,” even though the transaction was legitimate. While they’ve actually received what they purchased, they lie to get their money back and also get to keep what they bought.

It’s a type of first-party fraud, sometimes called friendly fraud. It exploits the chargeback process intended to protect consumers from unauthorized transactions or merchant misconduct.

Merchants, specifically small businesses, are the victims in friendly fraud chargeback scams. They lose revenue from the sale and may incur chargeback fees from payment processors on top of it. Worse, to dispute a chargeback merchants need to provide evidence—something that can be time-consuming and costly to find.

How chargeback fraud works

Typically, chargeback fraud scams follow the same structure:

  1. Customer completes a purchase, most often using their credit card.
  2. After receiving the product or service they bought, the customer disputes the charge with their bank or credit card company and requests a chargeback.
  3. The customer provides false or misleading information to support their claim, i.e. “I never received what I bought,” “it was defective,” or “the transaction wasn’t authorized.”
  4. The bank or card company investigates and issues a chargeback, refunding the customer’s money and debiting the merchant’s account.
  5. The merchant is left to bear the financial loss, along with any associated fees and penalties.

It’s important to note that not all chargeback fraud is committed intentionally. In some cases, customers might genuinely misunderstand the charge or have concerns about the quality of the product or service. Whether intentional or not, the act is still a form of fraud.

first-party fraud

Why chargeback fraud happens

Chargeback fraud, at its core, comes down to consumer honesty—or lack thereof. It may be an honest mistake or it may be a deliberate lie. Either way, there are common motives that lead to this fraud happening.

The primary reason, not surprisingly, is monetary benefit. Fraudsters are confident in getting chargebacks approved, and sometimes simplicity is all they need. At scale, there are organized crime rings that commit mass chargeback fraud, knowns as cyber shoplifting.

Some customers that wouldn’t normally commit fraud see loopholes in a return or chargeback policy and take the opportunity. All they likely need to do is make a few false claims about their purchase.

Accidental chargeback fraud does happen, mainly in cases where customers aren’t aware they’re costing the merchant directly. Some consumers may mistakenly view chargebacks as a convenient way to resolve issues or disputes. In cases of dissatisfaction or buyer’s remorse, some individuals resort to initiating a chargeback as the way to get a refund.

What are the consequences for chargeback fraud?

Chargeback fraud is illegal in many jurisdictions. But, the legal chargeback fraud consequences vary depending on the specific country or region’s laws.

The severity of the consequences also depend on the amount of money involved and the intent of the individual. Penalties for chargeback fraud can range from fines to imprisonment, depending on local laws and the scale of the fraud.

In any case, it has a few consequences for both the fraudster and the merchant.

Because merchants are the primary victims of chargeback fraud, they lose revenue and become liable for chargeback fees. If the merchant exceeds a certain threshold of chargebacks, they can face even more fees and penalties. Sometimes these go far enough that the merchant can lose their account with payment processors, leaving them unable to accept payments at all. Banks and card companies often will put increased restrictions on merchants with high chargebacks too.

Excessive chargebacks can also lead to negative reviews, loss of customer trust, and damage to the merchant’s brand image. This can have harsh long-term effects on customer loyalty and future sales.

For the fraudster, chargeback fraud can have legal repercussions. They may face criminal charges, fines, or even imprisonment if convicted.

How merchants find chargeback fraud

With the clear severity of the potential loss, merchants take chargeback fraud seriously. Payment processors and merchants alike have many methods they rely on to catch chargeback fraud. Fraud detection systems will use one, if not most, of these methods to detect and prevent scams:

  • Transaction monitoring – a key piece in fraud detection tools that analyzes customer behavior and transaction patterns against typical customer data to indicate potential fraudulent activity.
  • Order verification – verifying billing and shipping addresses, requiring additional identification, or using verification services like 3D Secure.
  • Collaboration with payment processors – payment processors often have fraud detection mechanisms in place and can provide guidance to merchants on managing chargeback risk.
  • Chargeback analysis and dispute management – Merchants analyze and track the reasons for chargebacks to identify recurring issues or trends to reduce them and spot fraudulent ones.
  • Continuous monitoring and improvement – Fraud patterns and tactics evolve over time, so it is crucial for merchants to stay updated on the latest fraud trends and continually improve their fraud prevention strategies.

AI’s role in preventing chargeback fraud

AI powers modern fraud systems by supercharging case management capabilities for fraud fighters. It gives merchants chargeback fraud prevention using machine learning and data analysis.

AI fraud platforms can analyze vast amounts of transactional data in milliseconds. They identify anomalies, flag suspicious transactions, and help merchants pinpoint the fraud.

Another key to catching fraud chargebacks is behavioral analysis. AI algorithms can create profiles that capture normal behavior. Sudden changes in purchasing habits or high-risk transactions then trigger alerts for investigation.

Real-time transaction monitoring is essential today as the majority of consumers want to pay in real time. AI tools monitor transactions as they happen and compare them to volumes of good buyer data to spot fraud.

AI tools also integrate with many transactional and customer data sources as well as external fraud databases. This, combined with predictive analytics, leverage historical data to spot chargeback fraud earlier.

Continuous learning and adaptation make AI models ready for evolving fraud patterns. As chargeback fraud tactics change, AI systems can update their detection mechanisms to stay ahead.

Choosing the right AI platform to catch chargeback fraud isn’t easy. If you want to explore that a best-in-class platform looks like and the cost, book a personalized demo with the DataVisor team.